What are digital and analog data rooms?

Data rooms enable companies to share con­fi­den­tial documents with others. Data rooms tend to be used for mergers, sales or other business trans­ac­tions. There are digital data rooms as well as location-based ones.

What’s a data room?

Data rooms orig­i­nat­ed alongside the process of due diligence. Due diligence is the careful ex­am­i­na­tion of documents related to the sale of a property, a company or its shares as well as prior to an initial public offering (IPO). Both parties, the seller and the buyer, examine all available data and in­for­ma­tion to identify and, if possible, eliminate risks and problems before the purchase takes place. They do this in a what’s known as a data room.

Orig­i­nal­ly data rooms were physical rooms in which the two parties, and oc­ca­sion­al­ly external parties such as tax and business con­sul­tants or auditors, would carefully review all existing documents without re­stric­tions or external dis­trac­tions. However, digital data rooms now perform a similar function and are able to ac­com­mo­date glob­al­iza­tion and the changing demands of the business world. The goal of any digital data room is to provide both parties with fair and un­re­strict­ed access to all important documents while also pro­tect­ing the stored data from unau­tho­rized access.

What types of data rooms are there?

Data rooms can be divided into two groups. Although there are some overlaps and special cases, the common names for data rooms are as follows:

Location-bound data rooms

Orig­i­nal­ly data rooms were physical rooms that all au­tho­rized parties had access to. This type of data room is still in use today. In location-bound data rooms, users benefit from personal contact with one another, and the risk of hacking or other cy­ber­at­tacks is lower. Data rooms are often set up in a neutral location to ensure maximum trans­paren­cy. Law firms, for example, tend to have them. All relevant documents are then kept in this data room for the duration of the due diligence process and closely reviewed by the au­tho­rized persons. The parties agree on the exact rules in advance.

Digital data rooms

However, the practice of location-based data rooms isn’t always ad­van­ta­geous. For parties operating at great distances, the use of a physical data room may cause delays. For this reason, many companies now rely on virtual data rooms.

Security is paramount in digital data rooms. The cloud solution used must be able to ensure that only au­tho­rized persons have access to the in­for­ma­tion, which is often very sensitive. Unau­tho­rized du­pli­ca­tion or dis­clo­sure of documents and unau­tho­rized access are not permitted in digital data rooms. A strong security ar­chi­tec­ture, suitable en­cryp­tion pro­ce­dures, strict access rights and strong passwords ensure that virtual data rooms are as secure and reliable as their physical coun­ter­parts. Des­ig­nat­ed ad­min­is­tra­tors are assigned rights and maintain an overview of all ac­tiv­i­ties taking place within the data room.

What are green and red data rooms?

Digital and physical data rooms are further sub­di­vid­ed by usage and different au­tho­riza­tions. This is referred to as a green or red data room.

Green data rooms

Green data rooms are ac­ces­si­ble at all times to all persons involved in a potential trans­ac­tion. Re­spec­tive parties will usually sign a con­fi­den­tial­i­ty agreement and are then in­tro­duced to the pro­ce­dures, oblig­a­tions and re­stric­tions of the data room. They can then access all documents. In the case of a physical data room, they’re given un­re­strict­ed access. In a digital room, they’re provided with all relevant access au­tho­riza­tions and passwords. Depending on the rules that have been es­tab­lished, the access and duration of in­di­vid­ual par­tic­i­pants may be recorded in an at­ten­dance log.

Red data rooms

Red data rooms are different. Here, only select people are allowed to enter. Access is severely limited and is often granted almost ex­clu­sive­ly to persons who are already pro­fes­sion­al­ly bound to secrecy. This applies, for example, to lawyers, auditors and tax con­sul­tants.

It’s possible for a red data room to be launched during the last stages of a trans­ac­tion. Access is then granted only to select employees involved in the final steps of the deal. This ensures the details of a trans­ac­tion remain con­fi­den­tial.

Prepa­ra­tion for data rooms

Some prepa­ra­tion must be un­der­tak­en before a data room can be opened. All parties must determine and confirm the rules, content and users of the data room(s). This procedure is important for both virtual and physical data rooms. It ensures a smooth and, above all, legally compliant process. The following pre­cau­tions are par­tic­u­lar­ly important to take before using a data room:

Rules of a data room

When agreeing to use a data room, valid rules should be es­tab­lished that all parties agree to adhere to at all times. This sim­pli­fies processes and ensures they’re fair for all users. Once signed, the rules are binding. It’s no longer possible to change them af­ter­wards.

Common rules for data rooms include, for example, es­tab­lish­ing an at­ten­dance list or banning copies and photos. Note-taking may be permitted. Generally, documents are not to be added to or removed from data rooms. In the case of location-based data rooms, a neutral su­per­vi­sor ensures that the rules are observed.

Content of data rooms

The content of a data room is de­ter­mined in advance. Often, audited and certified annual financial state­ments, articles of as­so­ci­a­tion or an up-to-date overview of staff are part of this content. An in­ter­est­ed party can gain a com­pre­hen­sive overview of a business by viewing this data. Nev­er­the­less, certain business secrets must be preserved to avoid risking com­pet­i­tive dis­ad­van­tages if a sale doesn’t ma­te­ri­al­ize. For example, sales returns usually aren’t part of the documents in data rooms. The parties and their rep­re­sen­ta­tives discuss the scope of the in­for­ma­tion prior to setting up the room.

Au­tho­rized persons

Who is granted access to a data room must be defined and recorded in advance. This usually applies not only to the companies involved, but also to external con­sul­tants and experts. All parties involved are listed prior to con­duct­ing due diligence. They fa­mil­iar­ize them­selves with the rules and must sign a com­pli­ance document. A con­fi­den­tial­i­ty agreement is part of the procedure.

What are the ad­van­tages of data rooms?

Physical and virtual data rooms have several ad­van­tages for business trans­ac­tions. Data rooms ensure that all parties involved agree to binding rules and work with the same struc­tured data sets. Rule vi­o­la­tions are rare because of the neutral en­vi­ron­ment and the presence of an in­de­pen­dent authority con­trol­ling the process. At­ten­dance registers make it possible to re­con­struct in­di­vid­ual steps and ensure efficient working.

Digital data rooms offer great flex­i­bil­i­ty and in­de­pen­dence. Different teams can review documents si­mul­ta­ne­ous­ly or in­de­pen­dent­ly and free from spatial re­stric­tions. Data can be prepared and shared in an optimally struc­tured manner. The challenge here is keeping data stored in the cloud secure, thus pre­vent­ing unau­tho­rized persons from gaining access to sensitive in­for­ma­tion.

When are data rooms used?

There are plenty of different scenarios where digital and physical data rooms are practical. In merger and ac­qui­si­tions (M&A), the data room continues to be a valued and proven practice. IPOs, in­sol­ven­cy pro­ceed­ings or re­struc­tur­ing of companies can also be optimally prepared in data rooms. In addition, data rooms are used for investor reporting, real estate trans­ac­tions or before a company is com­mis­sioned. This model is a good choice when sensitive data is to be made available to a specific group of people while also main­tain­ing the highest security standards possible.