I have yet to meet a client that enjoys populating a data room with its documents. Record-keeping is not fun at the best of times, and exposing all of one’s records for someone else to dissect and question can be an unpleasant exercise. So, it’s never particularly surprising when data rooms are populated with piles of information and minimal effort is put into organizational principles or even basic numbering. But data rooms matter, and with the shifting landscape for M&A, they matter an increasing amount.
Data rooms and sand-bagging
One of the major negotiation points that I have seen recently relates to something the industry calls “sand-bagging”. As someone from a place where sand-bags are primarily used to stop floodwaters, this terminology was originally confusing to me, but it works like this:
If you and I are entering into a transaction in which I sell you my company, I will have to make a bunch of statements about what you are getting and you will be able to hold me to those statements. If I get something wrong, you can typically sue me for damages from that error. These are your standard representations and warranties and the accompanying indemnification. Now what happens if you knew my representation or warranty was incorrect prior to agreeing to the terms with me? Specifically, should you be able to sue me for the breach even though you knew about it before signing? To do so is called sand-bagging. A clause that specifically allows you to do that is a pro-sand-bagging clause. A clause prohibiting it is an anti-sand-bagging clause. To this day, I do not know why it is represented by a sand-bag.
So why do data rooms matter?
But enough of Deal Mechanics 101. What does this have to do with your data room? Well, the way that purchasers typically find out about breaches of representations and warranties ahead of time is through diligence, including a thorough review of what is contained in the data room. Data room disclosures may reveal that the target is offside labour laws, has an environmental issue or has mistakes in its shareholder ledger. Typically, as well, the argument goes that the purchaser is supposed to know everything in the data room.
So, when we get to the point in the negotiation where the seller is asking my purchaser client not to claim for breaches of representations and warranties because the information was already disclosed in the data room, if the data room is a mess, my response, which is quite often persuasive, is that the data room has been populated so sporadically, haphazardly or generally unhelpfully that the notion that my client knows everything in it is inaccurate through no fault of my client. At that point, the seller is either left defending the merits of a data room that was quickly thrown together, or the seller is conceding the point, neither of which are helpful to the seller.
Contrast that with a well-maintained data room. In that situation, a seller could come to me and say “You’ve had all of this information from day one, it has been organized for your ease of reference, and we have promptly answered any further inquiries from you. How can you say you don’t know what is in there?” Granted, if the seller lacks bargaining power, the seller may lose the point anyway. But in this situation, I’d have to tell my purchaser client that the seller has made a good point.
Do the work up-front
Sometimes the steps we take to complete a transaction feel like they are just moving a bunch of paper around, and consequently it can be easy to do the minimum required to get the deal done. Setting up and maintaining a data room with foresight and attention to detail, however, can help you get better terms for your deal and ultimately leave you with a better outcome. Sometimes it’s just a matter of putting in work at the beginning to reap the rewards later on.
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