In our last two posts, we discussed the four phases of the sale process: Phase I: the Diligence Phase, Phase II: the Marketing Phase, Phase III: the Management Presentation Phase, and Phase IV: the Buyer Due Diligence and Documentation Phase. In the context of Phase IV, we mentioned the importance of “virtual data rooms” in facilitating the buyer due diligence process. In this article, we will do a deep dive on virtual data rooms, including what they are, how they work, and why sellers should use them.
In short, a virtual data room (“VDR”) is a secure online repository where key company documents are stored for easy access by buyers and their team of advisors. They are widely used during M&A transactions to help facilitate the extensive buyer due diligence process. Typically, sellers will place highly confidential documents critical to the transaction in a VDR so the buyer and their team of experts can access them without having to travel to a physical location. Having access to these documents enables the buyer to confirm that everything the owner has told them about the company thus far is accurate, and uncover any hidden “skeletons” in the company’s closet that could pose risks to the buyer or jeopardize the deal.
VDRs first came into existence around the early 2000s; before that, the thousands of pages of due diligence documentation were housed in physical, locked rooms that typically could only be accessed by appointment, one person or a small group of people at a time. The alternative to the physical data room was the submission of diligence information by mail or email. In this case, it was virtually impossible to confirm who viewed what information.
In addition, VDRs allow sellers to provide valuable, confidential company information to the buyer and their team in a controlled, secure manner. VDRs can be set up to allow access to all documents, or a specific set of documents, and only to a pre-approved list of individuals with a secure user ID and password. An upside of using a VDR: with certain providers, sellers and their teams can view who has visited the VDR, when and how often, how long they spent there, and which documents they accessed. More on this below.
Another bonus of VDRs is they allow multiple people across diverse locations to effortlessly access company documents as and when needed. For example, we once had client who was working with a buyer with 50 different team members in several cities, including attorneys, bankers, corporate and employee benefits specialists, real estate experts, and environmentalists. Thanks to VDR technology, they were easily able to access the company’s diligence documentation while also saving time and money by not having to travel to a physical location.
The type of information sellers should upload to the VDR depends on the company and the nature of the transaction, but generally, the VDR should contain any and all information that is even remotely necessary to be disclosed. As we may have mentioned in past posts, sellers cannot disclose too much information. If in doubt, disclose it.
Categories of documents included in the VDR include:
- A company overview or executive summary describing the company, including the confidential information memorandum and management presentation, as appropriate
- The executed letter of intent
- Financial data, including internal and external financial statements, budgets, projections, etc.
- Organizational documents, such as partnership agreements, operating agreements, articles of incorporation, board minutes and resolutions, description of the equity and debt capitalization
- Customer and vendor contracts, and purchase agreements
- Documentation pertaining to any legal action the company may be involved in (or any encumbrance that could potentially impact the company’s future value)
- Customer and vendor concentration information
- Equipment/asset data, including a list of all equipment/assets owned by the company, purchase dates, purchase or financing agreements, and, if applicable, third-party appraisals (particularly if equipment comprises a significant portion of the company’s value)
- Real estate and property information, including mortgage documents, liens, property descriptions, titles or deeds and easements, appraisals, leases, and environmental
- Employee data, i.e., lists of employees, payroll, benefits costs and data, compensation or employment agreements, and any non-competes
- Intellectual property
- Other information unique to the company
While owners who are preparing to sell their company may recognize that doing so involves providing the buyer with massive amounts of documentation and data, they may not realize that how the information is presented is almost as important as what information is being provided. The presence or absence of certain documents and data can make or break a deal, so it is critical for owners to properly present the information while fully disclosing every facet of their company. Using a VDR can help sellers easily organize company information and facilitate buyer diligence and collaboration while avoiding costly errors and omissions that can potentially result in post-closing litigation. Moreover, buyers expect it, and a VDR is a sign of professionalism.
Equally as important, the VDR memorializes all of the diligence information that the buyer (inclusive of their advisors) was provided and had the opportunity to review. As such, the VDR can provide protection for the seller in the event that there is a post-closing dispute regarding whether or not certain information was disclosed to the buyer and whether or not the buyer reviewed such information.
In closing, a VDR is the most professional, time-efficient, and cost-effective manner for a seller to disclose diligence information to a buyer and their myriad of dispersed advisors. The VDR is also a fundamental aspect of managing a sale process that sophisticated buyers are accustomed to using and expect from the companies that they seek to acquire.
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