september 2011 acc docket due diligence & your m&a success story fletcher gottfried
DESCRIPTION
Tips on executing a successful M&A due diligence planTRANSCRIPT
INSIDE:Canadian Briefings
September 2011
Due Diligence and M&A / IP in Joint Ventures / Importer Loopholes / Legal Cost ContainmentIn-house Defendants / Wastewater Violations / Legal Hold Workflow
CONTRACT, COPYRIGHT AND TRADEMARK LAW
ACC Docket 35 September 2011
&BY FRANK FLETCHER AND KEITH E. GOTTFRIED
You are in-house counsel at MidSize Software
Corporation, a leading publicly-held developer
and marketer of computer software based in
California’s Silicon Valley. MidSize has a market
capitalization of approximately $300 million.
Over the preceding fiscal year, MidSize had
almost an equivalent amount of revenue, which
means the stock market is valuing MidSize at
approximately one times its most recent fiscal
year revenue. There is a consensus among
management that MidSize’s stock price does not
reflect its intrinsic value or its growth prospects.
Your CEO has decided that MidSize needs to
grow by acquisition. She envisions a “roll-up”
strategy where MidSize would acquire relatively
small privately-held software companies that
can be acquired and integrated quickly, thus
expanding MidSize’s annual revenue.
Due Diligence
Your M&A Success Story
ACC Docket 36 September 2011
paid a flat royalty equivalent to 20 percent of
the purchase price for each unit of software
sold by TargetCo. Next, you receive a letter
from an investment banking firm that had
been retained by TargetCo in connection
with its efforts to find a buyer but was
subsequently terminated three months later
and replaced by another investment banking
firm. Attached to the letter is an agreement
that requires TargetCo to pay the investment
banking firm 3 percent of the aggregate
consideration paid for TargetCo in the event
that it was sold during the 12 months follow-
ing the termination of the agreement, which
did in fact occur. You also begin to receive
notices from collection agencies seeking
payment on behalf of the target’s vendors
for invoices that were not paid. That amount
quickly aggregates into millions of dollars
and explains why TargetCo has as much
cash as it does on its balance sheet. Unfor-
tunately, none of these invoices had been
recorded as accounts payable, and much
of TargetCo’s cash will be needed to pay
these invoices. As you begin to consolidate
TargetCo’s trademark portfolio, you discover
that although TargetCo’s trademarks are
indicated as registered on the software pack-
aging, none of the trademarks have been
registered in the United States, but rather
they are registered only in a few foreign
countries. Further, one of TargetCo’s prod-
ucts, a virus protection program promoted
as the best in the business, is discovered to
have had a programming flaw that prevents
it from detecting computer viruses. While a
patch is quickly developed and made avail-
able to all customers, it is too late for some
customers — a virus has already corrupted
their computer network. As a result of the
virus, tens of millions of dollars in damages
are incurred by affected customers. The product liability
lawsuits are filed in rapid succession across the country.
Next, a US Government agency indicates that it believes
TargetCo had been overcharging it for custom software de-
velopment work, and has filed a debarment action against
TargetCo to prevent it from doing business with any agency
or instrumentality of the US government, one of the largest
customers of both TargetCo and MidSize. You also now
start to hear rumors of some overseas payments, made to
facilitate the completion of contracts with several inter-
national governmental organizations, and your outside
The first target, TargetCo, is a small
privately-held venture-backed start-up with
products that are complementary to Mid-
Size’s offerings. While TargetCo is not cheap,
your CEO believes that as long as TargetCo
brings to MidSize the revenue it forecast, or
even an amount relatively close to that num-
ber, and given the synergies and earnings
accretion that are expected to be generated
from the acquisition of TargetCo, the acquisi-
tion should be a “home run” even if MidSize
pays a “full price” for TargetCo. Your CEO,
however, adds as a caveat that she is assum-
ing no “landmines” will be uncovered post-
acquisition. TargetCo has told MidSize that
other companies are lining up to make offers
so MidSize believes that it needs to move
quickly. Your CEO makes an offer which is
accepted by TargetCo.
Your CEO takes you aside and instructs
you to get this deal closed as soon as possible
so that MidSize can announce the deal and
demonstrate to its investors its commitment
to growth by acquisition. You are told to
get M&A counsel engaged yesterday and to
focus your efforts on negotiating the acqui-
sition agreement. You ask the CEO about
forming a due diligence team and adding
consultants, accountants and other industry
experts, and the CEO tells you that there is
“no time to waste needlessly kicking tires
and overlawyering the transaction.” You
easily meet the CEO’s accelerated schedule
for negotiating the acquisition agreement.
Following the approval of the acquisition
agreement by MidSize’s board, it is executed
by MidSize and TargetCo. The transaction
is structured as a simultaneous signing and
closing so it is consummated upon signing.
Your CEO congratulates you on completing
the acquisition of TargetCo. You are celebrat-
ed throughout the company as its “superstar M&A lawyer”
and as the “can do” lawyer who “gets deals done.” When
you are in ear shot, the CEO often comments loudly, “there
goes my favorite lawyer!”
Unfortunately, these halcyon days are short-lived, as
your “stock” is about to crash. Fast-forward 60 days follow-
ing the acquisition of TargetCo by MidSize. You receive
a letter from one of the major patent troll firms politely
asking you to enter into a patent license since allegedly
TargetCo’s software infringes on a few of their patents. In
connection with the license, the patent troll is seeking to be
FRANK FLETCHER is the general counsel of Nero AG, a developer of
platform-neutral software technology for editing and
managing video, music, photos and other multimedia, which is headquartered in Karlsbad,
Germany with subsidiaries in Hangzhou, China; Yokohama,
Japan; and Glendale, California. Fletcher is responsible for all
aspects of the company’s worldwide legal function, including mergers and acquisitions, software
licensing, patents, trademarks, antipiracy and litigation. Prior to
joining Nero, he was a member of the products and technologies law group at Sun Microsystems where he served as chief counsel for the
CPU manufacturing, integrated circuit testing and validation and
global business services groups. He is available at [email protected].
KEITH E. GOTTFRIED is a partner in the Washington, DC office of
Blank Rome LLP. He concentrates his practice primarily on mergers
and acquisitions, corporate governance, shareholder activism,
securities regulation, NYSE and Nasdaq compliance and general
corporate matters. Over the course of his career, Gottfried has worked on a number of high-profile mergers
and acquisitions across a broad range of industries and sectors. Prior to rejoining Blank Rome, he
was the general counsel of the US Department of Housing and Urban Development, a position to which
he was appointed by President George W. Bush and unanimously
confirmed by the US Senate. Previous to that, Gottfried was the
general counsel of Borland Software Corporation in Cupertino,
California. He is available at [email protected].
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ACC Docket 38 September 2011
counsel gives you a quick tutorial on the Foreign Corrupt
Practices Act. Finally, after an extensive review of Tar-
getCo’s schedule for launching new software products or
releasing updates to existing products, it is discovered that
the software development teams are at least six months
behind schedule, and there will be nothing for TargetCo to
release for at least the next two fiscal quarters. Numerous
HR-related issues begin to percolate at TargetCo, including
severance obligations that were not uncovered during the
course of the due diligence process. At the same time, you
learn that assignment of invention agreements cannot be
located for many of TargetCo’s top inventors.
As more bad news on the acquisition of TargetCo
becomes public knowledge, the financial and trade press
show no mercy and label the transaction as an ill-timed,
poorly executed fiasco. The MidSize board is furious over
not seeing the promised benefits from the acquisition and
now questions the strategy of growth by acquisition. The
board believes that it was not adequately briefed about the
risks of acquiring TargetCo. The investors of MidSize are
also angry, and several shareholder suits are filed claiming
that the board breached its fiduciary duties in not properly
evaluating the acquisition of TargetCo. After an initial pe-
riod of denial, your CEO now agrees that the acquisition of
TargetCo is an unequivocal disaster and demands to know
how you could have allowed her and the board to be so
“blindsided.” She makes it clear to you that she is no longer
a member of your “fan club” and glares coldly at you when
you pass by her in the hallway.
This scenario may seem familiar to many of you. After
all, it is well known that many mergers fail or turn out to
be great disappointments. While there are many reasons
to account for an M&A transaction not meeting expecta-
tions, a poorly planned and executed due diligence process
is often responsible. There are few aspects of the M&A
process that are more important — and often not carefully
planned and appropriately executed — than the due dili-
gence process. The due diligence process of any acquisition
is a critical, if not the most important, phase of any M&A
transaction. While different buyers may have different
goals for what they hope to achieve from the due diligence
phase, generally, this is the time to develop an understand-
ing of what you are buying, justify the proposed purchase
price and the transaction, determine whether there are
any unusual or unanticipated risks to the acquisition, and
determine whether there are any actual or contingent li-
abilities that may be assumed in the acquisition. To put it
succinctly, the due diligence phase is the time to identify
any “landmines” and to prevent the acquisition from result-
ing in disaster. This is also the time to identify issues relat-
ing to how the transaction will be structured, identify what
additional provisions will be needed to be included in the
1. Accumulate bargaining chips for the
negotiation of the acquisition agreement.
2. Assess possible synergies and cost-
saving opportunities with other
businesses of the acquirer.
3. Help management decide whether
to acquire the target.
4. Confirm the strategic rationale
for the transaction.
5. Justify the proposed purchase price.
6. Mitigate risk and avoid “landmines.”
7. Determine what legal hurdles exist to
acquiring the target or operating the
business (e.g., existence of a non-
competition agreement, restrictions on use
of IP, agreements with regulators, etc.).
8. Determine how to structure the transaction.
9. Determine how to document the transaction.
10. Plan the post-closing operation
and integration of the target.
The Big Ten Purposes of M&A Due Diligence
1. Company representatives (e.g., legal,
corporate development, finance, accounting,
marketing, product management, tax,
human resources, risk management, etc.)
2. Outside M&A counsel
3. Other legal counsel (e.g., antitrust,
labor/employee benefits, intellectual
property, tax, environmental, government
contracts, litigation, etc.)
4. Local/state law counsel (e.g., real
estate, zoning, state licensing, etc.)
5. Foreign counsel
6. Accountants (independent auditors,
an accounting firm’s transaction
advisory group, tax advisors, etc.)
7. Consultants
8. Investment bankers
9. Lender’s counsel
10. Private investigative firm
Assembling the M&A Due Diligence Team
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ACC Docket 40 September 2011
4. Can you identify possible synergies and cost-saving
opportunities with other businesses of the acquirer?
Using due diligence to justify the transaction 5. Is the due diligence process intended
to confirm a decision that has already
been made to acquire the target?
6. Is management still undecided on
whether to acquire the target?
7. Will the due diligence process be used to confirm
the strategic rationale for the transaction?
Connecting due diligence to the purchase price8. Does the proposed purchase price
need to be justified?
9. Are you trying to bolster the argument for a
downward adjustment in the purchase price?
10. Is there justification for increasing the proposed
purchase price, particularly if you are involved
in a competitive bidding situation?
Mitigating risk and avoiding “landmines” 11. Does the acquisition of the target carry
with it any unusual risks (e.g., ongoing
litigation, customer issues, regulatory
issues, etc.) that need to be evaluated
during the due diligence process?
12. If the target is a public company, have you
reviewed the risk factors that are contained in
the target’s annual and quarterly SEC filings?
13. If the target is not a public company, have you
reviewed the risk factors that are contained in the
annual and quarterly SEC filings of comparable
companies and the target’s competitors?
14. What are the potential “landmines” to look for?
15. Have you identified upfront what
the deal breakers are?
16. Have all relevant departments at the
company reviewed and commented on
the list of potential “landmines”?
17. Do the assets on the target’s
balance sheet actually exist?
18. Are the assets on the target’s balance
sheet in good operating condition?
19. Does the target have any actual or contingent
liabilities that may be assumed in the acquisition,
but may not appear on the target’s balance sheet
or in the accompanying footnotes thereto?
20. Are all customer contracts binding, and
do they all relate to the specific amounts
of revenue indicated by the seller?
definitive agreements, and accumulate bargaining chips to
be used for negotiating various aspects of the transaction.
Based on our past M&A experiences, and particularly,
reflecting back on due diligence processes that were well
executed and those that could have been more carefully
planned, we have prepared a list of questions that should
be considered and addressed sooner rather than later as
you commence the due diligence process in connection
with an acquisition transaction.
Understand the goals of your due diligence process1. Other than the customary goal of risk mitigation,
what are the goals of your due diligence process?
Write them down to avoid confusion.
2. What types of information are you seeking
to obtain from the due diligence process?
3. Can the due diligence process provide you
with bargaining chips for the negotiation
of the acquisition agreement?
1. Failure to prioritize areas of focus
2. Failure to plan due diligence
3. Failure to set appropriate materiality thresholds
4. Failure to properly coordinate all members
of the due diligence team and ensure that
there are open lines of communications
among members that are being used
5. Failure to efficiently use time afforded by
exclusivity agreement or letter of intent
6. Failure to quantify due diligence findings in
a way that credibly supports an argument
for a purchase price reduction
7. Failure to communicate findings from
the due diligence “ground” team to the
folks drafting the acquisition agreement
and other transactional documents
8. Failure to “harvest” due diligence findings and
leverage them into appropriate revisions to the
acquisition agreement and related documents
9. Undue reliance on the acquisition
agreement’s representations and warranties,
and the related disclosure schedules
as a substitute for “due diligence”
10. Insufficient participation in due diligence
process by acquirer’s senior-level personnel and
from legal, accounting and financial advisors
Ten Reasons Why M&A Due Diligence Fails
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ACC Docket 42 September 2011
26. What corporate approvals are required
to consummate acquisition (e.g.,
board, shareholder, etc.)?
27. What third-party consents are needed to
consummate acquisition (e.g., customers,
lenders, bondholders, licensors, etc.)?
28. What permits, licenses and other
governmental authorizations are needed to
operate the business going forward?
Determining how best to structure the transaction 29. What is the optimal corporate structure
for the acquisition (e.g., asset purchase,
stock purchase, merger, etc.)?
30. What tax-planning opportunities exist for the
transaction, such as a 338(h)(10) election?
Planning the post-closing operation of the target 21. What information is needed to be gathered
from the due diligence process to plan the
post-closing integration of the target?
22. What additional investment is required post-closing?
23. How much working capital will be required
to operate the business post-closing?
24. Which employees will you retain post-closing?
Determining what legal hurdles exist to acquiring the target or operating the business
25. What legal hurdles need to be met to acquire
the target or operate the business (e.g.,
existence of a non-competition agreement,
restrictions on use of IP, agreements with
regulators, governmental approvals, etc.)?
1. Agreements with professional services providers
(e.g., investment banking firms, law firms,
accounting firms, consulting firms, etc.)
2. Agreements restricting the target’s right to compete
3. Agreements restricting the target’s
right to solicit employees
4. Agreements that are triggered upon the sale
or other change in control of the target
5. Agreements that are not yet executed
6. Correspondence alleging breaches of agreements
7. Correspondence threatening a lawsuit
8. Lawyers’ response letters to auditors
9. Agreements in connection with previous M&A
transactions, whether completed, aborted or
still in progress (e.g., letters of intent, exclusivity
agreements, merger agreements, stock purchase
agreements, asset purchase agreements and
other business combination agreements)
10. Agreements with respect to ongoing earn-outs
in connection with past M&A transactions
11. Agreements to indemnify third parties, including
those in connection with previous M&A transactions
12. Agreements providing for indemnification
obligations of the target in connection with
past M&A transactions that may be deemed to
continue past any specified durational limits, and
in excess of any specified indemnity cap, due to
certain specified carve-outs, such as claims for
intentional misrepresentation, fraud and taxes
13. Settlement agreements, including those related to
litigation, governmental investigations and other past
disputes, and particularly those that provide for the
target to have any ongoing obligations or restrictions
14. Offer letters and other employment, compensation,
option and incentive agreements that the target is a
party to or, if not yet executed, that exist in draft form
15. Proprietary rights and confidentiality
agreements with employees
16. Consulting and independent contractor agreements
17. Severance agreements with former employees
18. Written communications between
the target and its stockholders
19. Samples of all packaging for its products
that contain legal notices and/or reference
to any protected intellectual property,
whether registered or unregistered
20. Presentations given by any employee of the target,
whether to customers, employees, investors, analysts,
trade, and professional associations or other groups
21. Press releases issued by the target over
the past three years
22. Certified copies of the target’s corporate
charter (long-form)
23. The corporation statute of the
target’s state of incorporation
24. Analyst reports on the target
25. Market research studies that reference the target,
whether commissioned by the target or another party
Twenty-Five Items to Enhance the Customary Due Diligence Request List
ACC Docket 44 September 2011
Using due diligence as part of your commitment to best practices in corporate governance
39. How will you demonstrate that the board of
directors took reasonable steps to inform itself, to
the extent of satisfying its fiduciary duties, of the
potential risks associated with the transaction?
40. What additional data points are needed
to convince the board of directors of why
they should approve the transaction?
41. Have either you or your CEO asked the
board of directors whether there are specific
areas of the due diligence process that
they are particularly concerned with?
42. Have either you or your CEO asked the board
of directors how they would like the due
diligence findings communicated to them?
Paying attention to the clock43. How much time do you think the due
diligence process will take?
44. Have you planned your due diligence
using a realistic time table?
45. Does the team negotiating the definitive
transaction agreement understand that, from
a timing perspective, they need to remain
in sync with the due diligence team?
Determining how best to document the transaction 31. What ancillary agreements will be needed,
such as escrow, transitional services, non-
compete, employment, consulting, etc.?
32. What specific representations and
warranties will be required to be included
in the acquisition agreement?
33. What special covenants should be contained
in the definitive acquisition agreement
(e.g., cooperation, tax, treatment of stock
options and restricted stock, etc.)?
34. Which particular closing documents
(e.g., officer certificates, legal opinions,
releases, etc.) will be required?
Using due diligence to support broadening the seller’s indemnification obligations
35. Should the seller’s indemnification
obligations be broadened?
36. Should a portion of the purchase price
be placed in escrow as security for the
seller’s indemnification obligations?
37. What types of special indemnification provisions
should be included in the acquisition agreement?
38. What should be the appropriate cap amount on
seller’s indemnification obligations, and how long
should such indemnification obligations last?
ACC Docket
• Outsource Resource: Outsourcing Challenges
During a Merger and Acquisition (Nov. 2009).
www.acc.com/docket/outsource_nov09
Presentations• Technology Issues in Mergers and Acquisitions
(Oct. 2010). www.acc.com/tech-m&a_oct10
• Avoiding Surprises in M&A Transactions (March
2009). www.acc.com/surprise-m&a_mar09
Forms & Policies• Intellectual Property Due Diligence Request List
(Oct. 2010). www.acc.com/forms/ip-dd_oct10
• IP Due Diligence Issues in M&A Transactions Checklist
(Feb. 2010). www.acc.com/quickref/ip-m&a_feb10
• Preliminary Due Diligence Checklist (July 2009).
www.acc.com/quickref/pre-dd_jul09
• Goals of Due Diligence (July 2009).
www.acc.com/quickref/duedil_jul09
Article• Mergers and Acquisitions (Fraser Milner Casgrain
LLP) (June 2010). www.acc.com/m&a-fraser_jun10
Education• Dealing with M&A transactions abroad? Join us at ACC’s
2011 Annual Meeting, October 23-26 in Denver, Colo.,
and attend session 204 – Hot Issues in International
M&A. This session will discuss the critical issues
associated with international M&A, including anti-
trust law, privacy, and environmental liability. Learn
more and register today at http://am.acc.com.
ACC has more material on this subject on our website.
Visit www.acc.com, where you can browse our resources
by practice area or search by keyword.
ACC Extras on… M&A Due Diligence
ACC Docket 45 September 2011
51. Are there unique issues of local or state law (e.g.,
real estate, zoning, state licensing, etc.) involved
in the acquisition that would suggest that local
counsel be represented on the due diligence team?
52. Are these assets and/or operations located
overseas and require that foreign counsel be
represented on the due diligence team?
53. Have you verified that your outside counsel
is appropriately staffing the due diligence
team and not just assigning you relatively
junior lawyers? Have you received a list of the
attorneys that have been assigned to the due
diligence team? Have you read their bios?
54. Will the company’s auditors be represented
on the due diligence team?
55. In addition to the company’s auditors, will
any other accounting firms be retained in
connection the due diligence process (e.g., an
accounting firm’s transaction advisory group)?
56. Are there any anticipated tax issues (e.g.,
open tax audits, NOL carryovers, etc.) with
respect to the target that would suggest
that tax advisors be retained in connection
with the due diligence process?
Deciding who should participate as part of your team46. Who from the company will be part of the
due diligence team (e.g., legal, corporate
development, finance, accounting,
marketing, product management, tax, human
resources, risk management, etc.)?
47. Who from your outside law firm will be part of the
due diligence team (e.g., M&A counsel, securities
counsel — if target is a public company — etc.)?
48. What legal specialties should be represented on
the due diligence team (e.g., antitrust, labor/
employee benefits, intellectual property, tax,
environmental, government contracts, etc.)?
49. Is your M&A law firm the right law firm to
coordinate due diligence, or does the nature
of the target’s business require a law firm
with very specific industry experience to
coordinate the due diligence process?
50. In addition to your M&A counsel’s law
firm, will other law firms be retained in
connection with the due diligence process?
Corporate Finance
Mergers and Acquisitions
Product Liability Defense
Energy and Agribusiness
Life Sciences
Financial Institutions
Bankruptcy
Commercial Litigation
Insurance Recovery
Securities Litigation
Real Estate
Employment and Bene" ts
Intellectual Property
Minneapolis ! Denver ! www.lindquist.com
ACC Docket 46 September 2011
Reporting due diligence findings69. How should each member of the due diligence
team memorialize their due diligence findings?
70. Should you provide each member of the
due diligence team with a template to use
to capture their due diligence findings?
71. What is the most appropriate and optimal method
to memorialize the aggregate due diligence
findings (e.g., memo, report, chart, etc.)?
72. Should you prepare a separate due diligence
summary or report that focuses only on issues that
have a quantitative impact on valuation of the
target and may affect ultimate purchase price?
73. Should you hold regular status update
meetings? How will they be organized? Who
will attend? How will results be presented?
Preparing and submitting the due diligence request list
74. Have you prepared and submitted to the target
a comprehensive due diligence request list that
has been appropriately tailored to the target
and the transaction you are pursuing? Is the
due diligence list appropriately tailored to the
target’s industry and regulatory environment?
75. Should each of the “legal specialists,” regulatory
counsel, employee benefits counsel, foreign
counsel, etc., prepare separate due diligence
request lists focused on their respective areas?
Haste makes wasteWhile the due diligence process may not be the most ex-
citing phase of an M&A transaction, there are many more
opportunities for the in-house counsel to be the “hero” in
that phase than the phase where definitive agreements are
executed. The M&A world is littered with deals that have
gone bad because folks unduly rushed a signing without
knowing what they were buying, and would be owning and
operating. We hope the questions that we list above will
provide in-house counsel with a useful roadmap for issues
that need to be clarified early in planning and conducting
the due diligence phase of any acquisition. By organizing
an efficient and effective due diligence plan up front, at
the end of the process, you will be the “hero” and remain
prudent in protecting the your company’s interests.∑
Have a comment on this article? Visit ACC’s blog
at www.inhouseaccess.com/articles/acc-docket.
57. Will any consultants be retained for the due
diligence? Who will engage these consultants?
Should they be retained by your law firm so as to
preserve the attorney-client privilege reasons or
should they be retained directly to save costs?
58. Will the company’s investment bankers be
represented on the due diligence team?
59. Who will conduct the customer/partner due
diligence, and when will that due diligence be done?
60. Will any of the parties providing financing
for the acquisition of the target be
represented on the due diligence team?
61. Is there any need to retain a private investigative
firm to conduct background checks on the
target’s management team, particularly where
the target holds various security clearances;
the loss of which would have a material
adverse effect on the target’s business?
62. Have you prepared an appropriate form
of confidentiality agreement up front to be
executed by each professional service firm
involved in the due diligence process?
63. Have you reviewed, and as appropriate, had
your outside counsel review and comment
on the engagement letters and/or retention
agreements for each professional service firm
involved in the due diligence process?
64. Should any of the non-legal service providers
participating in the due diligence process be
retained by your outside counsel so as to attempt
to preserve the attorney-client privilege?
Establishing appropriate reporting channels and lines of communication
65. Have you established appropriate reporting
channels, intervals and deadlines for the due
diligence team to forward their findings?
66. Have you established and communicated materiality
thresholds and what your company, as the acquirer,
would view as possible “deal breakers”?
67. Have you scheduled weekly conference calls with
due diligence team members to review findings and
update all on timing and progress of transaction?
68. Do you need to establish a virtual deal room for
transaction participants to provide updates?