7 M&A Deal Killers and How to Avoid Them07 April, 2015
Given today’s very active technology merger and acquisition market, and given that it looks to remain strong, it makes sense to examine the state of your company in order to maximize the value of your exit. Technology companies are generally bought, not sold, and the largest buyers—companies like IBM, Google, Oracle, and Citrix, to name a few—are looking at smaller companies on an ongoing basis to expand their portfolios. Constant readiness then becomes imperative in order to both look attractive to potential buyers and to maximize the value of your company.
Too often, however, technology companies seeking a profitable exit make the flawed assumption that the due diligence and valuation process resides solely in the hands of the buyer. This assumption can lead to fatal mistakes that can undermine value, slow the process, or even kill the deal. The truth is, as a selling company, you have an enormous opportunity to shorten due diligence timelines and maximize the value that the buyer assigns to your company.
Today’s buyer can be ruthless in evaluating your company’s strengths and weaknesses. Many due diligence teams will attempt to steamroll you in order to expose risks and reduce value. How do you ensure that you’ve done all you can to look good in the face of this kind of scrutiny? Putting yourself in the buyer’s shoes and anticipating what they will be looking for is the best way to ensure that your company will be ready when a buyer knocks on the door.
The bottom line is that the more you can do to be ready, the more likely that your deal will be successful and that you will maximize its value. Below are several areas of your company that will be scrutinized by a buyer and can potentially kill your deal.
DEAL KILLER #1 — FAILURE TO VALIDATE BENEFIT TO THE BUYER
Can you provide the evidence to support the buyer’s business case to buy your company? One of the most important things you can do as a selling company is to understand your own value in the hands of a potential buyer. Why are they buying you? What are the synergies your company will bring to theirs? In all M&A deals there will be a sponsor at the buying company. Their job is to create a business case for buying your company and integrating it into the larger entity. If you don’t understand what that business case is, and if you can’t assist that internal sponsor in developing that case and presenting it to their support team then the deal will likely never get off the ground.
DEAL KILLER #2 — FAILURE TO PROVE OWNERSHIP OF IP
Do a quick search of the news on any given day and you’ll find a swirl of litigation, claims, and counter claims surrounding the ownership of intellectual property. Claims concerning the ownership of intellectual property are becoming both an offensive and defensive strategy for large technology buyers. Can you provide evidence that you own your intellectual property?
Often company executives are not aware of what’s in their code base, what they own, what they don’t own, what they have rights to transfer or not transfer, or what third-party technologies they are utilizing. Not having a firm grasp of your intellectual property can have serious ramifications on deal timing and deal success. Today the top technology acquirers will demand an audit of your code base to determine that everything in your code base is owned by you and that you have the right to transfer it.
Do an audit of your own code before someone else demands it and then put the resulting documents into your data room. If issues arise they can be remedied long before they can have disastrous effects on a deal.
DEAL KILLER #3 — UNRESOLVED LITIGATION
It should go without saying that threats of litigation are major red flags for buyers; however, it’s not uncommon for the due diligence process to reveal litigation exposure of which the owners of the selling company weren’t even aware. These exposures can be associated with ex-employees, past or present customers, vendors, intellectual property issues, and can even be related to company practices that are no longer in use.
Unresolved litigation will reduce deal value and should be dealt with well before a buyer shows interest. Once the due diligence process has started, unresolved litigation is much more difficult and costly to deal with and will delay and potentially kill a deal. Review unresolved and potential litigation with an attorney, put the relevant documents into your data room and resolve issues before they become factors in whether or not your company looks attractive to a buyer.
DEAL KILLER #4 — ACCOUNTING DESCREPANCIES
Accurate financial statements are central to determining value in a transaction. Can your company survive the scrutiny of a public company audit? If your company is acquired by a public company, you will be subjected to a public company audit. Any unidentified exposure in revenue recognition, booking, or deferred revenue practices will directly reduce deal value.
Are your forecasts credible and consistent? Do you have any taxation issues? If you can’t credibly present your financial picture to a potential buyer you throw your credibility into question, at best delaying a deal, at worst killing it. Buyers are expert at smoking out inaccuracies in your forecasts or reported financials, and they’ll take that out pound by pound from your transaction value. If your company hasn’t had a recent audit, or ever had one, it’s probably time to do it.
DEAL KILLER #5 — EXPOSURES & RISKS OF COMPANY AGREEMENTS
One of the scary realizations you may experience when attempting to sell a company is that buyers will require you to produce all of the agreements your company has entered into from its very first day of business. These include, but are certainly not limited to, vendor agreements, customer agreements, and employee agreements. A potential buyer will want to see that they’re all signed and that you’re not in default or out of compliance with any of them.
It’s important to take a complete inventory of these agreements and ensure that nothing is missing, incomplete, or inaccurate. In particular, buyers will be looking for any nonstandard terms and conditions, such as exclusivity, source code escrows, unusual support or product obligations, termination rights, or the nonassignment or cancellation of a contract. If there’s value associated with a contract and it’s not transferable, that will be of interest to the buyer and potentially reduce the value of the deal. Inventory your company agreements now, identify any nonstandard terms, make sure they’re all accounted for and signed, and upload them to a virtual data room so they’re accessible when a buyer wants to see them.
DEAL KILLER #6 — EXPOSURES & RISKS OF CORPORATE GOVERNANCE
When a buyer scrutinizes your company they’ll want to know how the processes, customs, policies, laws, and institutions of your company impact how your company is controlled. They’ll want to know the nature and extent of the accountability of the participants in the business as well as the relationships among the stakeholders and the goals by which the company is governed.
Have all of your company’s securities and stock issuances been properly issued and authorized? Are board meeting minutes available for review? Are management, investors and the Board of Directors in agreement on distribution of proceeds? Have 409A valuations been performed by reliable sources? Are all of the critical corporate documents in your virtual data room? When Corporate Governance policies are incomplete or sloppy it causes delays in the due diligence process and is costly to tidy up. Do it ahead of time. Make sure everything is complete and available for review in a virtual data room.
DEAL KILLER #7 — EXPOSURES & RISKS OF HR ISSUES
When a buyer looks at your company they’ll want to know who your employees are and they’ll want to examine all employee agreements. Of particular interest will be any change in control terms that affect stock vesting, but also whether any employment terms will change severance or compensation. They’ll want to know about key employees and whether they’re planning to stay with the new company. Key employees are typically central to the deal, and the announcement that a key employee is leaving may impact deal value.
Before considering a sale, ensure that all your employee records and contracts are in order, current, signed and organized in a virtual data room for review. It’s of particular importance to ensure that proprietary rights agreements are current and in order. If there are proprietary rights agreements that apply to ex-employees and they are not current or in order, tracking down those ex-employees in the midst of the due diligence process can be a nightmare. In addition, you should be sure that you have all your current and ex-employee and shareholder addresses. Nothing is more frustrating then delaying the deal because you cannot locate an ex-employee to gain their signature on a consent or document that should have been signed years ago.
Today’s buyers are ruthless when it comes to due diligence, so it’s imperative when entering into a potential transaction to be organized, thorough, and to ensure that nothing the buyer might be interested in seeing is inaccurate or missing. Start by knowing a potential buyer’s business case and be prepared to articulate exactly how your business will add value to theirs. Second, put yourself in the shoes of the buyer and do an honest self-assessment of your company. Are there any glaring red flags? Would you be impressed if you were the buyer?
Being prepared and ready can make the difference between a good deal and a great deal, or even a deal that goes through versus one that dies. Don’t wait. Your company should always operate as if a buyer is right around the corner.
To learn more about avoiding the common pitfalls of sell-side due diligence and maximizing the value of your exit download our free white paper:
Based on the white paper by David Stastny, Centaur Partners LLC