Explaining due diligence data rooms

• What a due diligence data room is and why it matters.
• The role of a trusted administrator over confidential deal data.

A practical explainer on the purpose of a data room in due diligence.

Welcome to the Dealmaking with Laura DeFrancesco podcast.

I'm Laura DeFrancesco, your host.

We're talking all about mergers and acquisitions, buying and selling small businesses, as well as corporate law.

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Welcome back to another episode of the Dealmaking with Laura D.

Francesco podcast.

I'm so excited today.

We're going to be talking about due diligence and data rooms.

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If you're new to mergers and acquisitions or entrepreneurship through acquisition, I hope this podcast will be helpful in explaining whether you're a buyer or a seller, the ins and outs of data rooms, and what you can expect in a transaction.

So without further ado, let's talk about the purpose of a data room.

Due diligence is the process by which the buyer learns more information about the seller's company to determine what the interest is in purchasing the business as well as what the deal terms would be.

But due diligence goes both ways.

There should also be due diligence that the seller does on the buyer.

We've had actually a number of episodes on due diligence already in the podcast that you can refer back to.

This one will be specifically about data rooms.

We do have a seller due diligence episode as well.

So most of the time, the person setting up the data room will be the seller's counsel.

itself is where that confidential information is shared.

And so there's a lot of importance around how that's completed to best protect the seller because confidential information is the lifeblood of a business.

That's the customers, the employees, the contracts, the vendors, all of that information.

With that information, a competitor or an interested buyer could sweep the company out from underneath of them if they so .

So that's why it's super important to do this well.

And of course, with the correct legal counsel at Dean Street Law, we're happy to help you if you'd like.

What is a data room?

Simply, it is where the due diligence materials that are being provided from one side to another are centralized in a repository and safeguarded through various technological means of tracking and limiting access and making sure that the and the overall process is securing the confidential information of the parties.

How nuanced and complex that is varies tremendously on deal size, complexity of the deal, and the amount of confidential information and level of confidentiality and sensitivity around that information, both in terms of the information that's being shared and to whom it is being shared.

So in a strategic acquisition, is interested in purchasing another competitor.

There is going to be a much higher level of diligence and precaution around making sure that the documents provided and the information provided is provided in a way that maintains the protection of the business and is as secure as possible.

Likewise, when the value of that information or the sensitivity of that information is increased, is going to have more protections around it as well.

Similarly, when the deal size increases, then you're just going to have more protections around it as well because the parties will be more sophisticated and expectations will be there as well.

So typically, this is something that's going to be set up by the seller's council, but sometimes it's set up by broker or sometimes it's set up by the buyer.

Either way, the most important thing is to make sure that the solution fits the scope based on the complexities of the transactions and the nuances of that sensitive information.

So the data room is typically virtual.

It used to be boxes and papers were sent or access was provided to the business to be able to review certain documents or they were scanned in or they were faxed or something like that.

At this point, they are virtual, which is a good thing and a bad thing.

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If you have the people coming into the building to look at the papers and they're not taking them with them, that's pretty high level of security.

You know exactly what they're looking at.

You know who's seeing it.

They're not taking copies with them, right?

That would be olden days a bit more secure.

Now you have electronic copies, which could easily be disseminated, used against a party.

Although there are non-disclosure agreements, the best practice is always something that makes sense practically.

is followed up with a contract.

So you have to make sure that the information being shared isn't outsized for what would be appropriate.

So for instance, if it's a competitive situation, or even if the seller is more conservative, they would typically redact customer names, employee names, vendor names before sharing information.

They might use customer numbers, or employee initials or something like that or employee titles to provide that information without divulging the most confidential information of theirs before a purchase agreement is signed.

So you have to think of the documents that are being provided and the manner that they're being provided in.

Overall, the virtual data room has a whole different level of security depending on what type of data room it is.

You have everything from Google, Dropbox, essentially services for document service sharing without the particular protections of a traditional data room to professional virtual data rooms.

But regardless of whether you're using a document hosting or document sharing platform that's not traditionally used for a data room but is more realistic for a deal of, say, a million dollars or a couple million dollars, that's going to have different settings that you can use than the technology available.

and professional data rooms.

So professional data rooms will have different tracking so that only certain people can download versus only certain people can view versus only certain people can print.

And then you'll also have like most of them would be like if someone printed it, it would be stamped kind of like DocuSign is with that information of who was accessed and what date and what time.

And then same if it was printed or saved or something like that.

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There are a lot of protections around access to information that a virtual data room can provide and being really nuanced around who has what access and what rights.

You also have things like Dropbox and Google Drive and everything where they don't have as many nuanced controls, but you still have protections.

You can have limited access to a certain group of people who you've pre-identified using their address.

addresses, email address, you could do view only, that would still allow them to print and email and download and everything.

So you have to be conscientious around the sensitivity of the information and how it's transmitted, how it's tracked, and overall controls related to that.

And then, of course, how much you want to invest in money and time to protect and secure your information.

In addition, that provides a really helpful, centralized location through a virtual information for the data room where you can easily add people to a deal or share information a lot more easily, of course, than it used to be back in the day.

And if you have the appropriate confidentiality agreements signed by everybody reviewing that information, lawyers, just so you know, have a legal obligation confidentiality.

So lawyers don't typically sign NDAs, but they still have that obligation to maintain confidentiality legally.

And then anybody else viewing the confidential information , we've already signed a non-disclosure agreement as well.

It does facilitate easy communication, especially when you're talking about sharing dozens of documents instead of sending them via email where it could be forwarded, it could be lost, anything like that.

It makes it a lot easier to have it organized all in a data room.

So why are data rooms used?

To facilitate ease of communication, ease of sharing information, ease of protecting information.

and they're prevalent in almost every single deal.

You'll see a virtual data room of some sort, even if it's just a Google Drive or Dropbox file.

We use them in every single deal and set them up, especially when we're representing the sellers.

If we're representing the buyers, typically that's something the seller sets up, but we are happy to jump in if necessary to help set it up.

We also provide instructions on how to set it up when we send our due diligence request list.

in a few minutes.

But overall, the function of it is for sharing confidential information, doing that virtually rather than in person.

There may be certain situations where information shouldn't be uploaded to a virtual data room.

For instance, trade secrets or something like that.

You wouldn't want to put those in documents, let alone on a virtual data room or shared with others because the secretness of them in and of itself is what protects the information.

So you have to have a knowledge, a working knowledge of sensitivity of information, appropriateness, and there still may be some information that would be better shown or provided in person rather than via documents online just to provide that extra level of protection so that someone you know is only able to view it, not able to download it, not able to screenshot it.

And by the way, the professional data rooms are also don't allow screenshotting and whatnot as well.

Of course, you could still have one phone taking a picture of a computer and they wouldn't know that.

So there are ways around it.

So for anything wildly confidential, in-person would be better.

When it comes to navigating corporate law, entrepreneurship, and managing small businesses, experience matters.

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.

Visit deanstreetlaw.

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Now let's talk about those best practices that I mentioned in terms of organizing the data room in a logical way.

So first off is folders and structuring it overall.

So typically a due diligence request list is going to be provided and it will generally in our due diligence request list to create a data room with folders based on the different sections of the request list.

And if you are preparing a data room yourself, that's generally how you would do it is based on what questions are being asked.

If there aren't organized questions being asked, you would just organize it via what's logical.

Contracts, organizational documents, , permits, employment contracts, financial documents, taxes, bank account statements.

You might have those broken up into more centralized in terms of like financial and then under financial have taxes, bank statements, financial statements broken up then in subfolders by year.

So folders are your friends.

I assure you folders are your friends and organize it logically in a way that would make sense for you.

with the due diligence request list.

That's always appreciated.

And then I always find it helpful also to number the folders so that you can clearly designate if you're referring to someone that it's in folder one, financial statements from 2024, for instance.

So typically the way we would do it is we would number one, that topic, two, period, that topic, three, period, that topic.

And then any subfolders would be three, .

And then you would continue on.

If you had subfolders beyond that, it would be 3.

1.

1, 3.

1.

2, 3.

1.

3.

So you have a sequential order to it.

And then if you'd like to be really organized when the documents that are uploaded are actually named and describing what they are responding to, it's always really helpful.

names that have nothing to do or just have 2024.

2024 what?

2024 balance sheet.

That would be helpful.

So I always find it the more descriptive that you can be and purposely changing the document name and perhaps even continuing that numbering order based on where it left off of providing that level of detail and care is really helpful.

It's expected at a bigger deal size because the parties are more sophisticated.

.

And overall, it makes it a lot easier.

When uploading the documents, I always recommend that I have a folder that the sellers upload the documents to, or they upload all the documents, and then I review them, and then I share access to the data room.

So there's two ways that could be done.

The reason being, I want to make sure that the documents being provided are redacted appropriately, are responsive to the questions that are being asked, and overall aren't going to provide issues for the is signed.

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, this is their confidential information and the best practices and the best conservative approach for providing confidential information will serve them in the long run.

When I'm representing the buyer, you're generally not putting together the data room and deciding on the permissions, but sometimes it can happen.

So generally you want to be conservative.

I don't ever make it so that anybody can access the folder.

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I ask for their names, their emails, their role, and make sure that I have an understanding of who those need to be.

When you're talking about bigger deals, you'll be shocked how many people need access to the data room.

Sometimes on big deals, you'll have six or seven attorneys working on it.

I'm talking about like a $25 to $50 million deal, so bigger deals.

But you'll be shocked the amount of people that need access to it.

is needed to compile , such as if we were the buyers and preparing for some reason some sort of schedule based on financial information needed from the seller, then we might need download access.

But you just try to be as logical as possible.

Try not to make it too restrictive.

But as an attorney, I'm always asking the seller, what do you prefer?

What do you feel comfortable with?

This is how I intend to structure it.

What are your thoughts?

So overall, just getting feedback from them.

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and just saying, oh, well, you want everything?

Let me give you every document that I've ever had.

Here's my computer files.

You know, making sure that it's organized, it's relevant, it's labeled, everything like that will make everybody's lives a lot easier.

I hope this has been a helpful episode.

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through acquisition, a legal guide to buying a small business.

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Cheers and happy dealmaking.

Thank you so much for joining us on this episode of the Dealmaking with Laura DeFrancesco podcast.

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