Why “Due Diligence” Doesn’t Have to Make You Cringe: Contract Drafting & Systems Tips to Prepare in Advance

By Allison Hushek on August 20, 2024

Due diligence (“DD”) is a review process that allows a potential acquirer, merger partner, investor or lender (for convenience, an “Acquirer”) to identify and assess risks, liabilities and business issues in the target company (“Target”) before finalizing a transaction.

DD Checklist. Typically, a 10-page checklist is sent to the Target by the Acquirer to assemble and drop requested documents into an online, protected data room. Those documents generally consist of financial reports, debt documents, assets lists, governing instruments, tax filings, sales & marketing materials, IT documents, intellectual property filings, facilities & real estate contracts, top revenue generating agreements, top expense agreements, employee & HR matters, licenses & permits, insurance policies, and pending or threatened litigation summaries. After the Acquirer receives the first round of documents in the data room, they may continue to issue DD checklists to Target based on questions they have about what they’ve reviewed thus far.

The Challenge. The difficulty in assembling the DD checklist is that you have to continue with day-to-day operations of the business, and you may not be able to delegate per usual because the potential transaction is highly confidential. In addition, you may have to assemble charts that don’t exist, which can take a lot of time and focus. For example, the Acquirer will ask for a chart of all material, live agreements that contain the following encumbrances on the Target: anti-assignment clauses, change of control encumbrances, noncompetes, nonsolicitations, other restrictive covenants (e.g., rights of first refusal or first offer), most favored nation (“MFN”) language, no termination outside a 60-day notice period, extensive post-termination transition services obligations, and other unusual consents or notices. If you assembled this chart 2 years earlier, it may be outdated because contract expirations occur along the way and because a particular partner may not be a top revenue generator anymore. So it has to be created in DD.

Preparation: Contract Drafting & Systems. DD can be less painful if you prepare as much as you can during the times you are not under DD. Below is a list of considerations for in-house lawyers to make DD easier with respect to agreements:

1)      Uniform templates and title paragraphs. When reviewing multiple contracts during DD, it’s a lot quicker to review uniformed contract templates. It’s also helpful to title paragraph headings in contracts (e.g., Assignment; Right of First Refusal; Termination; Exclusivity; MFN).

2)      Minimize encumbrance clauses. If there’s ever an excuse to refuse to agree to a clause the other party is requesting be included in a contract during negotiations, it’s the thought of DD. Create informal company policies for business units and the legal team that prohibit inclusion of restrictive covenants and encumbrances unless approved by one of the top three company execs, for instance.

3)      Centralize signatures. Oftentimes if there’s not a centralized signature process for contracts at a company, business units will enter into agreements with their own signatures, forget to forward it along, and the finance and legal teams have no idea those contracts exist. It’s key to have a centralized signature process to ensure DD isn’t excluding any critical information the Acquirer should be apprised of for the transaction.

4)      Digitally store executed contracts. All signed contracts should be stored digitally in a share drive under a logical folder system with limited access to select individuals. This will allow you to quickly copy and paste certain agreements into the data room in accordance with the DD checklist. It would be extra helpful if agreements no longer in effect are in an “Archived” subfolder because the Acquirer primarily focuses on live contracts.

Conclusion. I’m not going to sweet talk you into believing preparation rids the pain of DD. The process is painful. But enacting a few steps along the way can make it much smoother to where you don’t feel like you’re drowning, and you can potentially look forward to the new era post transaction. 

Playbook Law is a solo firm providing General Counsel Services for Startups and Interim In-House Counsel for Established Companies in the Technology, Gaming, Entertainment + Sports industries.

This blog is provided for information purposes only and does not constitute legal advice and is not intended to form an attorney-client relationship.

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