Due Diligence (DD) is an evaluation process to understand the business, ownership, business model, management and operations of a proposed investee or target company that is looking for an investment or acquisition. In addition to gaining commercial understanding of the business, it has a legal element to understand the potential regulatory, contractual and reputational risks related to the specific business type. The process also provides insights into its customer, vendor and employee relationships and most importantly future projections of the business as to its competitive edge in that industry. This process helps the investors/acquirers of the business to analyse the investment viability and growth opportunities.

Why DD is a painful exercise?

While the DD process varies greatly from company to company and depends on the specifics of each potential investment/acquisition, it is a time-consuming procedure which involves the engagement of advisors in the discovery of information crucial for the investment/acquisition.

Interestingly, the legal component of a DD process is just 10-20% but takes a considerable amount of time for the investors/acquirers (typically, ranging from 1-3 months based on the funding stage) that translates into huge legal and financial costs. Do you know the reason why?

To understand the pain points of the DD process, we need to dissect the steps involved in it and analyse the gaps at each stage.

The DD process can be broadly categorised into 2 stages, namely:

Stage 1 – Data Room Setup and Management

Stage 2 – Document Review and DD Report

In this article we will discuss how standardization, process and use of technology can help the Data Room Setup and Management. We will cover Stage 2 in Part 2 of this article followed by a case study.

Stage 1 – Data Room Setup and Management

Step 01 – Preliminary research on investee/target company. For an effective DD exercise, advisors need to understand and conduct a preliminary research on the company including its corporate history. This not only helps identify the DD checklist requirements but also helps the professionals to be well prepared before the kick-off call with the investee/target company for a meaningful discussion and cooperation.

There are several legal research databases and tools available that can help such as Altinfo for Registrar of Companies (ROC) Search Reports, Deal Research Databases such as Private Circle, SaveRisk, PitchBook provide in-depth information regarding the parties to the deals, industry, corporate and financial filings, shareholding and corporate structure, litigations, etc.

Step 02 – Requisition: Post the kickoff call/meeting with the parties to understand the deal specifics, the advisors can prepare a DD checklist. While this sounds easy, this is a cumbersome area when it comes to generating the regulatory checklist.

  • DD Checklist: This includes multiple areas such as business overview, operations, management and employees, contracts, IP, Tech, Insurance, etc. Typically, advisors pickup checklists used in previous projects, modify and use it for the next DD which is a cumbersome and error prone process. This can be easily standardized and automated on a system.

For example – a one time exercise of creating a master checklist covering each checklist area and all possible information/document requirements that you have for different types of DD’s and then automating this master checklist can help pick and choose the relevant checklist items for the specific DD type and generate a DD checklist in minutes (approx. 2-3 hrs of saving). Legal tech systems such as Quant’s Qollate can help automate the DD checklist generation that can then be shared on the system itself with the relevant stakeholders for action. One can keep updating the checklist items per the latest DDs to ensure the master checklist stays current and comprehensive.

  • Regulatory Checklist: This is a challenging area and varies per the industry, jurisdictions, number of employees, products/services, wages, type of business entity and so on. Typically, a lot of time (approx. 10-12 hrs saving) goes in research and identification of the applicable laws and documents that will be required. This is where use of compliance systems can help generate the checklist of applicable laws and compliance requirements such as Quant’s DIY compliance that is freely available.
  • Requisition List: Post the generation of DD and Regulatory Checklist, several additional/missing requisition lists are created that flow back and forth between the target company and the advisors based on review of documents/information provided. These lists are either made on Word or Excel and sent through emails. This is a completely inefficient, manual way of data collation that is prone to error/misses, takes a lot of professional time and elongates the DD timelines. What if the legal tech system can help you generate the sub-requisitions real time for the parties to directly upload the information?

For example: Legal tech systems like Qollate provide functionalities to shorten the process of requisition (15-20 hrs saving). Additional requisition items can be added to the same checklist with auto-notifications intimating the parties about the new requisition. There is no need to collate all the remaining checklist items, create a requisition list and send on email to parties. This is where legal tech can take over.

Step 03 – Data Collaboration: This step involves the collaboration among the parties where the target company would be required to share the data per the above checklist to perform the DD. The pain points of the step involve the following:

  • Unstructured Data: Most of the times the target company entities tend to share quite unstructured raw data during the process resulting into a structuring exercise of the data to be done by the advisors which is unnecessary and not a good use of their time (approx. 8-10 hrs). This adds to the costs as client is charged per an advisor’s time while a system or a data organiser can easily take up this task at a lesser cost.

Solution: Virtual Data Room (VDR) systems such as CapLinked, RubyDatum, Intralinks, iDeals, Deal Room, etc. help solve this issue where folder structures can be created per the DD checklist and data is uploaded by the target company in a structured manner.

  • Huge Volume of Data: Huge transactions involve a huge volume of data. Sharing such huge volume of data is not possible through emails or regular Data Management System’s (DMS) like OneDrive or Google Drive.

Solution: VDRs help upload data/multiple documents quickly from various drives or systems, move or relocate files within the system and share data in a controlled, secure, and trackable manner.

  • Security of the Data: The data shared during the DD process is extremely sensitive and confidential for the parties and can lead to huge liabilities. Data shared via email, OneDrive or Google Drive is technically not a very secure medium and should not be compromised specifically during DD.

Solution: Therefore, VDRs or legal tech systems with highest levels of security configurations from 2 factor authentication, role-based access, password protections, controlled privileges from workspace to folder levels, watermarks, digital rights management, audit trails and so on are recommended for DDs.

Thus, standardization of documents, process & use of technology can play a vital role to reduce DD cycles for the investors/acquirers and cost savings for target companies. Advisors can ensure a focused, high-quality review while balancing time sensitivity and accuracy with cost control. It also enables professionals to take on high end work and let technology do the heavy lifting and take over the mundane.

To be continued… …Look out for Part 2 of the Article.

Authored by Legal Innovation Team, Algo Legal, for further queries reach out to us at: [email protected]

This material and the information contained herein prepared by Algo Legal is intended to provide general information on a subject or subjects and is not an exhaustive treatment of such subject(s). Algo Legal is not, by means of this material, rendering professional advice or services. The information is not intended to be relied upon as the sole basis for any decision. Algo Legal shall not be responsible for any loss whatsoever sustained by any person who relies on this material.