Disclosure schedules are arguably one of the most arduous and time-consuming deliverables on the company-side or seller-side of any transaction. Whether, as  part of the management of your startup, you are tasked with driving an equity or debt financing to closing or with gearing up for an exit event, disclosure schedules will be one of the many documents that you will negotiate and deliver as part of your deal. So, what exactly are disclosure schedules, why are they important in your deal, and how can you best prepare to put them together?

What Are Disclosure Schedules?
In a purchase agreement or merger agreement, roughly half of the pages in the agreement will be “representations and warranties,” which are “promises” that are being made on behalf of and about the company. An investor or a buyer needs assurances that their money is going toward a company that actually exists, is financially viable, is free from litigation claims, etc. Of course, all of these promises might not actually be true or complete and there may be facts out there that might make certain representations false or incomplete. The disclosure schedules are within a standalone document that corresponds closely with the representations in the purchase agreement or merger agreement. This document is your opportunity to list out the existing facts which may make a representation untrue or incomplete.

There are mainly two types of disclosures you make in the disclosure schedules. The first is an exception to a representation (i.e., a fact that makes a representation untrue or incomplete). For example, a purchase agreement may have a representation that your company has not been involved in any claims or litigation for the past five years. If, two years ago, an employee made a claim against your company for wrongful termination, you would describe that fact in the corresponding section of the disclosure schedules. The second is a listing required by a representation. For example, one typical representation in a purchase agreement or merger agreement will require you to list your contracts with top customers based on annual revenue. In the corresponding section of the disclosure schedules, you would list the top 10 or 20 customers, or whatever the agreement requires (sometimes just based on a threshold level of revenue).

Purpose of Disclosure Schedules
For the target company and its owners, the disclosure schedules play an important role in the company’s or owner’s liability after the closing of the transaction. If the company or an owner makes a representation or warranty and, after the closing, the investor or buyer finds that representation was not true and suffers damages as a result, depending on how your agreement is structured, the investor or buyer can come after the company or the owners for a portion of the purchase price to cover their losses. If the company or owners list an exception to a representation on the disclosure schedules, they would not be in breach of the representation because the disclosure will modify the representation, so they would not be liable to the investor or buyer. For example, a seller in an M&A transaction could represent in a purchase agreement that it did not have any outstanding tax liabilities. If this representation were untrue and the buyer was damaged by a tax liability post-closing, the buyer could potentially recover from the seller for the amount of the tax liability due. However, if the seller properly disclosed all tax liabilities on the disclosure schedule, the seller would not be in breach of the representation and the risk of loss would have shifted to the buyer.

Disclosure schedules are also important to the investor or the buyer, as they advance the investor’s or buyer’s due diligence of the target company and give the investor or buyer a level of detail about the company that cannot practically be included in the purchase or merger agreement. The representations and warranties, as modified by the disclosure schedules, create the basis that claims for indemnification will be made by the buyer or investors.

Disclosure Schedules in Financings vs. M&A
Financing/minority investment diligence and M&A diligence serve different purposes; thus, the disclosure schedules are prepared and used for different purposes. The type of diligence involved in minority investments is less about identifying smaller risks and more for identifying material items that would cause an investor to not invest, validating the business case, determining whether the investment proposal is a good fit, and screening for the viability of the deal and investment potential. In M&A, the smaller risks matter and diligence gives the buyer an idea of what they could potentially be liable for in the future (i.e., are they buying additional liabilities?). Minority investment diligence is generally forward-thinking, whereas for M&A it is very much retrospective. As such, disclosure schedules in an M&A deal will typically be a much more extensive document and time-consuming process than those in a financing transaction.

Level of Disclosures
Many companies struggle with the level of disclosure in the disclosure schedules. As a general matter, companies should not hide facts from the investor or buyer that should be on the disclosure schedules. Over-disclosing in the disclosure schedules may alarm the buyer, but over-disclosing is helpful to the company as it reduces the company’s and owner’s risk of liability for breaching their representations and warranties. Companies should collaborate closely with their legal counsel when crafting disclosures for the disclosure schedules.

How to Prepare for Drafting Your Disclosure Schedules

• Keep all of your records leading up to your transaction organized. When things are easier to find in your system, it is easier to provide backup for your disclosures.
• Retain historical records of employee claims or other third-party claims.
• Track agreements with your top customers and suppliers, and track any customer disputes.
• Keep organized records and summaries of your benefits plans and insurance policies.
• Involve employees with the appropriate knowledge to help with parts of the disclosure schedules.
• Work closely with your counsel to revise the representations and warranties, craft disclosures, and balance the threshold of over-disclosure.

Putting It All Together
In conclusion, the meticulous preparation of disclosure schedules is a critical step in safeguarding the interests of both sellers and investors in any transaction. By ensuring comprehensive and accurate disclosures, startup founders and investors can mitigate potential risks, build trust, and facilitate smoother negotiations. Embracing transparency through well-crafted disclosure schedules not only protects against future liabilities but also reinforces the foundation for a successful and enduring business relationship. As you navigate your next deal, remember that thoroughness and clarity in your disclosures can be pivotal to your long-term success.

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