What is a Disclosure Schedule, and Why Do I Need to Prepare One?

When a company receives a venture investment, or is acquired, it typically must prepare a “disclosure schedule” (also sometimes called a “schedule of exceptions” or “disclosure letter”). This article addresses common client questions about disclosure schedules. While this piece focuses on US law and practice, similar concepts apply in many other jurisdictions.

What is a disclosure schedule?

A company that is receiving investment or being acquired will need to make representations and warranties (for purposes of this article, we’ll just refer to them as “representations”) about the state of the company and its business. In oversimplified terms, representations are simply a collection of statements about the company and its business that are material to the investor’s decision to invest in the company or the buyer’s decision to buy the company. These representations are usually contained in one (lengthy) section of the investment or acquisition agreement. For example, in the National Venture Capital Association (NVCA) model form of Preferred Stock Purchase Agreement (available on this page), the company’s representations are in Section 2.

Company representations come in two varieties:

1. General statements of fact, e.g., “the Company has no active litigation.” If this statement is true, no disclosure is required. If this statement is not true, then the company will need to disclose the active litigation on the disclosure schedule so that the representation and the disclosure schedule, taken together, constitute a true statement.

2. Listing requirements, e.g., “Schedule 3.2 lists all of the Company’s registered trademarks.” This representation requires the company to list out its trademarks; if the company has no trademarks, the disclosure would just say “none.”

The representations function together with the disclosure schedule as a kind of Q&A, where the representations are the question and the disclosure schedule is the answer.

What purpose do disclosure schedules serve?

Disclosure schedules help ensure that investors or buyers have the information they need to make an investment or buying decision, and that the company mitigates risk that might otherwise arise from failure to disclose this information. For example, if a purchase agreement in a venture financing includes a representation that a company has no active litigation, it prompts the company to disclose any such litigation, which the investor can then review. This helps avoid the practically and legally awkward question of, “Why didn’t you tell me this before we closed?”

In financing transactions, failure to thoroughly disclose can result in all manner of negative consequences, including breach of contract damages or a retroactive (downward) adjustment to the investment purchase price (i.e., valuation). Likewise, in acquisitions, failure to thoroughly disclose can lead to a range of adverse outcomes, including allowing the buyer to walk away from closing and/or reduce the purchase price.

How do I prepare a disclosure schedule?

The company almost always prepares the initial draft of the disclosure schedule, as outside counsel typically does not have sufficient visibility into the company’s day-to-day operations to prepare complete disclosures. Plus, it is the company itself that is typically making the representations, and so it is ultimately the company’s responsibility to stand behind the disclosure schedule. That said, to help start the process, company counsel will often offer to prepare a “shell” disclosure schedule with sections corresponding to the relevant sections of the investment or acquisition agreement, which the company can complete based on information in its possession. Because the representations are often written in dense legal language, company counsel will often include a “plain English” summary of the representations, or offer to walk through the representations on a call.

For subsequent financings, companies can generally start with the disclosure schedule from the prior round and update it to reflect changes to the company, as well as to account for any new representations that have been added to the financing documents.

How can I make the disclosure schedule process easier for my company?

The best way to minimize the time and delay associated with preparing disclosure schedules is to have your corporate and legal records organized well in advance of a deal, so that you can quickly access the underlying information and share materials as needed. Preparing disclosure schedules (and the related due diligence process) is much more difficult, time-consuming and stressful if the company needs to chase down corporate information and records in real time. For tips on how to get your corporate house in order for diligence and disclosures, see this Cooley GO article.