The Importance of Disclosure Schedules in Mergers and Acquisitions
Disclosure schedules are an integral part of any merger or acquisition (M&A) transaction. The disclosure schedules contain information required by the acquisition agreement—typically a listing of important contracts, intellectual property, employee information, and other material matters 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 potentially 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.
Because poorly prepared disclosure schedules have the potential for significant liability, it is important that they be compiled carefully and thoroughly. Disclosure schedules prepared at the last minute are likely to be incomplete or inadequate, creating problems to closing a deal or injecting unnecessary risk into the transaction.
Typically, the disclosure schedule process is undertaken by employees of the selling company together with outside M&A legal counsel. But the disclosure schedules can require a significant amount of time to assemble, and the initial drafting should be undertaken early on. It is not uncommon 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 often made by a selling company in preparing the disclosure schedules. Here is a list of the more common ones:
- The seller fails to include the right employees who have the knowledge necessary to assist in the preparation of the disclosure schedules. Although it is understandable for many reasons why a selling company limits to a very small number of people the group which is aware of a possible deal, that small group frequently does not have access to all the information necessary to complete the disclosure schedules.
- The seller fails to carefully review every sentence of every representation and warranty of the seller in the acquisition agreement, to determine what is required to be disclosed. The language and thresholds for disclosure are extremely important, and will be negotiated between buyer and seller. Ideally, thresholds will be established so that the burden of disclosure is not overwhelming (e.g., requiring disclosure of any contracts over $500,000, as opposed to disclosure of any contracts).
- The capitalization 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, or not listing the parties to the contract).
- The schedule of leases for the company does not contain all required information (such as title of the lease, landlord, date of lease, location, rent and other payments, security deposit, 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 or 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 benefit plans (medical, dental, vision, life insurance, disability, stock options, bonus plans, ERISA plans, 401(k) plans, PTO plans, etc.) are incomplete or not descriptive enough.
- The disclosure schedule for insurance policies is incomplete (such as missing information on the type of insurance, the carrier, the policy number, the term, the deductible, and the annual premium).
- 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 (such as missing information about the type of account, the account number, the bank, and the authorized signatories).
- There are incomplete financial statements or liability disclosure, 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 so important but yet so time consuming to prepare, here are a few tips based on my experience:
- The seller has to start preparing the disclosure schedules very early on in a deal, even before the acquisition agreement is finalized. At the end of this article, I link to a template that the seller can start with, and then modify as the acquisition agreement is finalized.
- Management team of the seller has to be alerted as to the high importance of the disclosure schedules.
- Key knowledgeable employees within the seller have to be involved in the preparation of the schedules.
- The disclosures need to be coordinated and tied in to what is contained in 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 preparation of the disclosure schedules, so that they can make appropriate modifications.
- The seller must be cognizant of developments in the business that may require updates to the disclosure schedules (such as new contracts, new litigation, new intellectual property developed, etc.).
- The seller’s M&A counsel has to qualify as much as reasonably practical the representations and warranties of the seller in the acquisition agreement by “materiality” and “knowledge” qualifiers, so as to make the disclosure schedules less problematic to prepare.
- The seller’s M&A counsel also should endeavor 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 lessens the work involved in preparing the disclosure schedules.
Sample Template of Disclosure Schedules
Below is a link to a sample template of disclosure schedules that will often be required for an M&A transaction. Note that the exact scope and language of the schedules can be subject to extensive negotiation, and thus the final form of the disclosure schedules will often vary significantly from what is contained below. But this is a good starting point for the seller’s employees to prepare the first draft of the disclosure schedules. The disclaimers at the beginning of the disclosure schedules are important.
For a comprehensive book on M&A, see Mergers and Acquisitions of Privately Held Companies: Analysis, Forms, and Agreements.
Copyright © by Richard D. Harroch. All Rights Reserved. Many thanks to Richard Smith, an M&A partner at Orrick, Herrington & Sutfcliffe, for his helpful input into this article.
Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a large venture capital fund in the San Francisco area. His focus is on investing in Internet and digital media companies, and he was the founder of several Internet companies. His articles have appeared online in Forbes, Fortune, MSN, Yahoo, FoxBusiness, and AllBusiness.com. Richard is the author of several books on startups and entrepreneurship as well as the co-author of Poker for Dummies and a Wall Street Journal-bestselling book on small business. He was also a corporate partner at the law firm of Orrick, Herrington & Sutcliffe, with experience in startups, mergers and acquisitions, strategic alliances, and venture capital.
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