An end to the paper chase

GPs are increasingly using virtual data rooms for more than just M&A transactions. By Marlin Piscitelli, Merrill Corporation

Merlin Piscitelli is director of International DataSite, a division of Merrill Corporation that provides hosted virtual data rooms. He can be reached at

Despite the economic doom and gloom, it's worth noting that the past few months have still resulted in a significant volume of transactions. For example, in Europe alone, according to Mergermarket, the first six months of 2008 saw 2,781 M&A deals announced worth a whopping €463 billion. Tough markets often present strong businesses – particularly in the private equity sphere – with deal making opportunities as cash-rich buyers can take advantage of soft valuations.

But nonetheless it is undeniable there has been a significant decline in the number of transactions compared to the height of the boom in early 2007. Given this, while some private equity houses are continuing to look out for good-value deals, most are retrenching and concentrating on steering their portfolio companies through these difficult times.

The emergence of the virtual data room
The central question facing many GPs with regard to their portfolio companies is: how do we stay on top of all the complex challenges facing them and ensure they continue to achieve their maximum value? As providers of virtual data rooms (VDRs), we believe this technology may provide an answer.

VDRs are already used by many private equity firms as a matter of course on M&A transactions in the US and adoption is increasing in Europe too—at 100 percent per annum for the last few years. Our most recent research found that over 80 percent of private equity executives would consider using a VDR for due diligence, whether on the buy-side or sell-side, and over one-fifth would use one for postdeal integration.

The latter use demonstrates that VDRs are not simply a technology to be deployed on a one-off project basis. Private equity firms are beginning to appreciate their value for more long-term uses through the financial lifecycle.

Those firms looking to raise new funds, for example, are favouring VDRs as a way of placing a comprehensive amount of information securely online, allowing it to reach a much larger—and potentially global—investing base faster and more efficiently. Increasingly private equity firms are utilising VDRs for portfolio management too.

We're seeing these trends grow in Europe, particularly during these more straitened economic times. Fundamental to this is the fact that VDRs ease communication between private equity firms, portfolio companies and investors. Merrill DataSite's integrated Q&A Forum, for instance, allows investors or advisors to post queries which are logged and available for the firm to respond to promptly. This improves investor relations and ultimately could lead to enhanced engagement and investment in funds.

The end of the paper chase
In simple terms, a VDR is an online document repository for a company's secure documents which need to be reviewed by multiple parties. While the due diligence process is the obvious moment in which to use a VDR, there is no reason why it should not be viewed as a user-friendly content management system for any important paperwork.

Traditionally a private equity firm's portfolio management involves huge amounts of printed paper files, with regular reporting between the portfolio companies' management and the GP, and financial accounts to be scrutinised and approved.

The drawbacks to this don't need too much explanation. Printing, collating and reviewing everything in this ‘paper chase’ is a cumbersome, expensive and slow way of doing things. For a start, the amount of paper involved is huge—often thousands of pages each quarter for an average private equity firm across its entire portfolio. For both the portfolio company and the PE firm, collecting this material, ordering it, indexing it and reading it all takes a long time.

With a VDR you can have those pages loaded, fully searchable and available for view in a few hours. Private equity firms can also manage their portfolio companies with regularly scheduled document submissions, to aid in effective benchmarking and execution of goals.

Supporting the expansion into emerging markets
As private equity firms become increasingly global and portfolio companies more widely dispersed, we expect VDRs to come into their own in this regard. As we know, the economies in North America and Western Europe are predicted to be flat over the next couple of years, with most transaction activity expected to come from emerging economies, and indeed GPs in New York and London are increasingly looking to acquire businesses in higher-growth markets in Eastern Europe, South America and Asia. With this need to diversify across the world comes the worry about buying businesses that may underperform and suffer from being ‘out of sight, out of mind’. But because they are accessible securely from a computer anywhere in the world, VDRs allow PE firms to easily review material from portfolio companies in these countries.

Adding value over the long term
The current economic climate – where there is less market appetite for quick and easy acquisitions – has led to a major change in how private equity firms are managing their portfolios. Research commissioned by Merrill DataSite and carried out by Mergermarket earlier this year found that 69 percent of private equity executives thought agreed acquisitions would make up the bulk of global M&A activity over the coming year, against just 13 percent who said hostile bids would do so.

In tune with this, therefore, there is an increasing emphasis on preparing companies early for an exit and ensuring that everything is geared to making a disposal to a friendly party as simple as possible – what's known as ‘asset readiness’.

Indeed, in a recent study, Ernst & Young emphasized that early preparation – building a culture and infrastructure well in advance of any liquidation/exit – pays off. Fully 50 percent of IPO “market out-performers” were described as being “well prepared,” compared to 33 percent of all other companies. These principles, of course, hold true for private sales as well.

Market paranoia has increased substantially in the past year and a half. Even businesses once considered dependably solid are scrutinised carefully by potential bidders. If this applies to once-major banks and insurance companies, it applies even more to small cap or mid-market businesses of the sort owned by many PE firms. Reputation alone is not enough to assist a sale. Business fundamentals have to be proved – and equally they must be easy to prove.

By loading a company's documentation onto a VDR from the start, the vendor gives it the opportunity to be as transparent as possible. This removes the problem of having to rush to demonstrate sound financials to an interested party, a process which often takes up valuable time. In the current environment, when time is of the essence, anything which shortens the deal completion span is welcome and potentially important.

Perhaps just as importantly from the point of view of the acquiring company, having all documentation on a VDR smoothes over the transition process. A VDR can hold not just financial information, but also details on personnel, assets, and other crucial business elements. Frequently this information can get lost between one business owner and another. Valuable employees can feel neglected by new management; certain assets can be ignored in favour of others; existing legal contracts can be forgotten and emerge later to hinder the business.

By ensuring this information is held in one place, fully visible and searchable, private equity firms make the acquisition of one of their businesses a much less painful process. This helps build trust and encourage confidence with the bidder, and could ultimately lead to a faster – and more valuable – transaction.

Tackling regulation and compliance
Finally, there is a regulatory benefit for private equity houses in using VDRs too. Because deals nowadays are subject to international regulations and stringent audit criteria – which require advisors not only to follow the rules, but to demonstrate that they have done so – a VDR is an ideal vehicle for compliance. The onus on high quality documentation at the due diligence stage will only increase as the regulatory environment responds to the credit crisis with an even tighter set of standards.

The Merrill DataSite solution provides secure, permission-based access to all parties. They also provide the capacity to track individual activity and log who has read a particular document, as well as when and for how long (down to the second). This has obvious benefits during due diligence – where sellers can see who is spending most time looking at particular documents, allowing them to identifying the really interested bidders from those merely looking, and respond accordingly. It also means that VDRs are ideal for monitoring and auditing, enabling companies to meet compliance requirements through the proof of disclosure that this tracking data provides.

“VDRs are not simply a technology to be deployed on a one-off project basis. Private equity firms are beginning to appreciate their value for more longterm uses through the financial lifecycle”

Equally, this applies to reporting performance to LPs and securing approval of portfolio companies' accounts. When using printed paper, reports from portfolio companies could easily get lost in the post, or buried beneath a pile of similar documents. Important information could be missed. From the GP's point of view, they might not know they have not received a particular document. From a portfolio company's point of view, they don't necessarily know if a document has been received. A VDR solves both these problems – either party, with the relevant approval, can load all necessary pages onto the system, alert its partners, and track whether they have viewed the page or not.

There is no doubt that the economic environment has changed beyond anyone's expectations over the past 18 months. New challenges have emerged at unprecedented speed and have provided considerable hurdles even to established, well-run businesses. It is hard even for the most experienced PE firm to keep abreast of all the difficulties its portfolio companies and funds are facing. Nonetheless we believe that the ability of VDRs to respond effectively to these challenges – where access to information, promptly and accurately, is crucial – means VDR adoption could be a key element in helping drive market momentum during uncertain times ahead.