The 7 Deadly Sins of M&A22 November, 2016
We sat with David Stastny, former Managing Director of Centaur Partners, to discuss tips and best practice on avoiding the pitfalls of the M&A process.
VaultSeries: Why do you think that companies are often undervalued during the M&A process, or that deals fall through completely? David Stastny: Too often, technology companies seeking a profitable exit make the flawed assumption that the due diligence 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. The trick is to avoid what I call the Seven Deadly Sins of M&A. #1 FAILURE TO VALIDATE VALUE TO THE BUYER
VaultSeries: Why do you think that companies are often undervalued during the M&A process, or that deals fall through completely?
David Stastny: Too often, technology companies seeking a profitable exit make the flawed assumption that the due diligence 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. The trick is to avoid what I call the Seven Deadly Sins of M&A.
#1 FAILURE TO VALIDATE VALUE TO THE BUYER
Of all the deadly sins, this is the most important. Can you provide the evidence to support the buyer’s business case to purchase your company?
In all M&A deals there will be a sponsor at the buying company whose job is to create a business case for buying your company. If you don’t understand that business case, 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.
It is crucial that you understand your company’s value in the hands of a potential buyer and be able to articulate the synergies your company will bring to theirs.
#2 FAILURE TO PROVE OWNERSHIP OF INTELLECTUAL PROPERTY
Often company executives are unaware 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. Most top technology acquirers will demand an audit of your code base to determine that you own everything in it and that you have the right to transfer it.
#3 UNRESOLVED LITIGATION
Are there potential lawsuits or litigations that could surface during due diligence or after the deal is announced? It’s not uncommon for the due diligence process to reveal litigation exposure that the owners of the selling company were not even aware existed.
These exposures could relate to IP, customers, former or current employees or even company practices that are no longer in use. Don’t fool yourself: If your company is facing any real or potential lawsuits they will be exposed during the due diligence process likely resulting in reduced value.
#4 DISCREPENCIES IN FINANCIAL, ACCOUNTING OR OPPERATIONAL PLANNING
Can your company face the scrutiny of a public company audit? Many small companies can’t. If your company is acquired by a public company, your company will be subjected to a public company audit. Any unidentified exposure in revenue recognition, booking, or deferred revenue practices will directly reduce your deal value at least dollar for dollar. 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.
#5 FAILURE TO VALIDATE COMPANY AGREEMENTS
One of the frightening realizations you may experience when attempting to sell a company is that buyers will require you to produce all of your company agreements entered into from the very first day you started doing business.
These could be vendor agreements, customer agreements, employee agreements, or any other type of agreement you’ve entered into. The buyer will be interested to see if these agreements are 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.
#6 UNRESOLVED HR OR EMPLOYEE LIABILITIES
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.
Ensure that you've kept up best practices for employee reviews, performance improvement, bonuses and termination. If you haven't, there’s a potential for litigation. It’s amazing how many employee disputes will arise during the deal process.
#7 SLOPPY CORPORATE GOVERNANCE
When scrutinizing your company a buyer will want to know how your company’s processes, customs, policies, laws and institutions impact how it 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. 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, organized and available for review in a virtual data room.
Remember 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.