Due Diligence Review
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The insurer will review all of the due diligence reports prepared for the transaction. This includes any vendor due diligence reports (VDD) that the seller may have prepared. Buy-side due diligence (BDD) is much more reliable and therefore more valuable to the underwriter. This is because VDD is often prepared with “rose tinted spectacles” by the seller who is obviously trying to make the target company appear in its best condition and issue-free.
The scope of the due diligence process, and therefore reports, will be of key importance to the underwriter. The wider the scope, the better the report because a wide scope will have reviewed more issues. For example, most due diligence reports are prepared using a materiality threshold so certain issues deemed to be lower than a certain value won’t have been reviewed in detail. The lower this threshold is, the wider the scope is. Therefore, insurers will respond positively to due diligence reports with a low materiality threshold and this could result in better coverage in the W&I policy (most likely a lower de minimis).
It is standard for legal, financial and tax due diligence reports to have been prepared. These three reports will contain a wide review of the majority of issues facing the target. Without one of these three reports, W&I coverage can be severely restricted. For some types of target company, such as software companies or real estate holding companies, more specialist due diligence reports can be prepared. For example, a report reviewing the code of software companies can be common and likewise, an environmental report will often be prepared for real estate transactions.