When you’re trying to sell your business, there are certain signs that things are moving forward in a serious manner. Perhaps you and the buyer have already entered into a letter of intent (LOI) or a similar memorandum of understanding. Once it’s abundantly clear that the sale process is progressing, any conscientious buyer will want to know as much about your company as possible so that it’s fully aware of any outstanding or potential liabilities. This will require a buyer to conduct what is called a due diligence investigation. In short, due diligence is the process by which the buyer requests any documents, data, and other information that it would like to review in order to identify any potential liabilities or roadblocks to the consummation of the transaction. The results of the due diligence process can cause the buyer to react in a variety of ways, from demanding a reduction of the purchase price to terminating the transaction altogether. For more discussion regarding the entire sale process, see Selling Your Business: Eight Steps.
The first thing you need to know is what kind of information the buyer wants to review. The most cautious purchaser will want to see everything. However, depending on the particular nature of your business, other purchasers might only be focused on specific areas. For example, if you own a technology company, then the buyer might be primarily focused on your intellectual property (IP) ownership and applications, IP licenses, employee assignments of proprietary rights, and so on. If your business is uniquely prone to environmental concerns, then the primary focus of the buyer’s diligence review might be environmental reports and certifications. It all depends on the buyer’s specific concerns.
Other standard categories of due diligence review include financials, corporate formation and governance documentation, real property, tax matters, litigation, customer and supplier contracts, employee and independent contractor agreements, employee benefit matters, equipment, licensure and regulatory issues, and insurance. In any case, the buyer should provide you with a list (the due diligence request list) of all categories of documentation and information sought, including any specific documents the buyer already knows it wants to see. You should emphasize to the buyer that the initial list provided should be as comprehensive as possible so as to limit or avoid incremental, supplemental requests that might create additional confusion or burden for your company’s management.
You should designate one or a handful of persons to be due diligence contacts for the acquirer (each, a diligence contact). This will allow for the due diligence process to be better organized, more efficient, and less frustrating for all parties involved. A diligence contact could be you, the general counsel, the chief operating officer, the chief financial officer, or anyone else you would deem best suited to manage the process. This person will also be charged with coordinating responses to the buyer’s due diligence requests from those departments that are beyond the diligence contact’s direct supervision. Because the diligence contact will likely be burdened with unprecedented responsibilities, this person should be trustworthy, conscientious, and efficient. The diligence contact’s responsiveness to the buyer and its legal team might be critical in determining the outcome of the sale.
Once you’ve received the due diligence request list, the managers of every relevant department should carefully review it so that they can point out any requests that might be overly-burdensome or impossible to provide. These managers should also give you immediate feedback regarding any items that can be summarily answered with “none” or “not applicable.”
Any requests that are overly burdensome should be negotiated with the buyer as soon as possible so as to manage expectations. For example, if the nature of your business requires all directors, officers, employees, contractors, and other representatives to sign a boilerplate nondisclosure agreement (NDA), then these NDAs could number in the hundreds, if not the thousands. If the terms of these NDAs do not materially differ from one another, then it is likely that you can negotiate upfront with the buyer to either provide a handful of sample NDAs or your company’s standard form.
The data room is either a physical or virtual environment where documents are made available for the buyer and its legal counsel to peruse all due diligence documents. If the buyer’s diligence inquiries are fairly limited, then perhaps you don’t need a data room at all. It might be sufficient for you to provide the requested documents via mail or email. But in situations where the buyer asks for a substantial number of documents, a data room is an efficient way to categorize the documents, make them available, and limit the number of supplemental diligence requests from the buyer.
A well-constructed physical data room will be located in the offices of the company or its legal counsel, with folders categorized and numbered consistently with the format of the due diligence request list. Then, the buyer or its counsel can visit the data room at agreed-upon times to review and/or copy the documentation.
A virtual data room is one that exists online and is hosted by a virtual data room service provider. These Internet spaces allow the company to scan and upload all diligence documents into a protected web environment so that the buyer can readily access them 24 hours a day. The buyer only needs proper credentials (a password, for example) to access the documents. This can be very convenient and efficient because it does not require the buyer or their legal counsel to physically visit your office location, which could disrupt your business activities, and it also makes the information accessible to them around the clock.
Your company’s diligence contact should use the buyer’s due diligence request list as a guide for not only categorizing and providing the documents requested, but also for keeping track of what materials have already been delivered. One of the most frustrating things for a seller is to have a purchaser make repeated requests for information that the seller is confident it has already provided. Lastly, as a general note, the company should be as thorough as possible in its response to the initial due diligence request list. This will not only minimize subsequent requests, but will also reduce any leverage that the buyer would otherwise gain if a potential liability were to be revealed later rather than sooner in the negotiating process. For example, if the company only makes the buyer aware of an outstanding tax liability on the day before the deal is scheduled to close, then the buyer will have much more leverage to demand a commensurate reduction in the purchase price, or else threaten to delay or cancel the closing.