The Evolution of Data Rooms in M&A

In this episode, Gina Cocking and Jeff Guylay pick up their discussion around the due diligence process related to the sale of a company.

This episode is a great add-on to the previously released four-episode series exploring the due diligence process:

EP003: Business aspects of due diligence

EP004: Legal aspects of due diligence 

EP005: Accounting aspects of due diligence 

EP006: Technology aspects of due diligence 

As we explore the organizational aspects of a due diligence data room, you’ll hear the reminiscing of both Gina and Jeff as they remember their days on Wall Street physically managing the data rooms of decades past when there were literally rooms full of documents that buyers would make appointments to review while the analysts on the deal watched.  

You’ll hear how much data rooms have transformed in recent years with the birth of the electronic data room.

Get ready for a call-to-action, which Gina describes as a “resolution” that you can make any time, to get your company’s documents located, organized, and filed in a neat system to be ready for a transaction.   

Thus our title for the episode: Get your Ducks in a Row.

We answer the following questions in this podcast episode:

What are data rooms, and why are they so important in the due diligence process? (2:00)

What were data rooms like in decades past? (2:30)

What are data rooms like today? (4:30)

What is contained in an electronic data room? (6:20)

Are data rooms static or do they change over time? (10:00)

How is confidentiality protected in a data room?  (16:00)

What can a company do to prepare for a transaction? (20:00)

What do you suggest companies do immediately after listening to this episode in regards to data rooms? (27:00)

What are data rooms, and why are they so important in the due diligence process? (2:00)

Jeff: Big picture, data rooms are the electronic location of all the materials that we help our clients collect and collate during our process of selling the company.

They contain all the information that buyers and investors will need to complete a transaction. So it’s everything from articles of incorporations, to financial models, to contracts, etc.

Gina: The data room is critical in any buyside or sellside process. The data room is where all the documents are kept that the buyers have access to when reviewing the business. We also give access to the buyers’ accountants, attorneys, HR consultants, marketing consultants, etc.

Datarooms are all electronic (online) nowadays, but it has not always been that way.

What were data rooms like in decades past? (2:30)

Jeff: As an analyst in investment banking in the ’90s, I would sit in a physical data room on Wall Street. We would have buyers come through, and they would have to sign into the data room and show ID.

It was a room full of documents where buyers could spend several days going through documents. They were not able to take any documents out of the data room. They could ask to selectively photocopy certain documents, and we analysts would photocopy them.

The business folks, the attorneys, the accountants would come in in-person and spend days digging through the documents. 

Gina: I remember being stuck in Bethlehem, Pennsylvania in a basement of a chemicals manufacturing facility for about two weeks.

One of the challenges in a physical data room is you couldn’t have multiple buyers come in at the same time. 

You also had to double-check all the files when everyone left to make sure nobody took a document. 

What are data rooms like today? (4:30)

Jeff: The efficiency with electronic data rooms has been a game-changer.  You can have 30 professionals across various functions looking at documents at the same time and really increase the cycle time of the transaction.

Everybody has a unique password, they sign in (online). We can see what documents they’ve downloaded, which ones they’ve reviewed, and which ones they haven’t looked at.

You can see who is really being active. It’s a great tool for us as advisors to see who is most interested in a transaction.

What is contained in an electronic data room? (6:20)

Gina: In the data room, you will have various workstreams based on who will be asking for documents. You’ll have workstreams for business, accounting, tax, legal, technology consultants, marketing, HR, and insurance professionals.

From a business perspective, it will include all monthly reporting packages, KPIs (Key Performance Indicators), MD&As (Management Discussion and Analysis of the financial results); whatever a business is using to manage the business on a day-to-day basis.

Business information will also include company presentations made to outside shareholders and banks, internal presentations, presentations made to clients, information on past employees, current employees, payroll data, insurance information, claims history, insurance applications. 

Jeff: The data room acts as a central repository of all the information that describes the company, its operations, history, and future. 

We start building this data room on day one of our engagement. Colonnade is always thinking ahead about ways that we can help our clients manage the process as efficiently and effectively as possible.

Download Colonnade’s sample due diligence list here.

Are data rooms static or do they change over time? (10:00)

Jeff: Our data rooms are living data rooms. Documents continue to be populated throughout the process.

On day one, we start asking for documents. These documents include items that we need to produce the financial model and create the Confidential Information Memorandum.

Later, we assess what information we need for second-round bids and ultimately confirmatory diligence. 

Gina: Everything that we ask for is to help us to understand our client’s story and to position us to be able to answer questions as if we were a company insider.  I would say our typical list is 250 to 300 documents that we’re requesting.

How is confidentiality protected in a data room?  (16:00)

Gina: All of our clients worry about what goes into the data room, who’s going to see it, and how we protect the secret sauce of the business.

We work carefully with our clients from the start to determine what documents they are comfortable sharing at which stages of the process.

Jeff: If we contact 50 buyers, and 20 folks are interested enough to take a book (Confidential Information Memorandum), we might have an initial data room that would be a prelude to initial Indications of Interest.

(See our podcast episode, Narrowing the Field – Indications of Interest and Letters of Intent).

Moving to the next phase you might have six interested buyers, and you can phase in the documents that folks are able to see. We control access electronically. 

Gina: I am a big proponent of putting a lot of information in the data room before LOIs are due because then you get better LOIs. They are more well thought out, a lot of the diligence has been done, and when they say, “We are going to pay X,” there’s really not much else that they are going to discover at that point that can change that price. 

We do a lot of redacting. Instead of putting a customer’s name in, it’s company one, company two, company three. We take out employee names. We black out contract terms. We black out the name of vendors. We can do that also in the financial information. 

Jeff:  We as advisors do a lot of the heavy lifting to first identify the sensitive topics and then manage methods of disclosure. Sometimes we have multiple versions of the data room. We might have a strategic (competitor) data room that is different from the financial sponsor data room.

What can a company do to prepare for a transaction? (20:00)

Gina: First and foremost, digitize everything. We’re in 2022. There should be nothing that is still on paper. You should have a central repository, a server, Dropbox – some solution for all of your documents in one place.

Create a document tracker. It can be an Excel list of key documents in your organization including business licenses, lawsuits, complaints, vendor contracts, client contracts, etc.

The list should have the title, the date, the expiration date, key contract terms, etc. Do it now. Pay a temp $20 an hour to get that all into a diligence tracker for you. This will avoid paying lawyers $300 to $500 an hour later. 

Jeff: Being organized upfront is exactly the right strategy. The more that you can front-load, the smoother the process will go, and your legal costs will ultimately be lower if you’re more organized.

Gina (23:41): Data hygiene is critical to any process, and the time to start is now.

Jeff:  Doing this heavy lifting upfront in the process is really key to driving efficiency. Speed is key in any transaction and making sure that we can streamline the process from the day that we pick up the phone and start talking to folks through the closing date is really key. The data room is the place where it happens.

What do you suggest companies do immediately after listening to this episode in regards to data rooms? (27:00)

Gina: A great resolution for a company is to get your documents organized. It is easier to stay on top of your contracts and your licenses if you’re organized. If you have a tracker, you know where everything is. You won’t wake up in the middle of the night wondering where things are. 

You will also realize what you don’t have, what is not documented, what has expired. Keeping everything in one place instead of in the control of various employees of the business will put you in a position to run your business better and go through a sale process better. 

From 10:45 (earlier in the podcast). 

Gina: The other thing to remember is that speed is key to any process. Once you get into that exclusivity phase, we want to get through that to signing and funding as quickly as possible. 

Jeff: Getting these documents in advance is key. It takes time to find, organize, and scrub all the documents for confidentiality. It’s critical to moving the process along because time kills all deals.

Conclusion

Colonnade works with our clients to:

• Get them ready for a sale – including some of the tips we talked about today
• Prepare a thorough, company-specific due diligence list, with an eye towards what buyers and investors will expect in both preliminary and confirmatory due diligence
• Manage the assembly and dissemination of information throughout the process, being mindful of confidential information and when and to whom we present that sensitive data
• Manage buyers and investors throughout the diligence phase on our clients’ behalf so they can stay focused on running their businesses