Keeping tech M&A deals on the rails
Global technology M&A is booming, but soaring headline values often mask fractious negotiations and the fact that many deals fall over before completion. Fieldfisher corporate technology specialists Brian Chadwick, Tom Ward and Tim Bird consider why some tech transactions don't make it over the finish line.
Macro-economic and political tensions caused overall M&A activity to wobble last year, but the value of tech M&A remained an unremitting cause for optimism.
Data compiled by Mergermarket show UK tech M&A was worth £23 billion in 2019, the sector's second highest value on record, bucking the trend of slowing domestic M&A as a whole (which fell 27% from 2018 to £134.7 billion).
Gaming, fintech, AI and e-commerce have been among the standout performers in tech M&A, in the UK and across the world.
But hidden behind many headline deals of the past few years were several disgruntled stakeholders who regret the way sales were handled.
In some cases, deals never made it over the line, leaving nothing but a mess of bills and bad feeling to show for what has typically been months of negotiating; in others, "successful" deals have become focal points of bitter litigation.
The blame game
There are various reasons why tech M&A deals turn sour.
The speed at which many tech companies grow leaves little time for good corporate housekeeping along the way.
The verbal promises company founders and early employees make to each other in the run up to, or during, that growth period, can be the roots of problems that emerge when it comes to selling the business.
When the time comes to sell, the buyer’s law firm will want to dig deep into the target's legal commitments as part of the due diligence phase.
This involves looking at things like share options, bonuses and ownership of intellectual property (IP) – aspects that most small companies that have grown up quickly won’t have thought about or drafted contracts for.
In the absence of formal legal documents, and faced with awkward questions from the buyer's legal team, personalities tend to fill the void with claims of undocumented promises about who owns what.
If a company becomes an M&A target, things tend to move very rapidly and even the strongest relationships can be tested.
If it is impossible to resolve disagreements, the buyer will simply walk away, even if they are already a long way down the deal path, as it is rarely worth the risk of being saddled with crippling commitments.
Avoiding conflict
Although it is difficult to correct the mistakes of the past and unreasonable to expect accidental entrepreneurs to have the foresight to draw up a legally binding contract for every decision they make, there are ways to avoid running into difficulties.
Once a business reaches a certain size, and staff who have worked hard to build the company up indicate they want to take their foot off the gas, this is usually a good time to open conversations about possible exit strategies and what people expect to take with them.
These conversations should be started, and ideally concluded, before a buyer becomes involved, as the acquirer's schedule may not allow the seller time for sensitive discussions.
Indemnities are another frequently used legal tool for getting deals through while protecting (usually) the buyer.
Parties to an M&A deal, in tech as in other industries, typically indemnify against whether share transactions happen successfully or not.
For tech companies, which typically have highly complicated products, it is common to indemnify against claims from any erstwhile consultants that they have IP rights to the content they helped create.
Very often, small tech businesses have not have performed any kind of corporate governance – many will never have even had a board meeting – which can also present issues that need to be indemnified.
GDPR compliance is one of the main issues which tends to be overlooked by small companies, to the horror of buyers who discover the data on which the acquisition target relies for its revenue was not legally collected and stored.
Finally, share ownership can often be called into question where co-founders have fallen out with each other and an aggrieved party has left the business still owning shares.
When a potentially lucrative deal is on the cards, that estranged shareholder may suddenly think they have some leverage, and try to gain compensation for any past perceived misdemeanours of their former colleagues.
Having a raft of indemnities can raise hackles on both sides, usually on the part of the seller who has to provide them, but these can usually be negotiated to a point where buyer and seller are willing, if not always 100% happy, to proceed with the deal.
Post-completion, some companies try to avoid meeting commitments agreed as part of the deal, such as paying milestone-based earn-outs.
While there may be legitimate reasons for not paying earn-outs, it is worth bearing in mind that it can impact a buyer's ability to do future deals, if they gain a reputation for not honouring commitments.
How can lawyers help?
In tech M&A deals, whatever their size, obtaining specialised legal advice is invaluable.
It is important to retain lawyers that speak the language of their tech M&A clients – who understand the industry and are adept at spotting potential pitfalls and opportunities in the deal process.
A legal team that includes past in-house legal expertise is particularly useful, as they can look at the deal from an insider's perspective as well as offering an objective view.
As well as assisting with due diligence lawyers can help manage practical issues such as difficult relationships between key stakeholders within a business or between buyer and seller, and offer specialist advice on matters such as IP, licensing arrangements, GDPR, employment and real estate issues connected with the sale.
For more information on our tech M&A expertise, please download our guide to M&A in Europe and China, contact one of the authors of this article or visit the M&A and technology pages on the Fieldfisher website.
Data compiled by Mergermarket show UK tech M&A was worth £23 billion in 2019, the sector's second highest value on record, bucking the trend of slowing domestic M&A as a whole (which fell 27% from 2018 to £134.7 billion).
Gaming, fintech, AI and e-commerce have been among the standout performers in tech M&A, in the UK and across the world.
But hidden behind many headline deals of the past few years were several disgruntled stakeholders who regret the way sales were handled.
In some cases, deals never made it over the line, leaving nothing but a mess of bills and bad feeling to show for what has typically been months of negotiating; in others, "successful" deals have become focal points of bitter litigation.
The blame game
There are various reasons why tech M&A deals turn sour.
The speed at which many tech companies grow leaves little time for good corporate housekeeping along the way.
The verbal promises company founders and early employees make to each other in the run up to, or during, that growth period, can be the roots of problems that emerge when it comes to selling the business.
When the time comes to sell, the buyer’s law firm will want to dig deep into the target's legal commitments as part of the due diligence phase.
This involves looking at things like share options, bonuses and ownership of intellectual property (IP) – aspects that most small companies that have grown up quickly won’t have thought about or drafted contracts for.
In the absence of formal legal documents, and faced with awkward questions from the buyer's legal team, personalities tend to fill the void with claims of undocumented promises about who owns what.
If a company becomes an M&A target, things tend to move very rapidly and even the strongest relationships can be tested.
If it is impossible to resolve disagreements, the buyer will simply walk away, even if they are already a long way down the deal path, as it is rarely worth the risk of being saddled with crippling commitments.
Avoiding conflict
Although it is difficult to correct the mistakes of the past and unreasonable to expect accidental entrepreneurs to have the foresight to draw up a legally binding contract for every decision they make, there are ways to avoid running into difficulties.
Once a business reaches a certain size, and staff who have worked hard to build the company up indicate they want to take their foot off the gas, this is usually a good time to open conversations about possible exit strategies and what people expect to take with them.
These conversations should be started, and ideally concluded, before a buyer becomes involved, as the acquirer's schedule may not allow the seller time for sensitive discussions.
Indemnities are another frequently used legal tool for getting deals through while protecting (usually) the buyer.
Parties to an M&A deal, in tech as in other industries, typically indemnify against whether share transactions happen successfully or not.
For tech companies, which typically have highly complicated products, it is common to indemnify against claims from any erstwhile consultants that they have IP rights to the content they helped create.
Very often, small tech businesses have not have performed any kind of corporate governance – many will never have even had a board meeting – which can also present issues that need to be indemnified.
GDPR compliance is one of the main issues which tends to be overlooked by small companies, to the horror of buyers who discover the data on which the acquisition target relies for its revenue was not legally collected and stored.
Finally, share ownership can often be called into question where co-founders have fallen out with each other and an aggrieved party has left the business still owning shares.
When a potentially lucrative deal is on the cards, that estranged shareholder may suddenly think they have some leverage, and try to gain compensation for any past perceived misdemeanours of their former colleagues.
Having a raft of indemnities can raise hackles on both sides, usually on the part of the seller who has to provide them, but these can usually be negotiated to a point where buyer and seller are willing, if not always 100% happy, to proceed with the deal.
Post-completion, some companies try to avoid meeting commitments agreed as part of the deal, such as paying milestone-based earn-outs.
While there may be legitimate reasons for not paying earn-outs, it is worth bearing in mind that it can impact a buyer's ability to do future deals, if they gain a reputation for not honouring commitments.
How can lawyers help?
In tech M&A deals, whatever their size, obtaining specialised legal advice is invaluable.
It is important to retain lawyers that speak the language of their tech M&A clients – who understand the industry and are adept at spotting potential pitfalls and opportunities in the deal process.
A legal team that includes past in-house legal expertise is particularly useful, as they can look at the deal from an insider's perspective as well as offering an objective view.
As well as assisting with due diligence lawyers can help manage practical issues such as difficult relationships between key stakeholders within a business or between buyer and seller, and offer specialist advice on matters such as IP, licensing arrangements, GDPR, employment and real estate issues connected with the sale.
For more information on our tech M&A expertise, please download our guide to M&A in Europe and China, contact one of the authors of this article or visit the M&A and technology pages on the Fieldfisher website.