Our years of experience of advising tech companies on M&A have shown us that there are a number of key issues which commonly crop up, risking lower valuations, or in the worst case, stopping a transaction. This is particularly the case with IT and business services/enterprise software businesses. Being pro-active about these matters early on can make all the difference between a successful exit and a frustrating and disappointing experience.
1. Customer Contracts
The lifeline of any company are its customer contracts. If a big chunk of a company’s revenue is generated from only a few customer contracts, then it is important to check if the customer has any rights to terminate the contract following the company’s sale. If a key contract contains such a ‘change of control’ provision, the seller(s) need to think about how to approach the customer about the sale and what their likely reaction will be (particularly if the intended buyer is a competitor). Buyers often want the customer(s) to agree to the sale and not break their agreements before the purchase of the company.
2. Intellectual Property
For many tech businesses (in particular enterprise software businesses), much of their value will be in the IP they own, and buyers will be very focussed on this. It is crucial that the company actually owns the IP that it says it does – however, we often find quite major problems with this. One common occurrence is where a company has used independent contractors (or other third parties, particularly overseas companies) to develop their tech stack without making sure that the agreements with those suppliers leaves all the IP with the company (and not with the supplier). Other common problems arise with disgruntled founders (who have left the business) claiming ownership of IP.
3. Company Ownership
Buyers want to know that they are buying 100% of the company. Whilst this may seem obvious (and something that should be easy), you’d be surprised by the number of times we come across issues here – a common example being where a former founder/key employee claims to be entitled to shares or options but where the paperwork was never formalised, etc. Not surprisingly this is a big turn off for buyers.
From our experience, the key message with tax is ‘keep it simple’! A buyer will want to know that the company’s tax affairs have been run properly so that there is no lingering tax liability. Companies with complex tax planning arrangements often end up tying themselves in knots, with unforeseen problems arising from schemes which were not properly thought through. Obtaining proper professional advice when setting up any tax planning scheme, including EMI and other share option schemes, is important to make sure everything is done properly. We have found that you can hardly ever correct past mistakes when it comes to tax matters, and it can have quite serious ramifications on a sale process where companies get this wrong.
Buyers will want to understand the underlying software owned by the company and, as well as systems tests to check performance under various stress-testing scenarios, will often run a ‘Black Duck’ test to discover all open source used in the company’s software, flagging vulnerabilities and risks. They will also often review the company’s source code and check the licence terms for each piece of open source code. Companies should therefore make sure that they obtain, maintain and comply with all the licences that they need for their software.
Tech Exit Triage webinar
You can also view a CMS webinar about tech exit triage below.