How to Conduct Due Diligence in a Virtual Data Room?

When it’s time to close an important financial deal, like a merger and acquisition (M&A), the ‘seller’ company creates a data room for due diligence to allow the ‘buyers’ to evaluate important corporate documents to enable the buyer to make an informed decision. Due diligence aids the process of uncovering any potential liability that may be associated with the deal.

What is a due diligence data room?

The due diligence data room is where all the important documents, such as contracts, tax history, employee information, and a host of other corporate records are filed, for evaluation by the due diligence team of a buyer company. The type of documents filed is often determined by the nature of the transaction. The due diligence data room consists of a confidential document, and the data room serves as a secure unit where such critical documents are kept for authorized personnel to peruse and analyze.

Due diligence data room may be virtual or physical. The latter used to be the corporate trend until the introduction of a corporate due diligence virtual data room. VDRs have proved to be effective for carrying out due diligence in a fast and secure manner, hence it has gained much preference over the physical data room in the twenty-first century.

Overall, due diligence data room helps companies to make informed decisions on the risks, costs, and benefits associated with making a critical financial deal, such as an M&A, and IPO.

Virtual Data Rooms: The Best Providers in Canada

Functions of a virtual data room for due diligence

A virtual data room for due diligence is important for several reasons. Just as the due diligence process is critical, the VDR system helps to pay close attention to all of these details in an automated manner.

User activity management

During a due diligence procedure, several documents are viewed by the due diligence team, making it nearly impossible to track all the documents viewed when a physical data room is used for due diligence. The virtual data room resolves this issue as it allows for proper tracking of how the documents are being used.

In the case where different due diligence teams are simultaneously using the VDR, the system is able to track how each team interacts with the document. This allows the seller to have an overall idea of a buyer’s main interest and follow up promising targets. The system prevents unauthorized data sharing by authorized persons. With audit logs, exfiltration can be controlled and you can also tell who viewed, edited, copied, or exported a file. This helps to eliminate risks that even the most innocent yet careless use of data could cause.

Read more about user management features in a virtual data room

Granular access control

The virtual data room due diligence system allows you to control the access to confidential documents. Since the due diligence team consists of professionals with different areas of expertise, such as analysts, lawyers, financial advisers, etc., they are given access to documents that concern only their roles in the due diligence process. This function helps to maintain the confidentiality of the documents and prevent unauthorized viewing. Also, VDRs allow multi-layered authentication to ensure a user’s identity. This helps to verify a user’s legitimacy before granting access and ensure maximum security.

Dynamic watermarking

This feature in a virtual data room helps to keep a document secure and reduces the risks of leaks. Some of the watermarks are customizable and serve as a fence that makes it hard to peruse a document, as it embeds certain information like who is viewing, location, and the time the document was viewed. It discourages unauthorized viewing and downloading, and allows a source to be traced easily if ever confidentiality is breached.

Secure printing

There might be a need to grant a user access to print some of the documents. Secure printing allows the client to easily print a document without permitting them to convert it into a PDF. This would ensure that the document is not saved on the user’s system, where it could be easily accessed by unauthorized persons. This feature helps to eliminate any intentional or unintentional breach of confidentiality.

Files to PDF conversion

This function allows for bulk uploads and conversion of documents to PDF formats for easy viewing. This ensures that all documents remain in their original state while the due diligence team interacts with them. It further makes it easy to track any changes made to the documents.

Sync with a web-based app

VDRs allow a seamless sync to other web-based platforms that are important to the due diligence process, such as a team-management platform, like Slack.

Q&A session

The Q&A session allows for an interaction process during due diligence, where the team can ask questions about certain documents and get clarified in real-time. It gives the team a chance to interact while making reference to the documents in question. It enables notification alerts, for questions to be immediately attended to, allowing for a smooth communication process.

The team can make better decisions based on the session, has in-depth information supplied almost immediately when it’s needed. This way, it makes it easier to spot targets who are truly interested in the deal, based on their depth of interaction with the supplied files, and helps to successfully close the deal in good time. You can as well be assured that all communication is secure. And it eliminates the need for more expensive physical interaction.

Expiry date

Like in a Physical Data Room, the due diligence process has a time frame. The same principles determine how long a user can access the documents on your VDR system. The system allows you to effect an expiry date when access to the VDR will be terminated. This can be done remotely after a determined period, or it could as well be predetermined before granting the user access.

It helps you to stay in charge of the entire due diligence process, even when most part of it is done virtually.

How to prepare a virtual data room for due diligence?

Are you ready to prepare your data room for due diligence? Here’s a guideline to follow as you prepare for data room due diligence:

1. Find the right data room provider

You should evaluate the features and functionality of the virtual data room providers. Ensure that your VDR provider is security-compliant. Avoid using the usual cloud storage so you don’t compromise on the confidentiality of your due diligence documents. Evaluate all the features for user control, security, intuitiveness, and document tracking, among others.

2. Determine what stage of the due diligence process you are

The VDR could be set up as a teaser for investors before the actual due diligence process begins, and confidential information is shared.

3. Follow a file structure using proper file-naming systems

Ensure the data is properly organized, ordered, and according to the existing file naming conventions. Set up all documents, indexed in alphabetical order according to the due diligence technique. It also helps to prepare you beforehand in case the investor or buyer has a due diligence checklist as well.

4. Group top-tier folders

Structure file folders by grouping files in major folders according to how important they are to the business operation. Start with the top-tier folders, which should be as few as possible. Then the top-tier folders should comprise different subfolders, detailing different categories of document, grouped in the order of their similarity.

5. Index files in a data room

This acts like a virtual table of contents where all the files are structured and numbered. This feature allows a user to easily find a required document. Use the checklist to organize your files alphabetically into folders and create subfolder structures under the same category but in different file groups. Indexing of documents, which allows for easy search, is readily automated on most VDR systems.

Ensure folders are properly organized for accessibility, and named in such a way that is comprehensible to the VDR users. Organizing your files should be based on industry standards, business structure, and models.

Don’t forget to scan all the physical documents that are critical to the due diligence process. Properly name them so they don’t get lost amongst other files, and the team that needs those documents can immediately identify them when needed.

6. Consider security

Determine who will access what files, the extent of their interaction with specific files, and if they’ll be able to download or print certain files. Ensure your VDR is security compliant and allows you to manage permissions and access.

You may also create group permissions for users, based on their team roles and how much data they need to have access to. Be sure to check all files thoroughly, so that only the right files are uploaded in each folder, to avoid leaking important information.

7. Add stakeholders

Add all stakeholders in the due diligence team to the data room, and group them appropriately. Consider the analysts to be onboarded, such as the bankers, advisers, and lawyers, on both sides of a deal. Accord to them the necessary access, effecting controls like edit, no-download, among others.

8. Run internal due diligence

It’s not unusual to find that some documents were missed in the prepping process. That’s why you should get some trusted team members to test the VDR beforehand. Running an internal due diligence would help you locate slips and omissions. It’s better that these are discovered and fixed before the actual due diligence process starts. This step also allows you to test the functionality of the VDR and lets you have a feel of how users interact with the system.

Due diligence data room checklist

The due diligence process can be really overwhelming if not duly prepared for. That’s why it’s important to make significant preparation for due diligence data room software for future use. It can be a daunting task for a physical data room; however, for a virtual data room, the documents can be stored for future use. At such time, when the need for due diligence arises, all that would be left would be to select only the important document required for that particular deal.

It’s important to prepare your due diligence data room beforehand so that all procedures can begin seamlessly, without causing any need for rush, which could lead to costly oversights. This due diligence checklist will help to prepare for acquirers or investors when the need arises. 

Here’s a list of due diligence documents you need in your data room:

  • Business information documents. This refers to all the documents that describe the incorporation of the company, such as permits and trade licenses. Some of these documents include certificates of incorporation, shareholder details, trademarks, all business licenses, employee contracts, tax documents, by-laws and amendments, list of business jurisdictions, schedule of property owned, and business offices and equipment facilities.
  • Financial information documents. The potential buyers will need to know how the business has fared financially in a minimum of three years, hence these documents are crucial to seal the deal. You’ll need to collate documents like financial statements, forecasts and plans, loan agreements, internal and external auditor’s report, ledger and trial balance for at least two fiscal years, prepaid assets and expenses, and other financial agreements.
  • Revenue information documents. This should entail documents detailing the revenue stream of the company. Include about five contracts from the current financial year, revenue details in the last one year, contract and billing details, sales force and structure of compensation, annual customer lists, and pipeline documents. It should also include cash flow statements, investment statements, and cash and cash equivalent balances.
  • Human resources (HR) documents. Provide documents regarding the work and people culture of the organization, such as employees, employee benefits, and independent contractors. Some of the documents are employee resumes, training programs, policies on leaves, holidays, and overtime, health and safety policy, list of benefits sponsored by the company, and appraisal policies.
  • Accounts receivable. This should include document schedules of receivable accounts based on their categories for the relevant period. Other documents include credit policy, credit collection procedures, past write-offs, analysis, and trend of period aging for interim and annual periods.
  • Intellectual property documents. You need to include all intellectual property (IP) document in your due diligence data room, its important to carefully itemize all IPs without missing any detail, as they are critical to the judgment of the due diligence analyst team. Some of the documents include trademarks, brand names, and logos, patents, valuation statements, proprietary technology owned, innovations and designs, domain names, technical data rights, copies of development projects, list of third-party software, details, and address of personnel responsible for managing trademark rights, product manuals, and documentation, etc.
  • Legal documents. Here, all important legal documentation concerning the company is filed such as loan agreements, lease agreements, legal cases, vendor agreements, power of attorney, warranties and guarantees, government litigation proceedings, etc.

Why do businesses use VDR for due diligence?

Using a virtual data room for due diligence greatly improves the mergers and acquisitions process. Well, you probably might have wondered why using VDR for conducting due diligence is so pivotal?  Here are some of the reasons:

  • Ease of access. You don’t have to wade through copies upon copies of a confidential document during due diligence. The system allows documents to be uploaded once and located on time. Hence, it takes less time to prepare and less time to access.
  • Minimal cost. The virtual due diligence software is cheaper to build and maintain over its short and long-term use. The latter attracts more cost implication in terms of several copies of documents, transportation cost, etc. Also, several deals could be closed, using the same VDR, and by granting different group access to participants. PDRs would require almost a new set-up for every new deal.
  • Parallel user-access. Different uses can work within the VDR from different locations simultaneously. They won’t have to wait endlessly for their turn to get access to the VDR. This ultimately hastens the process of the deal.
  • Secure use. Through the existing security measures, confidential documents are protected and their use monitored. It would prove difficult to do this effectively in the case of a PDR. Every activity is as well monitored such that administrators know who performed what actions in a VDR system.
  • Work on the go. Analysts can use filters to reach for important documents and use data analysis tools for easy workflow within the VDR system. This may be nearly impossible with a Physical Data Room.

To understand why data room for due diligence is a necessity, we need to understand what due diligence is.

In a nutshell, due diligence is a procedure in which the selling side exposes all the files associated with the transaction while the other side takes its time to examine the files in-depth. Commonly, the second side of partakers includes purchasers and financiers. A seller looks for space where due diligence is planned to be held: here come data room services, especially data room for due diligence  – environments designed for painless and risk-free preservation and exploration of the files.

The deal-maker may choose an analog depository or Web-based storage. These classes differ in many aspects which would be discussed soon. Notwithstanding, disregarding the nature due diligence data rooms accomplish the identical duty – these environments bridge owners with bidders and make it possible for them to hear one another. Usually, the papers shared inside any repository reflect five main dimensions of a company’s operation:

  • Financial
  • Legal
  • Operational
  • IT
  • Personnel

To browse the files a prospect user waits for the approval of the one who owns a data room due diligence: unwanted visitors expect zero chances to enter the depository without permission. Hence, owing to a data room, due diligence turns into a structured, safe and supervised stage. Nevertheless, the experience you get depends on whether you choose a land-based data room for due diligence or whether you give preference to virtual data rooms for mergers and acquisitions.

Advantages of due diligence data rooms

Since partakers exploit a virtual data room, due diligence moves to the cloud: the investigation occurs there. Unlike analog due diligence data rooms, a VDR for due diligence lets the prospect bidders view the copies directly from the laptops. It means that businessmen can forget about expensive and effort-demanding trips and can save their resources. Notwithstanding, the elimination of geographical borders and restrictions is not the only benefit virtual data room providers possess to surprise the users.

  • The VDR for due diligence proves to be open more quickly than a land-based repository. Considering no hard copies are required and no indexes are to be ascribed the VDR can be prepared within hours or sooner.
  • A due diligence virtual data room is characterized by a lower price in a contrast to an analog depository: it is frugally to open Web-based storage and to watch it.
  • While exploiting a virtual data room due diligence participants can work side by side: bidders are not forced to wait in line to get access to files as bidders in land-based depositories do.
  • Owing to a VDR due diligence runs faster as a seller is not obliged to wait while the engaged purchasers are waiting for their turn.
  • Because of a digital data room due diligence becomes rather riskless. Obviously, it proves to be pretty hard to steal a copy of a document from a PDR and security guards always know who and when entered the depository. But a Web-based service allows an administrator to use more tools to prevent any attacks and threats – encryption, special marks, scanning for malware, etc.
  • Every action of due diligence data rooms visitor is recorded. It means that the room supervisors know exactly who entered the repository and what sort of actions was performed. By no means could anyone copy or print files without permission and each step of a bidder would be reflected in an audit report.
  • It is easier and more comfy to exploit a cloud repository as it is full of instruments that make data analysis simple. Buyers can follow navigation hints and use search filters, can edit documents, etc.
  • Some data room providers develop applications that help bidders view files via their gadgets and work on-the-go. Hence, the deal accomplishment does not stop if a selected participant cannot attend the appointment.
  • One Internet-based repository is suitable for the accomplishment of several deals at once. As administrators can divide bidders into groups each group has permission to examine a selected pile of copies while the rest would never see those papers. Besides, it is enough to set up the cloud storage once to exploit this space for deals again.