THE CONCEPT OF DATA ROOM IN DUE DILIGENCE What is data room?

A Data Room provides all important business documents/information which may be on Financial, regulatory, IPR, marketing, Press report or any important material aspect pertaining to a business transaction. Other wise it provides for a common platform/place where all records of important business information are kept for the review by a potential buyer after signing of a Non Disclosure Agreement (NDA). As data room discloses confidential data which is not available for public and may relate to business process, trade secret, technology information etc, the access to data room is made after signing of Non Disclosure Agreement.

Provisions are also made to mitigate the risks of data destruction or data stealing. For this purpose the restrictive provisions are made for entry, study, noting and exit from the data room. This includes physical checking of the persons conducting such study in the data room. Installing close circuit camera in the data room and monitoring the activity of the persons on time to time basis is a regular activity. It results in adequate expenditure and prior to that make proper budgeting is required.

Principles are also laid down for copying documents to clearly state about the nature of documents which could be copied in the data room. For this purpose also photocopiers and scanning machines are kept, electronic data similarly also monitored for which copies are required to be made.

Why Data Room?

1. Removes ambiguity in the minds of buyer about the profitability, growth prospectus, and sustainability of business that is proposed to be bought.

2. Provides material information that helps in doing a SWOT analysis.

3. It enables the buyer to do a better bargain through the analysis of the data.

4. May expose the weakness of the seller which is not directly provided to the buyer- For example, a material off balance sheet transaction.

5. Provides data that helps in better Valuation of business for both buyer and seller.

What type of information is provided under a data room?

The following are the examples of information that is provided in a Data Room. This list is not however exhaustive.

1. Financial documents such as Annual Reports, Financial statements filed with regulatory authorities, cash flow statements, documentation with bankers etc.

2. Basic corporate documents such as certificate of incorporation, Memorandum and Articles of Association, Share-holding agreement, various types of registrations, documents on General and Board Meetings, insurance contracts etc.

3. HR information

4. Equipment and information on operational aspects.

5. Information relating to sales, marketing etc 6. Compliance related information

7. Information published in media.

8. IPR details

9. Information on litigation

Some Occasions those require creation of Data Room.

1. Mergers, amalgamations and Acquisitions 2. Strategic Alliances

3. Partnering agreement 4. Business Coalitions 5. Outsourcing agreement

6. Technology or Product Licensing

7. Joint Ventures through technical or financial collaboration 8. Venture Capital investment

9. Public Issue

Data Room – Virtual or Physical

Earlier data room was a physical location where all confidential and other documents are kept in a paper form and were kept under lock and key with custody of a responsible person. Generally the data room was created at vendor’s premises or lawyer’s office and specific time was allotted to the buyer and the authorised representatives of the buyer to enter and exit the premises which were set up as Data Room. Only one

prospective buyer was allowed to view the documents at a time. When a prospective bidder demands additional or new documents it was provided to them in physical copy through courier or registered post. It demanded the physical availability of experts from different fields at the place where the due diligence exercise was being carried out.

Under the prevailing globalised economy, using of traditional physical data rooms for due diligence is not only a time-consuming and difficult process but also is very expensive as it demands the prospective buyers to travel from their place to the place where the data room is located.

Technology has enhanced the efficiency of many business processes and activities. New and creative uses of technology are expected to have similar positive effects on existing businesses. Introduction of Virtual Data Room which is an effect of technology has come as a boon for due diligence exercise.

Virtual Data Room is a site where all the required data of the prospective buyer are stored in digitalized or electronic form. Due diligence exercise these days is carried out through creation of virtual data room in the form of internet site where all the confidential/material business information is stored.

In general the following steps are involved in creation of a virtual data room.

1. Demands of the prospective bidders are identified.

2. Identify a trust worthy data room service provider if necessary and enter into necessary agreement with them.

3. Creation of a website where all the required documents are stored with internet security, restriction to access the site etc

4. Signing of Non-Disclosure Agreement with prospective bidders

5. Service agreement with data room service provider and the prospective bidder

6. Prospective bidders, on signing of Non-Disclosure Agreement and the service agreement, are given Use Id and pass word of the virtual data room so that any number of prospective bidders and access to it.

Major Advantages of Virtual Data Room 1. Savings in cost

2. Saving in time

3. More Comfort to buyer and Seller

4. Availability of information at any time of the day

5. Enables multiple prospective bidders to access the Virtual Data Room 6. Easy to Set up

7. More Secured 8. Improved Efficiency

9. Copying/printing of documents may be restricted.

10. Closure of Virtual Data Room may happen at any time Some Disadvantages of Virtual Data Room

1. Limited interaction with prospective sellers.

2. Lack of clarity of documents loaded on the data-site

3. Inability to copy or print information some times becomes a hurdle

4. Access to sensitive information such as contracts to third parties poses legal challenges relating to confidentiality of information.

Virtual and Physical Data Room – A comparison

Sl. No. Particulars Physical Data Room Virtual Data Room

1 Form of documents Papers, files, boxes or any

Only one prospective bidder can review the documents at a time

Difficult to search the documents that is required

More convenient as it enables multiple bidders to review documents with search facility also.

6 Accessibility to data room Restricted time Any time.

7 Facility to restrict access of document access

Not there Access can be restricted.

8 Facility to check who has

10 Ability to copy documents Possible Not possible always

11 One to one communication in person with the seller or his representatives

Available Not available

Data room administration and data security

Administration of data room and its management including entry access and other security aspects including data security to be planned in detail and a trial run to be conducted before making the data room operational.

Due Diligence Vs Audit

An audit is concerned with historical financial statements only and provides an opinion as to whether the financial statements represent a “true and fair” view of the company’s operations. Due diligence, on the other hand, review not only look the historical financial performance of a business but also consider the forecast financial performance for the company under the current business plan. The following table describes the difference between Due Diligence and Audit.

Particulars Audit Due diligence

Scope Limited to financial analysis Includes not only analysis of financial statements, but also business plan, sustainability of business, future aspects, corporate and management structure, legal issues etc.

Data Based on historical data Covers future growth prospects in addition to historical data.

Mandatory Mandatory Mandatory based on the transaction.

Assurance Positive assurance i.e. true and fairness of the financial statements

Negative assurance. i.e. identification of risks if any.

Type Post mortem analysis It is required for future decision.

Nature Always uniform Varies according to the nature of transaction

Repetitiveness Recurring event Occasional event

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