When you selected the appropriate potential buyers, agreed on the terms (letter of intent) and ensured everyone signed a non-disclosure agreement (NDA) you are ready to start with the due diligence process. What information is needed for a buyer to conduct an adequate due diligence and what information will a buyer request? This information needs to be shared through a virtual data room. What is a virtual data room and what is the best virtual data room? When there are multiple buyers or the information to be shared is significant in size, sharing by email is impossible and risky. What do you need to consider regarding the disclosures in the purchase agreement?
What information to share
The purpose of an acquisition due diligence is:
- to validate the envisaged purchase price and the assumptions in the underlying valuation model
- to identify and quantify cash- and debt like items and to determine the normal level of working capital needed in the business
- if new items occur ensure these are adequately covered either through the purchase price or safeguarded in the purchase agreement through a guarantee or indemnification
- ensure no “deal breakers” exist: no significant risks which the buyer is unwilling to accept and cannot be mitigated in the purchase price or purchase contract
Generally, an acquisition due diligence includes several areas. Most common areas for a buyer due diligence are operational, commercial, legal, tax and financial. Other potential areas include IT, environmental, pension/HR, real estate, etc.
For an efficient and short due diligence process it is important to have a well prepared and populated virtual data room, with sufficient and adequate documentation for a buyer to perform its due diligence investigation. If the uploaded information is not enough or unclear, a buyer will get back to you and request additional information, which negatively impacts a speedy process. A buyer has to be able to understand the uploaded documentation without any clarification so ensure that all files uploaded are clear and do not contain unnecessary information.
Ensure your virtual data room contains sufficient high-quality info at the start of the diligence to ensure no unnecessary delays occur or incorrect conclusions are reached.
A delay in the process has a negative impact on your Company and the sales process:
- The longer the sales process takes, the higher the risk the potential transaction becomes public, consequently causing unrest under employees, customers or suppliers
- A delay requires more information needed to be provided. If the provided financials are up to a certain time period (for example, December 2020), a delay results in more financials needed to be provided (current trading update). These results are compared with the forecast that was provided in an earlier stage. Having actual current trading results below forecast negatively impacts the purchase price and requires additional explanations and convincing that this negative trend will not continue
- Risk of unforeseen negative events impacting the deal. The longer it takes to complete a deal, the higher the risk an event happens which could negatively impact the deal. For example, another COVID-19 lockdown, loss of a key customer, manufacturing breakdowns, fire, or a general market crisis.
Type of buyer
Generally speaking, there are two types of buyers, being a strategic buyer or a financial investor. A strategic buyer is a company active in the same business. For example, a competitor or supplier/customer. These buyers know the market you operate in very well. They focus their investigation on added value. So, this means they focus on customer and supplier price information, your key products, customers and suppliers. How do these reconcile to their own products, customers or suppliers? Their objective is to integrate your business into their own business or win margin lost in the supply chain.
Financials investors are private equity funds or family funds. These type of buyers focus less on your actual business, but more on the improvement and growth potential. Their objective is to sell the acquired business in 5 to 8 years against a higher price. They want to know your business can operate on a stand alone basis (i.e., with its own management) and if the profitability can be improved. Financial investors focus on companies displaying significant growth, companies they can integrate into other companies in their portfolio (buy and build strategy) or companies which they can restructure and sell for a higher value.
Make sure you investigate the buyer landscape. The information you provide needs to math the buyer. Be careful what you provide to strategic investors. In the case of discontinuance of the deal, you do not want all your employee or customer and price data to be in the hands of your main competitor.
Example information request list
The data room needs to contain adequate information which a buyer needs to evaluate your business. This means not too much or too little information. Too much information confuses a buyer. The more info provided, the more questions will follow. Too little information and a buyer is not able to perform a good due diligence investigation, causing a lot of additional questions and info requests. Al these requests need be provided in a short time frame, bringing additional pressure to your organisation and risk an incorrect file is uploaded.
So what information do you need to provide? The attached Excel is a detailed example of a due diligence information request list (IRL) or due diligence checklist. This type of lists will be shared by the (advisor) of the buyer.
How to share the information
Information provided during a due diligence is shared through a so-called virtual data room. A data room is a secured online data hosting site, containing all the information needed for a buyer to conduct its investigation. You can invite people to this site and be sure all your data is secured.
Which data room is the best
There are multiple data rooms available. Some are free, such as drop box, but do not offer the secured options a paid data room offers. As the information you share is sensitive and confidential ensure to always use a secured data room to share the information.
Key functionalities for a data room:
- Able to invite users and track the user activities (how many times logged in, what files they open, etc)
- Security to the information uploaded. For example, print or save disabled. If printing or saving is allowed, ensures a watermark is added.
- Files or folders to be shown only to specific user groups (relevant in the case of different buyers)
- A question and answer (Q&A) functionality
- Export functions for files and the folder index
- Ease of use (for uploading as well as downloading)
- Logging of the activity of the data room
- Strong password requirements for its users
Pricing of a data room can be per user or per page. Examples of secured virtual data rooms are DealRoom, Merrill Datasite, Intralinks, Virtual Vaults.
While cheaper, be careful of free data rooms given the lack of security of these sites. Consider the sensitivity and confidentiality of information you will share
What folder structure to use in the data room
Once you chosen your data room provider, you need to think about the information you want to share and how. Just dumping all the information in one folder confuses buyers and generates a chaos. The data room folder structure, or so-called data room index is key to ensure nobody wastes time and money endlessly browsing through the data room.
First off, divide the folders into the key areas a buyer performs its investigation. Often: corporate, financial, tax, human resources, commercial, operational, environmental, legal, technical, and IT. Then make sure to use sub folders per topic of each of the main areas. In those folders you can upload the required files.
Some hints and best practices when setting up the data room folder index:
- Do not overdo it! Creating a huge amount of folders will hide the information and people will get annoyed clicking and opening folders which are empty
- Following the above: do not have folders which are empty
- Use folders named by topic or area. Do not use years or numbers for folders
- If certain topics are not applicable but still requested, upload a text file indicating this item is not applicable. This way a buyer will know it is not applicable to your business and stops requesting it
- Create a Q&A folder. In this folder you upload files requested during meetings or specific requests.
- Do not upload the same file in more than one folder. Also, do not upload multiple versions of files. Ensure the file you upload is the correct and latest one. Review files before you upload them.
- With Excel files, ensure there are no hidden columns or sheets. Or in the case of a Pivot, that the source data is not accessible.
Ensure confidentiality and consider applicable legislation
While it might seem best to play open and transparent with a potential buyer, there are risks in uploading all information and data you have. Privacy legislation does not allow you to provide an employee file including all employee data (name, date of birth, contact details). Also, providing this data has the risk a potential buyer who dropped out of the process will try to contact your employees and recruit them.
Some contracts might have non-disclosure agreements included in them. Let your legal advisor check and advise you what can be uploaded.
Even though buyers sign a NDA, preventing is always better! Ensure no confidential information a buyer can abuse is uploaded to the virtual data room.
When using confidential or sensitive information make sure you clean or “blackline” the information. For contracts this means striking through (or blacklining) sensitive words or clauses. For example, pricing information or customer names. For Excel files this mean deleting certain lines or columns. For example customer or supplier names. Another option could be to rename customer and or supplier names to customer 1, customer 2, etc.
If a buyer insists on reviewing certain sensitive or confidential information a clean room can be used. A clean room is a data room which is separate from the broader data room and which contains selected sensitive information. The access to this data room is limited and often only to the advisors of the potential buyer. Also, a physical data room is possible for this purpose to ensure no copies are made.
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