CHAPTER 1 THE DUE DILIGENCE PROCESS AND ITS IMPACT ON THE DEAL
| Jurisdiction | United States |
(Sept 2018)
THE DUE DILIGENCE PROCESS AND ITS IMPACT ON THE DEAL
Rocky Mountain Mineral Law Foundation
Westminster, Colorado
John Davis
Holland & Hart LLP
Salt Lake City, Utah
Updated by Wells Parker
Dorsey & Whitney LLP
Salt Lake City, Utah
Mark Burghardt
Dorsey & Whitney LLP
Salt Lake City, Utah
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WELLS S. PARKER is a partner in Dorsey & Whitney LLP's Salt Lake City, Utah office, where he practices in the firm's Mining and Natural Resources Practice Group, focusing on natural resources development, energy, and environmental law. His practice includes transactions involving the purchase and sale of public and private mining companies and mining assets, and he represents mining companies in capital-raising projects, mine finance, and royalty and mineral streaming transactions. He represents clients on mining and mineral leases, joint venture agreements, surface use agreements, state and federal permitting, and regulatory approvals. Wells is an active member of the Rocky Mountain Mineral Law Foundation. Wells has served as an instructor for several of the Foundation's Mining Law Short Courses, and presented and published papers at Foundation Special Institutes on Public Land Law, Regulation and Management in 2014, on Horizontal Oil & Gas Development in 2012, and on Due Diligence in Mining and Oil & Gas Transactions in 2010. Wells earned his JD from Brigham Young University and a BA from the University of Utah.
MARK L. BURGHARDT represents clients in the energy and natural resource industry in litigation, administrative hearings, and transactions. Mark engages with clients to prevent and solve issues with the location and development of their oil, gas, mining, and renewable energy projects. He has worked with companies on projects involving federal, state, private, and Indian lands. Mark has also represented clients in a wide range of transactions and joint ventures. He has litigated energy development and land use disputes in both federal and state court and has routinely appeared before Utah Board of Oil, Gas and Mining and the Utah Division of Environmental Quality.
SYNOPSIS
A. Introduction
B. The Acquisition & Divestiture Process
1. The Need for Speed
2. The Auction Type Bidding Process
3. The Impact of the Modern Era - Preparing for Due Diligence Before It Begins
C. Objectives of Due Diligence
1. Assumptions Underlying Bid Values
2. The Purchaser's Future Plans
3. Issues That Affect Deal Terms
D. The Planning Phase
1. The Client Meeting - Considerations in Planning Due Diligence
2. Financial Statement Review
3. Public Company Filings, Technical Reports
4. Establishing Materiality
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5. The Due Diligence Checklist and Request List
6. Expertise and Team Resources
7. Deal Terms
8. Confidentiality and Access
9. Agreement on the Scope of the Review and Timeline
E. The Information Gathering and Review Phase
1. The Process Manager and Team Leaders
2. Collecting and Organizing Information
3. Due Diligence Evidence
F. The Documentation and Reporting Phase
1. Standards of Documentation
2. Informal Reports of Findings
3. Real Time Reports of Material Findings
4. Formal Due Diligence Reports
G. The Impact of Due Diligence on the Deal
A. Introduction
Early in their career, all natural resources transactional attorneys, landmen and environmental consultants are faced with their first due diligence project. Typically the attorney, landman, or consultant is provided with access to a data site, a key drive of documents or a box of paper documents, and is asked to conduct a review. The attorney, landman or consultant is generally provided with a laundry list of legal, title or environmental issues to look for and is told the common refrain "You'll know it when you find it."
In many ways, transactional due diligence is a modern-day treasure hunt, in which a team of attorneys, landmen and consultants search through documents and conduct site visits and target interviews in an effort to uncover important issues affecting the proposed transaction. This Special Institute is designed to provide the individuals leading due diligence projects with the strategies and tools to organize an effective due diligence process, and to help newer attorneys, landmen and consultants better understand the specific issues that might arise in their due diligence review, so that they will know and understand what they are looking for, before they find it.
The Rocky Mountain Mineral Law Foundation hosted its first Special Institute on Due Diligence in Mining and Oil and Gas Transactions in April of 2010. As part of the Special Institute in 2010 Alex Ritchie and John Davis published The Due Diligence Process And Its Impact On The Deal: A Primer On Bayoneting The Wounded1 , which we have updated for this Special Institute. Consistent with Alex and John's 2010 paper, the purposes of this paper is to provide an overview of the due diligence process, particularly in large transactions, where the process can be the
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difference between a successful and unsuccessful acquisition.2 After introducing changes in the way technology has impacted the due diligence process, this paper provides strategies to navigate the various phases of due diligence: (1) planning, (2) information gathering and review, and (3) documentation and reporting.
B. The Acquisition & Divestiture Process
1. The Need for Speed
Over the last 15 years, the accessibility of information has dramatically increased the speed of transactions and, by necessity, the speed at which due diligence is completed. Virtual data rooms have made information immediately accessible upon the execution of a letter of intent (or in some cases, upon little more than an expression of an interest and the execution of a confidentiality agreement). Brokers and business development executives are incentivized to close a deal quickly before the deal dies as a result of cold feet, better bids from competitors, re-trading of the purchase price, overstress on the existing business or operations, market criticism, changes in commodity prices, or the much maligned "deal killer," which can be an unacceptable deal term demanded or refused by the other party or, in some cases, an issue discovered in due diligence.
In the past economic downturns, such as the U.S. financial and banking crisis in 2007-2008 have caused greater care and thoroughness in due diligence.3 Similarly, and more recently, the #MeToo movement over the last year has caused a renewed emphasis on social due diligence focusing on human resource and labor issues within target companies.4 However, with nearly eight years of economic growth in the United States, due diligence in M&A transactions is moving as quickly as ever with emphasis on fast and efficient due diligence that moves a transactions toward a successful closing.5
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2. The Auction Type Bidding Process
The use of an investment banker and an electronic data room in an auction type bidding process has become more prevalent in recent years as companies seek to maximize bid values when divesting of assets or businesses. When representing companies planning a divestiture, investment bankers often drive the transaction, and begin the divestiture process with "kick off" meetings with the divesting company's key management personnel and counsel. These "kick off" meetings generally include the distribution of a standard data room information checklist. This checklist may require land, reserve, production, engineering, and operational data, and may even require the provision of an ARIES database that will allow a potential bidder's engineers and analysts to run their own projected cash flow models. Once collected and provided by the seller to the investment banker, these "evaluation" materials and data are used by the investment banker to prepare an offering document and to populate an electronic data room. The electronic data room may also contain a proposed purchase agreement drafted by seller's counsel and reflecting the comments of the seller and the investment banker. In many bid processes the purchase and sale agreement drafted by seller's counsel is generally more aggressively seller-favorable than desired by the investment banker. The investment banker may argue that the draft agreement is not "market," and counsel often argues that it will be market, after the bidders and their counsel provide comments.
After distribution of the offering document, bidders that execute a confidentiality agreement usually are then permitted to access the "evaluation" materials and data to prepare their bids. Once bids are submitted with a markup of the draft purchase agreement, the seller evaluates the bids with input from the investment banker and its counsel. Although the seller's investment banker and the business development executives often emphasize price and speed to closing, other executives and seller's counsel may attempt to redirect at least some focus of the evaluation on other factors, such as accuracy and completeness of the assets listed, liabilities to be assumed or retained, the financial strength of the bidder and the bidder's plans for the seller's employees.
Assuming the investment banker has properly eliminated from the process those bidders that are on "fishing expeditions" without a clear investment motive or management buy-in to proceed, the seller and the winning bidder may execute a letter of intent or may proceed directly to the negotiation and execution of a purchase agreement, in which case the seller will attempt to hold the winning bidder to its markup draft of the purchase agreement. In many transactions, the bidding parties, in an effort to be viewed as the most favorable bid, are encouraged by their investment banker and business development executives to...
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