Cut Legal Spend by Maintaining Diligence Materials ‘in the Cloud’
and an Ever-Ready Virtual Data Room
In this day and age, with the technologies currently available, no client - PE firm or strategic - should need to expend resources on external counsel to collect or review its agreements or other documents. At the very minimum, all clients should aspire to initiate and manage the diligence materials relating to their own portfolio assets electronically to minimize the use of law firm associates in the review, collection and organization of diligence materials.
After working with private equity firms (“PE firms”), one cannot help but develop a vision as to how these firms could reduce legal costs. Since the beginning of my legal career, I have been amazed at how much clients have spent on legal services during the process of acquiring, maintaining and divesting of companies, businesses and/or assets (each of the foregoing referred to as the “investment” or “portfolio asset”).
What has also amazed (even shocked) me is that a significant amount of the legal spend arises from PE firms using law firms to collect and review diligence materials relating to the very investments (the “diligence materials”) those firms intend to sell, especially during sales of businesses or “carve-out” transactions. The diligence materials are, of course, collected and reviewed so that law firms can aid their clients in establishing and building-out the virtual data rooms used by potential acquirors to value the portfolio assets. A PE firm should be able to maintain all of the diligence materials for each and every investment in a condition that would facilitate the efficient disposition of those investments.
I recall many transactions in which clients used junior law firm associates to review the clients’ files for all material contracts. In each case, once the material contracts were collected in a central location (e.g., a networked drive), then the law firm associates were tasked with categorizing the material contracts into the various (and typical) categories of contracts generally found in a “market” purchase and sale agreement for the disposition of the investment. Most people reading this post will know the categories, but, in any event, the categories generally include contracts with or relating to (1) top 10 customers, (2) top 10 suppliers, (3) most favored nations clauses, (4) non-competition clauses, (5) non-solicitation clauses and (6) joint venture agreements, among many other typical categories of material contracts.
In fact, there were other deal experiences in which clients, in consultation with the investment banking team but not the legal team, made the decision to provide only a sampling of the material contracts. So, inevitably, once diligence began in earnest and potential acquirors decided to really kick the proverbial tires of the portfolio asset, there was an all-hands-on-deck scramble to produce additional diligence materials. Again, most of the hands-on-deck scrambling were the hands of law firms associates, billing by the hour, and because there was “scrambling” or a “fire drill” involved, the work did not always benefit from forethought and planning intended to gain efficiencies in the review and organization of the diligence materials. These experiences necessary beg the question: How can diligence processes be managed more efficiently?
There are tech platform applications that facilitate the online life-cycle management of contracts and other documents, and such tech platforms can be easily be deployed by PE firms (and strategics). Consider:
- Apttus (https://apttus.com/)
- Cognitiv+ (http://www.cognitivplus.com/)
- Exari (https://www.exari.com/)
- Net Documents (https://www.netdocuments.com/en-us/)
Note that none of the platforms mentioned above have been tested or evaluated in terms of how well they could perform in the use case presented here. However, the published capabilities of these platforms suggest that the use case is feasible.
PE firms, in particular, are best poised to reframe how they manage diligence materials for their portfolio assets in order to minimize costs incurred in connection with managing (and optimizing) portfolio assets and, thereby, enhancing portfolio returns to the GP and LPs. A primary objective, or “best practices” standard, for PE firms is to minimize transaction costs and maximize returns to GP and LPs, all while mitigating commercial and legal risks.
The Vision: How could a PE firm organize and manage its contracts and other documents more efficiently in order to minimize the costs of acquiring, managing and divesting of their portfolio assets?
- Generally speaking, PE firms acquire investments - companies, businesses and /or assets – with certain targeted return objectives and hold periods identified. Firms, then, actually hold the investments for whatever period is necessary to realize the targeted return objectives or mitigate unforeseen losses. Hold periods typically vary from 3 to 7 years.
- The agreements used to document the sale (each a “purchase and sale agreement”) of investments generally have the same form or outline, though the agreements do vary from deal to deal for more complex transactions. That said, representations and warranties (“reps and warranties”) in such agreements are fairly similar from agreement to agreement.
- Reps and warranties serve as a form of confirmatory due diligence. The scopes of the reps and warranties, on the one hand, and the documents reviewed in diligence are parallel and go hand-in-hand. Visualized in the ideal state, the optimal document management system containing diligence materials relating to a portfolio asset should be an ever-ready virtual data room.
- An ever-ready virtual data room: PE firms should manage the diligence materials relating to their portfolio assets as if the firms could sell — or receive and evaluate offers to acquire — any of their portfolio assets at any given point in time, especially mid-market PE firms who have the most to gain by reducing transaction costs.
- What would it mean to implement an ever-ready virtual data room?
- All documents would be stored electronically. Each document (whether initiated by the portfolio company or one of its counterparties) would be originated through a cloud-based document management system that can track drafts, final versions and execution-related detail.
- The cloud-based document management system would be organized using the same index and nomenclature used with a virtual data room.
- The virtual data room, in turn, should mirror the order or outline of the reps and warranties in a typical purchase and sale agreement.
PE firm investments are acquired with an exit strategy in mind, whether that exit strategy involves a disposition in the form of a sale, an IPO or some other form; so, portfolio assets need to be acquired, managed and sold in a way that facilitates any such disposition, minimizes the costs associated with such disposition and minimizes the time required to effect any such disposition. Cloud-based document management systems make all this possible.
Finally, while the example used above is centered on the sale of portfolio assets of PE firms, the vision of an ever-ready virtual data room would be equally valuable in the case of an IPO or any other type of disposition, and the vision would be equally applicable to a strategics in the management of their businesses, subsidiaries and other assets.
#PracticeInnovation - #PrivateEquityEfficiencyGains - #PrivateEquityLegalSpend - #FrontierOfTheLaw