Key considerations for M&A in the Tech Sector
Despite a drop in deal volumes in Q2 2020 caused by Covid-19, M&A and investment in the UK Tech Sector bounced back strongly in Q3 2020 and market analysts are predicting strong levels of activity in 2021 and beyond.
Increased confidence from trade buyers and high levels of cash in PE and Tech funds has spurred a rebound in UK Tech deal activity. According to GlobalData’s deals database a total of 322 UK Tech sector deals were announced in Q3 2020 including 117 M&A deals (including megadeals like the sale of ARM to Nvidia), 27 private equity deals and 188 venture capital deals.
For Tech Sector companies, whether looking for investment, acquisitions or to exit, it is more important than ever to consider the key issues when doing a Tech related deal. Read on to see what you should be considering:
Get your house in order – like any business, if you’re looking for investment or to sell you must first ensure your business affairs are in good order. In particular, is there properly documented ownership or licensing of IP rights, are IP rights properly protected (e.g. through registered trademarks, patents etc), are there proper licences and contracts in place with customers, partners and suppliers, are key employees tied in and incentivised, are there any significant disputes to settle, is any business reorganisation required to ring-fence liabilities or non-core activities?
Confidentiality Agreements – getting a confidentiality agreement signed prior to any disclosure of information is essential. On a practical level during the transaction process, you may want to phase or restrict the disclosure of commercially sensitive data and technology and have control measures in place until negotiations have progressed sufficiently.
Deal structure – transactions are normally structured either as a share sale or an assets sale. For tax and other reasons, sellers typically prefer share sales which effectively pass all the assets and liabilities to the buyer. An asset purchase allows the parties to cherry-pick what is acquired, which reduces risk for a buyer.
Other factors may also dictate which structure is used including whether there are likely to be any issues in obtaining third party consents for any transfer of ownership (including transfer of IP rights) and data privacy issues, in terms of what consents may have been obtained from data subjects and if there is any risk of liability arising either as a result of the way business is being undertaken or the transaction itself.
Pricing – for Tech sector targets, a range of different pricing and payment mechanisms are often used due to the expectations and uncertainties around the future unrealised growth value of IP assets. Such mechanisms have been common in recent months to bridge expectations and risk concerns. For example, part of the price may be deferred and be conditional on certain events or milestones. In other cases, an earn out may be appropriate where all or part of the purchase price is calculated by reference to future performance of the target. In these cases, the parties will need to agree balanced provisions with clear targets, mechanisms and protections for both parties.
Due diligence – the due diligence process is key for investors and buyers in deciding whether to do a deal and at what price and deal terms. A virtual data room is used in many cases to facilitate the process. For Tech companies, due diligence will often be focussed on IP rights and licences, IT capabilities, data rights and contracts with key employees and third parties. In terms of IT, buyers will want information about the software used or developed, source codes, IT infrastructure and IT resilience. The buyer is likely to require in-depth warranties on these subjects in the purchase agreement to back up their due diligence exercise and, where problems have been identified, indemnities and holdbacks may also be required.
Data privacy– this will be an important feature in many transactions, particularly given the potential fines involved. A buyer will want information about a target’s compliance history and details of any breaches and both parties will be keen to ensure that the transaction itself does not breach the legislation. If the technology of the target is IT based, it will be important to show that it has been developed with cybersecurity and data protection in mind and what features are in place to protect users.
Founder/Key employee retention– key employees may have been incentivised and tied in perhaps through share option or other schemes and consideration will need to be given as to how those incentives can continue (or be replicated in the buying vehicle) if key employees are to be retained. If founders or key employees are not sufficiently incentivised, it may be appropriate to consider whether additional incentives ought to be offered in order to retain them. Often new service contracts are negotiated.
Restrictive covenants – these are usual in transactions, but, in the Tech sector, there is a tricky balance between the freedom of Founders/seller(s) to move on and continue to work after completion of the deal and protecting the business from potentially unfair competition. The more niche the technology involved, the more potential for protracted negotiation on this point. These clauses will need to be drafted carefully to ensure that they give adequate protection to the buyer and target business whilst still enabling the seller(s) to work and operate after the sale.
Whatever next steps you have planned, here at Greenwoods GRM LLP we can advise you on the best course to suit your business needs and circumstances. Our broad experience in Tech sector deals means you can have confidence that we will work with you to achieve the best outcome possible.
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