In any acquisition, there are literally hundreds of issues for directors and their advisors to consider. The following are our top ten tips which buyers of tech companies should consider before embarking on a due diligence exercise for a private company acquisition.
1. Is there a deal to be done?
Before embarking on detailed due diligence, ensure that you have agreed a deal in principle. A purchaser should seek buy-in from all majority shareholders and confirmation that any minorities are on board. If principals are miles apart on indicative pricing and other key terms, due diligence is unlikely to close the gap.
2. What key terms should be agreed?
In tech companies it is often key to ensure that shareholders who are active in the business are either tied into the business going forward after the sale or prevented from competing with the business. You should also be clear that any key technology or other business assets is included in the deal.
Beyond pricing and payment terms, it is crucial that all parties are clear about who will give warranties. It is useful also to consider whether the sellers giving warranties have the wherewithal to stand behind them. If not, it may be appropriate to insist on a deferred consideration structure or escrow to protect the position.
3. Always consider a term sheet.
Although term sheets (or heads of terms) are not generally legally binding (except in certain limited respects), they carry significant “moral” force in negotiations down the line. It is difficult for the sellers to back-track on agreed points.
The term sheet is also a good place to agree a transaction timetable. Transaction “drift” can be costly and, especially in the fast-moving tech sector, may even undermine the rationale for doing the deal at all.
Consider getting solicitors and other advisers cued up at this stage. Depending on the complexity of the term sheet and the extent to which it is legally binding, it may be appropriate to take advice to ensure that nothing substantial is being overlooked and that what you have agreed will be feasible in practice.
4. Stake a claim.
Before incurring substantial due diligence costs, make sure you have legally enforceable rights of exclusivity which lock out other bidders in the event that negotiations collapse.
Depending on bargaining power, it is sometimes even possible to obtain a costs indemnity, which covers your costs where the seller pulls out without good reason.
5. Get sellers on the hook.
If you get sellers to start spending money, they are psychologically committed to the deal. Encourage them to instruct advisers. Get them to do the heavy lifting for you on the due diligence side.
6. Prioritise key value areas.
If you’re buying the target for its intellectual property, techology assets or customer base, for example, look at these areas first. If there are problems here then the remainder of the due diligence may be academic.
Key issues in all acquisitions will be rights of termination on change of control or any consents of third parties which might be required to get the full benefit of any rights. Take advice early to work out the best way of addressing these issues.
If you expect to meet the target’s customers or suppliers, agree at an early stage when and how this will be conducted (but don’t be surprised if this is to be held in the final days before closing).
7. Consider key risk areas.
Environmental, pensions, disputes and tax are areas which often give rise to significant potential liabilities. If relevant they should be reviewed early in any due diligence process in order to determine whether they are best addressed by contractual protection, deal structure or both.
8. Explore the sellers’ priorities too.
Are there any potential deal-breaking issues you need to know about on the sellers’ side (e.g. tax treatment)? Understanding the sellers’ position can also help identify points which you can afford to “give” down the line.
9. Formalise due diligence requirements.
If you require information to be provided in a particular format or manner – e.g. a virtual data room – agree this at the outset. Virtual data rooms permit multiple members of the due diligence team to view documents and information at the same time. They also require the target to spend not insignificant sums setting everything up (see point 5).
Always agree a coherent and structured process for due diligence. Do not accept information otherwise than through agreed channels. Information provided informally or without written record can ultimately undermine warranty protection by opening the door to arguments that given issues were known to you when you entered the acquisition agreement.
10. Commit appropriate resources.
If you do not have a dedicated acquisition team, who will run your business in the meantime? Do not underestimate the amount of management time and other resources required to assess and execute an acquisition, and budget accordingly.