VDRs make due diligence document reviews easier for M&A bidders, but some drawbacks remain.

Inside Counsel
By Michael Kozubek
February 1, 2010

Performing due diligence in a merger or acquisition has become logistically easier in recent years through the use of virtual data and deal rooms (VDRs). The technology makes a target company’s centralized document repository available 24/7 to potential bidders via the Internet. VDRs can provide secure online access to business plans, projections, agreements, presentations, research, inventories and other sensitive information potential buyers need in shaping their offer.

Some experts say VDRs offer several advantages over the traditional method of inviting bidders to examine documents in a physical data room (PDR), including lower cost, faster completion of the deal and ability to better shield bidders from learning who they are bidding against.

But critics remain, with some M&A attorneys still preferring to examine physical documents. And even proponents acknowledge that in certain circumstances, a PDR, sometimes called a war room, may be needed to augment a VDR.

"Physical data rooms are not yet extinct," says Mark Greene, a partner at Cravath, Swaine & Moore.

Still, the VDR concept, which first emerged in the late 1980s when documents were shared on CDs, has clearly taken hold.

"Almost all deals are done using virtual data rooms today, even if there is a physical data room as well," says Jordan Ellington, president of TransPerfect Deal Interactive.

Cheaper and Faster

VDR vendors such as Ellington promote their lower up-front cost. They can eliminate document photocopying and indexing, as well as much of the travel costs associated with physical data rooms.

Once security levels are established, those reviewing the data can look at it from any computer. The systems make it easier to find information by offering keyword searching capability, Ellington says.

Because they can be accessed from anywhere, VDRs provide faster due diligence to bidders around the globe.

"Time is of the essence, so the faster and further you can cast your net in terms of potential buyers, the more you increase the likelihood of completing a deal sooner," Ellington says.

And while only one bidder can be in a PDR at a time, "With a virtual data room, you can have an unlimited number of potential bidders doing due diligence at the same time, which makes the process so much faster," says Dewey & LeBoeuf Partner Jane Ross.

Ross also points out that with VDRs the seller can maximize its leverage by keeping bidders in the dark about who else and how many others are bidding. Bidders have sometimes bumped into one another outside PDRs, she says, and careless use of sign-in sheets has allowed bidders to see who else has reviewed the documents.

"A VDR eliminates all of those potential pitfalls and thus gives a banker greater control over the information that bidders get about the amount and nature of the competition in the process," Ross says. "In addition, a VDR allows the target company to see exactly what information a bidder has looked at, giving it valuable information about the seriousness of a bidder."

Virtual Errors

Although VDRs are commonly used today, some assert the technology has its drawbacks.

"Marketers have convinced the clients that VDRs are cheaper," says Greene, who contends that review of physical data pays off in the long run. Greene says young associates make more mistakes when reviewing online text, especially when looking at large numbers of documents for hours in front of computer screens under tight time restraints. While VDRs can be set up to grant users the ability to print certain documents, Greene says they typically restrict printing.

"It is virtually certain that in the course of their visual review on the screen, young attorneys will miss things unless they take the time to print and review. The costs associated with errors [in review] could greatly outweigh the upfront cost savings of VDRs," says Greene.

But Ross says there is little need for printing documents that a reviewer can access online. "With a VDR, you can always call up a document from anywhere, in an airport, your home or your office," she says.

Even VDR proponents like Ross agree that physical data rooms still play a limited role in M&As. "They may provide benefit if there is a large volume of bulky documents that are difficult to scan," she says.

Brian Cabrera, general counsel of Synopsys Inc., which makes five to eight acquisitions or investments each year, says that although he is an advocate of VDRs, he remains cautious about over-reliance on technology without taking a closer look at a target.

Cabrera once sent an M&A attorney to Europe to size up a potential acquisition in person. "[I wanted to know] how busy they are. How full is the parking lot? How well organized is the office? And, of course, what is in the war room?" he says. The attorney discovered documents in the PDR that had not been included online.

Family Jewels

In choosing a VDR system, the same standards apply as with other computer systems—speed, security and reliability, including fail-safe procedures.

"The No. 1 concern for target companies is the accidental disclosure of information, including sensitive intellectual property information and the rest of the family jewels, to wrong parties," Ellington says. That can be avoided by encrypting data in PDF files and establishing different security levels allowing varying degrees of access for bidders, lawyers, accountants and investment bankers through the use of individual or group access settings.

Cabrera says that given the sensitive nature of the data, VDR providers should be SAS 70 compliant, meaning they have demonstrated that they have adequate safeguards when they host or process data belonging to their customers.

As for the potential for computers crashes, Ellington says information is duplicated interactively in multiple locations. "We recognize that downtime is very bad," he says. "Short periods can become very expensive."

Cabrera looks for VDRs to continue to evolve.

"This product space requires increased search tool features and also notification as to when and where new documents come on line in the data room," he says. "VDR tools without features such as these will be of limited use to those of us trying to ensure that we find any potential needles that may be in the haystacks of documents we review online."