This post is part four of our series exploring various aspects of due diligence in the context of a merger and acquisition (M&A) transaction. Our prior posts discussed M&A due diligence generally and its objectives, described the due diligence process and outlined considerations when assembling your due diligence team of experts and the due diligence request list. As indicated in our earlier post, the due diligence request list is the inventory of documents requested, provided and reviewed on the road to completing an M&A transaction. Once the seller and its counsel have had the chance to collect and review all of the items requested, the seller’s counsel typically prepares a formal written response to the due diligence request list. This post will focus, from the seller’s perspective, on preparation of such a response.
In an ideal world, the buyer would draft a due diligence request list that was perfectly customized for the seller’s business and operations and the seller would be able to produce all of the items requested at once. In practice, however, and in order to keep the due diligence process moving forward, the seller will usually be unable to assemble all of the requested information and materials at once. In these situations, the parties will usually deliver a partial response and will follow up with additional information as it is assembled. All materials delivered by the seller should be accompanied by a written response and should be organized to correspond with the due diligence request list (e.g., a response that addresses each requested document item-by-item). This will allow the buyer and seller to more efficiently and effectively locate and review the desired information and will make subsequent supplements or updates easier.
While the documents produced in response to a due diligence request can yield important information about the disclosing party and help uncover potential issues, the written responses indicating that particular items or requests are not applicable to the disclosing party can often be just as valuable to the recipient for purposes of narrowing the list of potential issues and areas of concern or focus.
Typically, commencement of the due diligence process will require that a large amount of information be located, reviewed, and produced in a relatively short period of time. In most cases, the buyer will require that the seller, and the seller will wish to, keep the potential transaction confidential and not disclose its existence to the employee base. This confidential treatment, however, reduces the number of people on the seller’s side available to help in the due diligence process. As a result, most of the information gathering is done by a handful of the seller’s personnel, who are oftentimes the high-level executives of the seller, or the seller’s legal counsel. Some of the information may need to be collected by or from employees who have yet to be informed of a potential transaction, and accordingly, production of such items may need to wait until the likelihood of consummating the transaction is higher.
It is important that no due diligence material is produced to the other side until counsel to the disclosing party has had the opportunity to screen, if not complete its review of, and organize, such material. A provider of information should always memorialize what they send to the other side. Often, particularly in time-intensive situations, the provider responds to the due diligence request with an “information dump,” where armfuls of documents are grabbed from drawers and file cabinets, boxed up, and sent without first being inventoried.
Among the unfortunate results of the “information dump” approach are:
- potential disputes down the road over what was and was not provided;
- potential inadvertent waivers of the attorney/client privilege; and
- potential disclosure of sensitive documents.
To minimize the risks of inadvertent disclosure, it is essential to establish a control mechanism with respect to the review, organization, and delivery of the documents by the provider and its evaluation by the recipient, and the creation of an accurate record of the documents so provided. The most common approach is to designate a single person or a very small group of people to act as a gatekeeper through which all documents must flow. In certain situations, this approach may produce internal resistance because of concerns that such coordination will slow down the review process.
The due diligence process can be very disruptive to the operations of a seller. Because the buyer is trying to review a large portion of the seller’s books and records (and the information may not be readily organized and available), collection and review can be time-consuming and can in turn divert the attention of company personnel to matters other than the seller’s core business objectives and operations. A well-organized due diligence review and response process can help to mitigate this disruption and maximize efficiency throughout the entire M&A process.