Virtual Data Room

Due diligence means checking a company's claims against its records. Those records are confidential, voluminous and spread across the business. The company needs one controlled place to put them where the investor's teams can work through them.

That place is the virtual data room. Once due diligence review begins, "the investee company begins the process by providing more detailed confidential information in what is typically referred to as a 'virtual data room' to the investment team".

It is the point at which the fund moves from what the company says about itself — in the teaser, the information memorandum and the management presentation — to what its documents actually show.

When it opens. The due diligence review (DDR) "does not commence unless the term sheet is executed by both parties". The data room is therefore a post-term-sheet step.

What goes in it. The workbook's examples of data room records:

• constitutional documents such as the memorandum and articles;
• board minutes and reports;
• books of account, tax returns, invoices, purchase orders and payroll statements;
• statutory filings;
• owned and leased property agreements;
• intellectual property documentation;
• employee lists and employment agreements;
• detailed segment financial information;
• historical audited financials.

How it is used.

1. The DDR teams draw up a schedule in consultation with the investee company's officials to conduct further discussions.
2. Follow-up due diligence calls are held, under the supervision of the investment bankers, with specific members of the executive and non-executive management team.
3. Based on the data room files, the deal team starts brainstorming the critical issues that often require fine-tuning of the deal structure or conditions precedent.

Who works from it. The three DDR components — business, commercial and technical DDR (normally by the investment team itself), financial DDR (usually by an accounting firm or investment bank engaged by the manager) and legal DDR (normally by a law firm practising corporate and transaction law).

What comes out. Confidential DDR reports to the investment manager. A copy is generally not made available to the company, though extracts may be sent for clarification. Findings feed a refined financial model and may lead to renegotiation and a revised final term sheet.

Illustrative figures. Deccan Consumer Fund II and Nagpur Agro Foods sign the term sheet with a 90-day exclusivity period. In week 1 the company opens a virtual data room with about 2,300 documents in folders mirroring the workbook's list.

None of this was in the CIM. In week 7 the deal team brainstorms the issues: the trademark must be assigned to the company as a condition precedent to the investment; the distributor arrangement must move to arm's length terms; and the valuation range comes down by Rs 20 crore to reflect the lower plant utilisation. These changes go into a revised final term sheet, which becomes the basis for the definitive agreements.

Chapter 7 (Investment Process and Governance of Funds) describes the virtual data room at 7.2 (Due Diligence Review), immediately after stating that DDR does not commence until the term sheet is executed. Expect a question on what kinds of records are placed in it, on when it comes into the process, and on how its findings lead to changes in deal structure or conditions precedent.

• The data room comes after the term sheet. The DDR does not commence unless the term sheet is executed by both parties.
• The investee company provides it, to the investment team. It is not the fund's own document store.
• Follow-up due diligence calls are supervised by the investment bankers.
• DDR reports go to the investment manager and are generally not shared with the company — only extracts, where clarification is needed.
• Do not confuse it with the CIM. The Confidential Information Memorandum is a prepared document received after an NDA; the data room holds the underlying records.
• Data-room findings commonly change conditions precedent and deal structure, and can lead to renegotiation of the term sheet.