M&A Due Diligence: The Diligence Process (Part 2)
This post is part two of our series exploring various aspects of due diligence in the context of a merger and acquisition (M&A) transaction. Our prior post discussed M&A due diligence generally and its objectives. This post will focus on the due diligence process.
Due diligence is routinely time consuming and often complex. However, the process can be manageable and cost-effective if a party spends time in advance creating a due diligence plan and forming a due diligence team.
Protecting confidential information
The typical first step in the diligence process is for the parties to enter into a nondisclosure agreement (NDA) if they do not have an appropriate one in place already. An NDA attempts to protect the subsequent disclosure of information that will be provided to a buyer or seller in connection with the due diligence review of the other party. A well-drafted NDA accomplishes the following:
- sets the ground rules concerning the disclosure and use of any provided information;
- defines the scope of the documents and materials that will be reviewed (e.g., certain competitive or sensitive information may be excluded initially from disclosure until the parties progress further in negotiations, or may be subject to further explicit screening procedures);
- may include prohibitions on the solicitation of employees of the other party and other “standstill” provisions; and
- addresses the processes and ongoing obligations of the parties (including the return or destruction of confidential information) in case the deal falls through during the due diligence stage.
Assembling the due diligence working group and getting up to speed
The next step is to assemble a due diligence working group and educate such individuals so that they understand the context of the proposed review and the transaction’s structure, economics and business purpose. By ensuring all diligence team members have a general understanding of the deal’s key features, the working group can prioritize its review and structure the campaign accordingly. Some of the specific deal aspects about which teammates should be briefed include its scope, review periods, common industry materiality thresholds and the expected timing of the transaction.
Requesting and reviewing the due diligence material
In this step, the parties should broadly identify the scope of the documents they would like to review and prepare a list of the requested documents and information (commonly referred to as a due diligence request list). This list creates a mechanism for identifying and cataloguing both the information requested and the information received and is usually very broad in the beginning of the due diligence process. Upon finalizing the list of initial documents that the reviewing party would like to receive, the due diligence request list is presented to the other side, which then begins to compile, index and copy the requested materials.
Because due diligence is an evolutionary process, the review of one document may prompt an additional line of inquiry or a need for additional documents on the same subject (e.g., supplemental due diligence requests concerning intellectual property, export, governmental contract, and environmental information matters). These supplemental due diligence requests are common and an important part of the process.
Once the materials have been prepared and organized, the disclosing party distributes the documents and materials to the reviewing party’s due diligence team. Historically, this distribution was made in person by delivering the documents to a “data” or “war” room at the offices of the disclosing party’s counsel. In such cases, the reviewing party’s due diligence team would perform its due diligence review in those offices. More recently, however, parties have begun to copy and mail (or email) due diligence documents to the reviewing party’s due diligence team and even post the materials to secure online data rooms. Online data rooms allow the reviewing party’s due diligence team to review the documents in the comfort of their own offices, which generally has the effect of decreasing the cost of the due diligence review (i.e., there is no need to travel to remote locations to carry out the review and the cost of duplication can often be eliminated entirely). However, convenience and potential cost reduction must be balanced against any issues that may result from the broader dissemination of sensitive information.
Results of the review
Once the diligence materials have been made available, the diligence teams may spend hours, days or even weeks reviewing such materials and compiling appropriate work product to memorialize their findings. As we will discuss in a later post, the results of the due diligence review will ripple through all aspects of a proposed M&A transaction – and often drive changes to the business and economic terms of the deal in order to appropriately allocate newly identified risks and liabilities.