Blockchain in the M&A process
A fundamental truth the legal industry must accept is that the right technology can make a huge difference in the way lawyers perform their roles. The accuracy of the advices as well as the counsel´s user experience while investigating a case could change drastically.
In this article, we will try to explain how blockchain could make legal experts ‘life easier in the M&A area.
“The very basic process of M&A entails such overhead costs, that many players are discouraged from even trying, even if the result could be mutually beneficial for all parties involved” (LEXIT, Finance Magnates).
One of the first stages of M&A is the due diligence, which is a complete review of documentation and facts by a potential buyer or its agents before purchasing an asset or a company.
In this specific phase, a data room is set up as part of the central repository of data relating to companies or divisions being acquired or sold. The data room enables the interested parties to review information pertaining to the business in a controlled environment where confidentiality can be preserved.
Conventionally this was achieved by establishing a supervised, physical data room in secured premises with controlled access. In most cases, with a physical data room, only one bidder team can access the room at a time. Due to their increased efficiency, many businesses and industries moved to use electronic data rooms instead of physical ones.
Even though this modus operandiis improved by providers such as Ideals, Intralinks, and Merrill, pitfalls still exist.
The current weaknesses of data rooms are that they are:
Time-consuming, complicated to use and, in general, not user-friendly to navigate
Error-prone: We could find files ignored, overwritten, lost or put in the wrong places.
“They are often not in order, or files are not properly ordered for an external user to easily find correct information” (Rocio Falcones, A&M).
Moreover, data rooms are usually set up on tight timelines which inevitably leads to errors and incorrect document versions getting uploaded.
Not up-to-date, as duplicates are not resolved or merged.
Often really expensive: Installing and arranging a data room requires a significant amount of time to structure and organize the folders, upload documents, and review the material, increasing the process cost
Blind: they don´t give extracted information and key insights from their content.
However, there are difficulties not related to data rooms but rather with the lack of diligence of the companies.
In this sense, according to 22 Mistakes Made by Sellers in M&A Transactions (Richard Harroch, All Business, your small business advantage): “due diligence investigations by buyers frequently find problems in the seller’s historical documentation process, including some or all of the following hurdles:
- Contracts not signed by both parties or without the amendment terms signed.
- Board or stockholder minutes or resolutions unsigned or with missing referenced exhibits.
- Incomplete or unsigned employee-related documents, such as stock option agreements or invention assignment agreements”.
Bearing in mind those mentioned above, what is blockchain technology and why is it so important for this sector?
Distributed ledgers or databases are systems that enable parties who don’t fully trust each other to form and maintain consensus about the existence, status and evolution of a set of shared facts.
Blockchain is a type or subcategory of DLT. “Blockchain is an expanding list of records akin to entries in a spreadsheet or ledger (called blocks, each one with the corresponding timestamp) that are linked together (in a chain) to the previous block and secured using advanced public key cryptographic protocols. The blocks in the chain are communicated to all members in a network (known as nodes, which have a common version of all transactions), this means that the blockchain is distributed, making it decentralised and thus mitigating risks from storing information in a centralised database. The members in the blockchain individually verify the contents of the records in the blocks, thus providing a distributed verification mechanism.
Collectively, the independent verification mechanism provides a robust degree of integrity to a block, meaning that any alteration to a record would be detected by the other members” (Grainne Lynch & Ignacio López del Moral, Blockchain in supply chain Logistics).
Taking into account the set of facts already described, are we aware of the many disruptive benefits that Blockchain could offer in this field?:
1. Integrity and transparency
● Would it be complicated to alter or delete the transactions?
● Could a third party certify the statements of the seller?
● Could one better trace buyer´s activity (milestone achievements) after the closing in case of earn-out arrangement?
● Does it pave the way for the entities ‘audit?
Blockchain could preconstitute evidence that an agreement has taken place between two parties with a fixed content, consideration, price, and with a timestamp.
2. Efficiency & Interoperability
● Would it be possible to avoid double spending or overwritten duplicate files? Would the buyer stop asking for remedying inefficiencies to close the deal?
● Could the industry save money by skipping middlemen? There is no need for a central administrator to maintain the file.
● Is blockchain a better solution in terms of interoperability?
3. Flexibility & Privacy
● Could one properly modulate accesses and powers? In M&A course of action, aside from seller, bidders and lawyers, there are many players involved, namely: investment bankers, mediators, tax & accounting experts, guarantors and appraisers. Each different role should have different access rights. “The attributes of blockchain technology are ideally suited to large networks of disparate partners” (Marc O'Brien, How Blockchain will Drive Future M&A Activity).
● Is it a more secure system? There is no single point of failure to shut the network down.
5. Better understanding
● On top of the ledger, could we exploit data and get key insights through machine learning and API calls to data sources? Could the information be displayed on a dashboard such as Kibana?
6. Other benefits
As a final point, one could enhance the process by:
● Forming a liability reserve to comply with SPA’s provisions.In fact, we could stipulate a ban on free disposal or transfer amount held during a predefined period of time. It would be similar to banking escrow, but more unbiased and not subject to high fees. In that case, the seller could increase the price in exchange for that extra guarantee.
● Securing and automating the price adjustment based on debt or a working capital model.
● Streamlining the democratizationby lowering the barriers to entering the M&A market.
In this regard, LEXIT (startup which has built a distributed Intellectual Property and Company Mergers & Acquisitions Marketplace) uses a decentralized network of service providers (whose reputation score is represented by a token) which compete to offer services to buyers and sellers, instead of locking them in tight contractual relations.
“We could imagine an electronic data room in which all negotiation topics and results are automatically hashed in a blockchain, making them immutable and irrefutable. This log is then rendered into a contract, which both parties sign digitally and execute with a smart contract protected cryptographic transaction”.
Nonetheless, blockchains are not magic. They don'tfix problems such as:
➢ Legality of the content of actions and transactions (authenticity).
➢ Consent obtained under threat or duress.
➢ Human errors or breach of duty of care (e.g., contracts not signed).
➢ Computing limitations: Blockchains are not designed to process huge amounts of data.
It is difficult to conceive of a future M&A without some aspects of the blockchain. The productivity, timeliness and different return on investment empowered by blockchain could definitely have an influence on law firm ‘s market offering decision.
About the Author:
Ignacio López del Moral is a well known profile in the blockchain spectrum in Spain. His career moves around its uses and benefits and he is a firm defensor of the cause.
He is currently involved in many topics in this area, the following amongst them: New digital business regulation expert at UST GLOBAL, where he is constantly developing blockchain related projects in top tier corporations in Europe. He also serves as a blockchain lawyer at LegalBlock and actively helps Blockchain Spain, a social movement to contribute to the development of Blockchain in Spain in collaboration with Latin-American and European colleagues.
Ignacio holds a Master´s Degree in Business Administration, CUNEF (2009) and a Master's Degree in Law (NUMBER 1 in the academic Ranking), CUNEF (2010).