The Importance of Disclosure Schedules In Mergers & Acquisitions
Disclosure schedules are an integral part of any merger or acquisition (M&A) transaction. They contain information required by the acquisition agreement—typically a listing of important contracts, intellectual property, employee information, and other materials as well as exceptions or qualifications to the detailed representations and warranties of the selling company contained in the acquisition agreement.
An incorrect or incomplete disclosure schedule could result in a breach of the acquisition agreement and possible significant liability to the selling company or its stockholders. Indeed, a well-drafted disclosure schedule will provide substantial protection against post-closing allegations that the selling company breached its representations and warranties.
Now, because poorly prepared disclosure schedules have the potential for significant liability, it is important that they are compiled in both a careful and thorough manner. Any disclosure schedule that is prepared at the last minute, is ikely to be incomplete or inadequate thus creating problems to closing a deal or bringing unnecessary risk into the transaction.
Typically, the process of producing a disclosure schedule is undertaken by employees of the selling company, together with an outside M&A legal counsel. However, the schedules can require a significant amount of time to produce, meaning that the initial drafting should be undertaken early on. It’s not unusual for disclosure schedules to go through a dozen or more drafts and negotiations with the buyer’s counsel.
Common Mistakes Made in Preparing the Disclosure Schedules
There are a number of mistakes that are frequently made by the selling company when it comes to the production and preparation of the disclosure schedules. Below is a list of the more common ones:
- The seller fails to include the right employees who have the necessary knowledge to assist in the preparation of the schedules. Although it is understandable for many reasons why a selling company limits the number of people that are aware of a possible deal, that small group frequently doesn’t have access to all the information necessary to complete the disclosure schedules.
- The seller fails to carefully review every sentence of each representation and warranty of the seller it makes in the acquisition agreement, to determine what is required for disclosure. The language and thresholds for disclosure are imperative and will be negotiated between buyer and seller. Ideally, thresholds will be established so that the burden of disclosure is not overwhelming.
- The capitalisation table is incomplete (such as incorrect amounts for stock, warrants, options, etc.).
- The schedule for subsidiaries of the company is incomplete or doesn’t list the jurisdiction of incorporation or percentage of the subsidiary owned.
- The list of material contracts is incomplete.
- The description of the material contracts is inadequate (such as including the wrong title of the contract, not listing all amendments to the contract etc.).
- The schedule of leases for the company does not contain all required information (such as title of the lease, landlord, date of lease, location etc.).
- The intellectual property disclosure is incomplete (such as missing information about patents, trademarks, service marks, domain names, etc.).
- The list of software used in the business (including any open source software) is incomplete.
- The schedule for employees is missing salary, bonus, or other key information.
- The schedules are missing the listing of any employment agreements or officer, director indemnification agreements.
- The schedules on the largest customers or suppliers are missing key data (such as dollar amounts involved or a description of the relationship).
- The disclosure schedule listing any key contracts that have a “change in control” provision is incomplete.
- The disclosure schedule listing all employee benefits is incomplete or not descriptive enough.
- The disclosure schedule for insurance policies is incomplete.
- There is an incomplete schedule of any required disclosures regarding litigation, arbitration, investigation, or other governmental proceedings.
- The schedule of any liens on the company’s assets is incomplete (such as failure to list the secured party, what contract it relates to, the date of the contract, and other relevant information).
- The tax disclosure schedule is incomplete (such as failing to disclose all income tax jurisdictions the company is subject to, any pending or past tax audits, any delinquent tax returns, or any unpaid tax liability).
- The disclosure schedule for bank accounts is incomplete.
- There are incomplete financial statements or liability disclosures, which are required by the seller’s financial representations and warranties.
Tips to Make the Preparation of the Disclosure Schedules Less Burdensome
Given that disclosure schedules are crucial, yet time consuming, here are a few tips:
- The seller has to start preparing the disclosure schedules very early on in a deal, even before the acquisition agreement is finalised.
- The seller’s management team has to be alerted to the high importance of the disclosure schedules.
- Key knowledgeable employees within the seller must be involved in the preparation process.
- The disclosures need to be coordinated and tied to what is contained within the seller’s online data room.
- Over-disclosure tends to be better than under-disclosure, but this has to be tempered with an understanding of the likely reaction to a disclosure from the buyer.
- Every new redlined draft of the acquisition agreement must be circulated to the parties involved in the preparation process, in order for the appropriate modifications to be made.
- The seller must be aware of developments in the business that may require updates to the disclosure schedules.
- The seller’s M&A counsel should qualify the seller’s representations and warranties as much as reasonably practical by including “materiality” and “knowledge” qualifiers, in order to make the preparation of the disclosure schedules less problematic.
- The seller’s M&A counsel also should endeavour to limit disclosures to lists of documents or matters, rather than descriptions of the contents of documents or matters (such as requiring a list of pending litigation rather than a description of each pending lawsuit); again, this approach reduces the work involved when preparing the disclosure schedules.
For more information about selling your business, contact our expert team at Benchmark International.