Introduction

The significance of data privacy due diligence in M&A processes has become a concern in today’s business landscape, impacting companies globally. While those within the M&A sector are well versed in traditional due diligence practices, there is a growing need to prioritize data privacy considerations during transactions. This shift is not only driven by regulatory requirements but also reflects a strategic adjustment to the evolving complexities of business operations, where data is both an asset and potential risk.

The increasing importance of data privacy is highlighted by shifts in regulations, such as the General Data Protection Regulation (GDPR) in Europe and the California Consumer Privacy Act (CCPA) in the United States. These regulations have introduced compliance challenges and financial implications for organizations, emphasizing the crucial role of data privacy across all business interactions. Later, we explore a legal case involving 130 companies, many of which are owned by private equity firms, and examine how it could impact their finances and reputation.

This article aims to highlight the importance of integrating data privacy due diligence as a standard M&A due diligence process. It provides some strategies to help you navigate the complexities of data privacy in M&A, ensuring your investments comply with regulations and foster sustainable growth in a data-driven world.

The Connection Between Data Privacy and Cybersecurity

When it comes to safeguarding information, data privacy and cybersecurity go hand in hand. Data privacy focuses on the collection, storage and use of personal data in accordance with laws and regulations while cybersecurity aims to prevent unauthorized access and security threats. Both pieces are critical for upholding consumer trust and preserving a company’s reputation, but it’s important to not mistake one for the other.

For instance, let’s consider a private equity firm assessing a tech startup that has created a mobile app. Data privacy due diligence reveals that the startup adheres to data privacy policies and that they handle their user data within legal boundaries. However further scrutiny highlights vulnerabilities in the app, leaving it exposed to potential data breaches which would impact data privacy.

In this scenario, although the startup follows data privacy regulations, its poor cybersecurity posture and practices pose a risk. A breach could lead to penalties, legal consequences, and reputational harm that could potentially devalue the investment. Therefore, it is important that private equity professionals evaluate both data privacy and cybersecurity aspects during diligence. By combining assessments of both, private equity firms can improve safeguarding their investments and strengthening the lasting worth and durability of their portfolio companies.

Introduction to Global Data Privacy Regulations

Understanding data privacy laws is essential as we observe the evolving landscape of data protection. Two recognized regulations that impact private equity firms and their portcos are the General Data Protection Regulation (GDPR) in Europe and the California Consumer Privacy Act (CCPA) in the United States. These regulations have established standards for data protection and have reshaped how businesses handle their customers’ data. For professionals involved in mergers and acquisitions, these regulations should play some role in assessing investment opportunities.

General Data Protection Regulation (GDPR)

The GDPR, which came into effect in May 2018, applies to all organizations operating within the EU and to those outside the EU that offer goods or services to EU residents or monitor their behavior. Key elements to consider in M&A diligence involve:

Data Privacy Impact Assessments (DPIAs): According to the GDPR, DPIAs are essential for high-risk data processing activities. When assessing a company that deals with customer data in Europe it’s crucial to confirm that they have conducted these assessments effectively to identify and address data processing risks.

Data Breach Reporting: Under the GDPR, breaches must be reported to authorities within 72 hours unless there is no risk to individual rights. When reviewing a target company, examine its breach record and incident response protocols to evaluate its ability and procedures for managing cybersecurity incidents.

Data Subject Rights: The GDPR grants individuals authority over their own data, including the rights to access, correct, and delete it. When evaluating a target company, assess its process for handling these rights and compliance with them, rights as failure could result in fines and harm to reputation.

California Consumer Privacy Act (CCPA)

The CCPA, which came into effect in January 2020, provides California residents with rights concerning their personal information. It applies to businesses meeting criteria related to revenue, data processing volumes or income from selling consumer data. Important factors to consider in M&A diligence involve:

Consumer Rights: According to the CCPA consumers are entitled to access, delete, and opt out of data sales. When assessing an acquisition, it is crucial to review how they manage these requests to ensure compliance and uphold consumer confidence.

Data Inventory and Mapping: The CCPA requires an inventory of personal data types,  sources of data collection, purposes of use, and disclosure details. During the diligence process, it is important to reivew the target company’s data mapping practices to determine their preparedness for CCPA compliance.

Vendor Management: Under the CCPA, businesses are responsible for ensuring their vendors comply with data privacy regulations as well. When evaluating a target company, it is important to examine their contracts and arrangements with vendors to identify any compliance gaps and associated risks.

Trends and Developments in Data Privacy

The data privacy landscape is constantly changing, with updates in existing laws and new regulations signaling a move toward stricter requirements and enforcement. This dynamic environment means that private equity firms should stay ahead of requirements and adjust investment strategies accordingly. Complying with data privacy laws not only helps avoid financial penalties and safeguard reputation, but it can also add value to investments by positioning companies as trustworthy partners, for consumers and businesses alike.

For some firms, the digitization of businesses and assets has brought data privacy and cybersecurity to the forefront of due diligence, shifting them from secondary considerations to central factors in assessing investments. For M&A professionals, understanding how a target company manages data privacy and cybersecurity should be essential for making well informed decisions and mitigating risks during a time when there is heightened scrutiny on the handling of personal information and user data.

Financial Impact of Data Privacy in M&A

The financial consequences related to data privacy can be substantial in deals. Conducting due diligence to evaluate a target’s stance on data privacy can uncover potential hidden liabilities or risk areas that could impact the value and structure of the transaction. Additionally, ensuring data privacy practices are in place can play a pivotal role in gauging the reliability and future success of an investment.

The Impact of Non Compliance

Failing to adhere to data privacy regulations may lead to penalties, legal expenses, and significant damage to reputation which could harm the company and diminish the overall worth of the investment. Recently, various Private Equity and Venture Capital firms faced repercussions from data privacy regulations when more than 130 companies, including many, within their portfolios, were taken to court for failing to comply with New Jerseys “Daniel’s Law.” This legislation is designed to protect public servants, such as police officers and judges, from having their personal data such as home addresses revealed.

The potential damages—specified as the greater of actual damages or $1,000 per violation per defendant, in addition to punitive damages and attorney fees—underscore the substantial financial risks involved.  With reported violations for each company reaching 20,000, the exposure from this single lawsuit could exceed $20 million, plus punitive damages and attorney fees, highlighting the critical need for meticulous data privacy due diligence. This underscores the importance of thorough data privacy diligence. For a more detailed analysis of this case by well-respected data privacy attorneys, click here.

The importance of data privacy and cybersecurity measures also extends to the (B2B) sector as well. Corporate clients are increasingly performing their own assessments of vendors’ data security practices. This scrutiny signals the growing acknowledgement that a vendor’s cybersecurity and data privacy practices can directly impact a customer downstream. In turn, this can serve as an advantage for businesses that take cybersecurity and data privacy seriously.

Incorporating Data Privacy into Due Diligence and M&A Strategy

Integrating considerations for data privacy into the due diligence phase of the deal cycle has become a priority for many firms. This section provides insights into the importance of merging data privacy into overall M&A strategies.

Evaluation Framework Overview

To assess target companies’ data privacy practices, it is essential to utilize an evaluation framework that ensures a consistent approach across all assessments. While firms should tailor their framework to suit their specific needs, some key aspects that all frameworks should include:

• Identifying all relevant data privacy regulations and requirements
• Reviewing all relevant data privacy processes and documentation
• Assessing current and past compliance with data privacy regulations
• Assessing current cybersecurity posture and identifying high priority gaps
• Reviewing the company’s history of data security incidents

These components are essential for determining the deal’s overall value and its impact on post-merger integration by identifying potential risks, ensuring regulatory compliance, and highlighting areas requiring investment or remediation.

For a data privacy due diligence checklist please refer to our provided template.  The template serves as a guide aimed at helping private equity firms and M&A attorneys conduct thorough data privacy due diligence. Given the evolving nature of data privacy laws and regulations, it is important to customize diligence procedures according to each transactions unique circumstances.

The Role of Experts in Due Diligence Procedures

Incorporating the expertise of data privacy specialists, a practice at most reputable law firms, is highly recommended for effectively navigating these complexities. Experts can assist your firm in identifying risks, offering solutions, and ensuring that the assessment accurately reflects the data privacy and cybersecurity posture of the target company.

Internal Capabilities

Some firms, particularly larger or well-resourced organizations, have the ability to build in house teams dedicated to data privacy and cybersecurity. These teams typically consist of positions such as Chief Privacy Officer (CPO), Chief Information Security Officer (CISO), Data Privacy Attorneys, IT experts, and compliance officers. By investing in training and professional growth, these companies can keep their teams updated on the latest trends, regulations, and technologies in data privacy and cybersecurity. Developing this expertise in house does enable a more cohesive approach to due diligence with dedicated staff ready to tackle data privacy issues at every phase of the M&A process.

External Consultants

For most firms, creating a complete in-house team may not be feasible due to resource limitations and the lack of an ongoing need. In this case, engaging external counsel and consultants becomes a practical and necessary option. External advisors can complement capabilities by offering specialized knowledge and unbiased perspectives. These professionals can help identify data privacy risks and suggest mitigation strategies to ensure compliance with relevant regulations. Engaging outside experts can be especially helpful during the diligence phase as their knowledge can greatly improve the thoroughness and accuracy of the assessment, resulting in a go-forward plan for each portco.

Key Points to Consider with External vs. In-house Teams

Whether building an in-house team or seeking external expertise, it is essential for firms to incorporate data privacy considerations into their M&A strategy. This involves establishing a due diligence framework that gives priority to data privacy and cybersecurity evaluations alongside financial and operational assessments. By addressing data privacy issues companies can reduce risks increase the value of their investments and secure long term success in an increasingly data driven and regulated business landscape. Both approaches come with their benefits with the decision depending on factors such as company size, available resources and strategic objectives.

Adapting Negotiation Terms Based on Data Privacy Insights

Insights obtained from data privacy assessments can directly impact negotiation strategies. Adjustments to deal terms might be help in accommodating expenses related to addressing data privacy and cybersecurity gaps. Crafting warranties, indemnities, and escrow agreements based on these insights can also protect investments from data privacy liabilities.

Adjusting Purchase Price and Deal Structure

Remediation Costs: If significant deficiencies are discovered, it might be wise to negotiate a purchase price to cover remediation expenses. These expenses may involve updating outdated systems, introducing new security controls, and providing training for employees.

Deferred Payments: Splitting a portion of the buying price into deferred payments or earn outs linked to the execution of data privacy and cybersecurity measures can offer extra protection, while also ensuring that the acquired company expedites the remediation of identified issues.

Warranties and Representations

Remediation Costs: If significant deficiencies are discovered, it might be wise to negotiate a purchase price to cover remediation expenses. These expenses may involve updating outdated systems, introducing new security controls, and providing training for employees.

Deferred Payments: Splitting a portion of the buying price into deferred payments or earn outs linked to the execution of data privacy and cybersecurity measures can offer extra protection, while also ensuring that the acquired company expedites the remediation of identified issues.

Indemnities

Breach of Data Privacy Warranties: Secure indemnities to cover breaches of data privacy warranties and representations. This provides financial protection against potential fines, legal costs, and remediation expenses arising from undisclosed data privacy issues.

Third Party Claims:  Ensure indemnities also cover third-party claims related to data breaches or non-compliance that occurred before the acquisition. This shields the buyer from liabilities that may surface after the deal closes.

Escrow Agreements

Escrow Holdbacks: Negotiate escrow holdbacks to cover potential data privacy liabilities. A portion of the purchase price can be held in escrow for a specified period, providing a financial buffer against any post-acquisition data privacy issues. The escrow holdback ensures that specific release conditions are met, such as fixing potential issues identified during diligence. This mechanism offers additional protection by guaranteeing that the seller addresses these issues before the escrow funds are released. Ensure that you define clear conditions for the release of escrow funds.

Integration and Monitoring

Post Closing Integration Plan: Develop a detailed post-acquisition integration plan that includes steps for aligning the target’s data privacy practices with your broader portfolio standards. This ensures a seamless transition and mitigates the risk of future data privacy issues.

Ongoing Monitoring: Implement ongoing monitoring mechanisms to ensure continued compliance with data privacy regulations. This includes regular audits, staff training, and updating policies and procedures as needed.

Important Considerations for Using These Strategies

The strategies outlined here are examples intended to be part of your toolkit for mitigating risks and exposures related to data privacy and cybersecurity. They are not necessarily meant to be applied to every deal, as overcomplicating a transaction can hinder progress. Instead, use these strategies selectively and appropriately to address specific risks as needed.

Additionally, we are not a law firm, data privacy experts, or M&A attorneys. While this guidance was crafted in collaboration with partners in the data privacy space, we are not providing legal recommendations. We strongly suggest consulting with your legal experts to tailor these strategies to your specific situation and ensure compliance with all relevant laws and regulations.

Our Message to Private Equity Firms

Private equity professionals must consider incorporating data privacy into their investment strategies. Adopting a proactive due diligence approach involves thoroughly evaluating data privacy and cybersecurity risks. Given the complexity of regulations, involving experts from inhouse counsel or outside counsel is essential. This approach protects investments and aligns with evolving consumer and regulatory expectations.

The Strategic Benefits of Prioritizing Data Privacy

Data privacy extends beyond compliance; it enhances investment value. Strong data privacy measures build trust with investors, consumers, and partners, providing a competitive advantage and laying the groundwork for long-term success. Prioritizing data privacy mitigates risks and aligns with the growing demand for businesses that value privacy.

Looking Ahead

The data privacy landscape is evolving due to regulatory changes and technological advancements. While this presents challenges, it also offers opportunities for firms that stay ahead of developments. Continuous improvement in data privacy practices is crucial for robust risk management. As regulations and consumer expectations change, staying informed and adaptable will be vital for navigating the future of data privacy in investments. In summary, safeguarding data is becoming a fundamental aspect of due diligence and risk evaluation. This shift requires firms to integrate data privacy and cybersecurity into their investment processes, viewing it as a value-adding factor for sustainable growth.