Selling a technology company is a complex process, but it all boils down into the final contract between the seller and the buyer. How do you ensure that the definitive agreement reflects your best interests and the value you have built in your company? On Thursday, August 9, Corum dealmakers will take a detailed look at the process that leads up to the final M&A contract, highlighting the key moments and the most dangerous pitfalls as the agreement comes together, with stories straight from Corum’s 30+ years of selling technology companies. This is the most important document of your company’s life – and possibly yours, as well – so take 30 minutes to understand how to do it right.
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Tech M&A Monthly: Best Practices for Definitive Agreements in Tech M&A
Good morning, afternoon, or evening, wherever you happen to be in the world. My name is Tim Goddard. I am the EVP of Marketing here at Corum Group. Very happy to be bringing you today a special report on tech M&A contracts, as well as, quite a few other items. Contracts are a big issue. And so we've got a big report on that. But I do want to get to a couple of other things first. We'll have a field report on a deal recently closed, we'll have our research report, and then our special report. So. Without any further ado, I'm gonna turn things over to Dan Bernstein, who's currently in Australia on a deal close down under, Dan?
We are proud to have represented QSR International in their strategic partnership with Rubicon Technology Partners. A leader in the qualitative data analytic space, QSR software is used worldwide by 1.5 million researchers seeking to uncover insights contained within the human data, collected via social media, consumer and community feedback. The partnership ensures QSR's continued growth and expansion in academic, governmental, and commercial spheres. QSR is based in Melbourne, Australia, and Rubicon is based in Silicon Valley. Another reminder that good technology is everywhere, the buyers are everywhere, and that no matter where you are, whether it is Silicon Valley, Columbus, Ohio, or Melbourne, Australia, you need a global process in order to get an optimal outcome. We are particularly excited about the work we are doing in Australia with firms like QSR. We are pleased to announce that Rubicon and News Corporation will join us as buyers, and QSR and Punters will join us as sellers at the upcoming World Financial Symposiums, Growth & Exit Strategies for Software and IT Companies conference. To be held in Sydney for the first time on 1st of October 2018. Held regularly in Silicon Valley, New York, and London, this event brings together global leaders in tech and finance for a day of in-depth panels and presentations from leading acquirers, entrepreneurs, bankers, and more. To learn more about WFS and the Growth & Exit's conference series, visit www.wfs.com/syndney-2018. I'll look forward to seeing many of you in Sydney in November.
Thanks, Dan, and congratulations. If you are not perhaps near Sydney, you can still attend a Growth & Exit Strategies conference whether you're in Europe or in the United States. London on September 27th, and then New York on October 16th. These are really the premiere tech and finance events. So if you are at all able to attend, I strongly encourage it, as I mentioned. More at wfs.com. Now let's turn things over to the Corum Research Team led by Elon Gasper, along with Amber Stoner and Patrick Cunningham, Elon.
Thanks, Tim. We begin with the public markets, where the S&P Tech and NASDAQ climbed to record highs in July, powered by big tech, the Dow rising even faster to narrow its gap with them a bit, reversing the recent trend. Most big international markets booked gains, too. But with the Dow still well below its all-time high, the call on whether this is still one long bull market must wait. Regardless, the tech bull charges on and the tech M&A window remains open, with high though price-disciplined demand vying for a limited supply of sellers. Our Corum Index showed a significant gain in year-over-year deal volume, and the 2018 tech megadeal wave continued. VC and startup exits increased with the widening scope of buyers' interest. But it's that megadeal tsunami still our headline for July after setting records in the first half. Enterprise B2B model targets continued to dominate, including France-based international IT services giant Atos spending $3.4B for outsourcing house Syntel to boost its presence in the US. And as we mentioned last month, chip maker Broadcom caused a squall of skepticism from investors and analysts in the year's biggest deal so far, laying out $19B for system software powerhouse CA, as Broadcom CEO Hock Tan declared a new ambition to create one of the world's leading infrastructure technology companies. Though most panned the lack of synergy we view the rationale as more a financial investment, in line with the trend we've noted toward converging behaviors of strategic and PE buyers and another reason doing a complete, global search for buyers is more important than ever. We'll cover other megadeals as we discuss sectors. First, what else happened in Infrastructure, Amber?
Infrastructure multiples remained steady for both sales and EBITDA, as security deals dominated July's dealflow. Outside of the security space, however, open source powerhouse SUSE, was bought for $2.5B by PE firm EQT with plans for expansion, including reports about intended bolt-ons. Email and data security firm Mimecast made two acquisitions in July, cybersecurity training firm Ataata to boost its cyber-resilience efforts, and Israeli zero-day malware isolation specialist Solebit for nearly $100M. AlienVault, offering unified security management tools, was bought by AT&T for over $0.5B to expand its security lineup into small and medium businesses. Data governance and GDPR compliance firm Data443 was wrapped up by logistics solutions developer Landstar to counter blockchain data leaks. Both strategic and financial buyers targeted identity and access management. Zero Trust security company ScaleFT was bought by Identity-as-a-Service firm Okta to strengthen its remote access capabilities. Endpoint privilege management company Avecto was acquired by secure access software developer Bomgar, shortly after Bomgar joined Francisco Partners' portfolio. And user verification software firm Centrify was picked up by Thoma Bravo following its other recent security acquisitions, LogRhythm and Imprivata. Finally, enterprise IT asset management expert E-ISG was acquired by Constellation's AssetWorks to add Federal Acquisition Regulation compliant reporting to its capabilities. How did vertical fare, Patrick?
In the vertical sector, sales and EBITDA multiples leveled out after first half volatility. We tracked consolidation waves across subsectors, including two megadeals in investment management. Charles River, which develops order management systems for investment firms, was grabbed for $2.6B by financial research firm State Street, as a component of a full-stack platform. Financial services veteran SS&C made its second megadeal this year, paying $1.5B for Boston-based Eze Software. We saw a summer crop of savvy AgTech solutions. In June, OnFarm, IoT data integrator for farmers, was nabbed by irrigation management firm SWIIM System to ease water regulation compliance. Last month, agronomic data management startup Agrible was picked up for $63M by Saskatchewan-based fertilizer firm Nutrien in its first ever software acquisition. And this week, soil health and conservation planning software provider Agren was harvested by Land O'Lakes. In ed-tech, adaptive learning startup Fishtree was nabbed by Follett to integrate Fishtree's machine learning insights into its own content management platform. And Socrative, specializing in interactive classroom applications focused on student understanding, was acquired by classroom workflow developer Showbie. Finally, in the A/E/C space, Australia's Spookfish, which applies machine learning for property assessment, was hooked for $80M by aerial imagery innovator Eagleview. What happened in the horizontal sector?
Sales multiples in horizontal are up, jumping ahead of the B2B pack to record highs. And EBITDA multiples are nearing October 2017 levels. Ethics and compliance firm Navex was acquired by BC Partners for $1.3B. In 2012, NAVEX bought Corum client PolicyTech, a compliance document management company based in Pocatello, Idaho, which it's still there, because PolicyTech went through a process that found the right partner to put them in a position to succeed in the long term. Amid the adoption of GDPR and the California Consumer Privacy Act, data marketing giant Acxiom sold its Marketing Solutions business for $2.3B to IPG in its largest tech deal ever. In the wake of that megadeal, Forrester Research bought two companies, AI enabled customer engagement platform GlimpzIt, and client satisfaction monitoring SaaS FeedbackNow, to build its own real-time customer experience cloud. As Dan mentioned, Corum client QSR, qualitative data analytics leader, was acquired by Rubicon Technology Partners. AI-enabled marketing intelligence platform Datorama was bought for $800M by Salesforce to bolster its Marketing Cloud service. And another AI-data analytics startup Kogentix was purchased by Accenture to strengthen its data engineering business Applied Intelligence. In HR, workforce training company Alchemy Systems was purchased for $480M by safety and compliance QA provider Intertek. HR management SaaS company PeopleDoc was acquired by Ultimate Software for $300M in its first acquisition in nearly two years. HR software companies reached into document management as well. Hubdoc, with solutions for accountants, was acquired by Xero for $60M in its first acquisition since 2014. And HR-focused SpringCM was picked up by DocuSign for $220M moving it beyond digital signatures to provide a more full-service suite of contract lifecycle products. In SCM, UK-based e-commerce delivery platform MetaPack was bought for nearly $230M by US Postal Service partner Stamps.com to move beyond the US. And finally, JDA Software made its first acquisition since merging with RedPrairie in 2012, picking up AI enabled analytics and market intelligence firm Blue Yonder.
And last week, SoftBank-owned chip designer Arm claimed it found the final piece of its IoT enablement puzzle by paying a reported $600M for analytics specialist Treasure Data, continuing SoftBank's acquisitive march through AI and IoT. Back to you, Tim.
Thanks, Elon. Now to introduce our next section I would like to turn things over to Corum's CEO and founder, Bruce Milne.
Today's special presentation is on merger agreements. We'll hear from a panel of experts on best practices for definitive agreements in tech M&A. These agreements are prepared during due diligence, part of the eight steps for an optimal outcome. This is stage six, which covers verification of statements, opinions needed, the establishment of the confidential data room, more due diligence, and finally, the completion of the definitive agreement, the merger agreement and attachments, which we're talking about today. Due diligence and the drafting of these agreements is done simultaneously after you have created your letter of intent from your negotiation. You have to assess risks and problems; those have to feed into your contract. You have to respond to the buyer's checklist, full disclosure, complete transparency. Are you ready? Here's a full list, it'll be online. Included corporation legal structure. Financial data, including three-year projections, tax status contracts, both from buyers and with your customers. Regulatory, insurance, litigation, or threats of litigation. Employee relations or problems. A big one, intellectual property. And finally, markets and competition. Here to lead our panel is legal expert, Joel Espelien.
10 Critical Elements of M&A Agreements
Thanks, Bruce. Understanding the process is critical. Now we're gonna walk through 10 critical elements of M&A agreements with Corum's worldwide team of deal makers, who collectively have seen more deals, and done more deals than anyone. We start with Ivan Ruzic in New York, on the interplay between financial statements and the definitive agreement, Ivan?
One of the primary areas of the contract, reps and warranties and related due diligence, is financial. You need to guarantee past and provide reasonable guidance on future plans. Make sure the buyer understands how your books and records are maintained early in the due diligence process. This little might surprise us in the drafting of the contract. Working capital and how it's calculated is in most contracts and has been one of the major areas of concern lately, especially with deals involving private equity. Again, no surprises. Discuss this early in the process. On budgets, be realistic and conservative for the coming year. Missing targets can delay, reduce, or even kill the deal. And finally, work with your accounting advisor to understand where you may have financial exposure either in the accuracy of your numbers or in liability. This will become useful information when negotiating reps and warrants.
Thanks. These issues can be particularly challenging in cross-border deals. Continuing on this theme, let's hear more from Jeff Brown in Houston on working capital and balance sheet adjustments.
So, you thought you negotiated the price for your company but think again. The purchase agreement determines how the balance sheet will be treated, and that treatment will result in a price adjustment. There's lots of value in your balance sheet, and the way that it's divided up will impact the amount of money you put in your pocket or leave for the buyer. The two popular methods for dividing up the balance sheet are called block box and completion accounts. The block box method is more popular outside the US. Neither method is intended to alter the amount saved for the business, but in practice it can. And here are some pitfalls. Structure language that says the transaction will be done on a cash-free, debt-free basis, with a normalized level of working capital is not enough. Sounds like the seller gets all the cash and pays all the debt. But that's not exactly true. Every business needs a certain amount of working capital. And that amount may change with seasonality, product price, or margin cycles. So what's normal? Also be sure you and the buyer are using the same accounting math. The buyer may want to classify some of your short-term deferred revenue as long-term and a liability, resulting in a balance sheet adjustment against you.
Thanks, Jeff. We see those issues in nearly every deal. Next, we turn to Rob Schram here in Seattle, on the all-important question of the escrow holdback, the money that you don't get at the close.
To satisfy potential future indemnity claims that are detailed within the indemnification section of the agreement, a portion of the purchase price is typically withheld in the form of an escrow, held by a third-party or a holdback held by the buyer. Escrow terms describe the percentage of the consideration withheld, the duration of the obligation, known as the survival period, how and by whom the escrow is to be funded and so forth. To prevent death by a thousand cuts, often a basket provision is included that outlines the minimum amount of damage the buyer must sustain before the seller is required to pay for losses.
Finally, a cap provision places a limit on the aggregate of claims drawn against the escrow. Some liabilities (for example, IRS audits, taxation, intentional fraud, etc.) remain uncapped. Generally, we see escrow amounts in the range of 10% to 15%, and a survival period of 12 to 24 months. The exact numbers depend on the inherent risk and the likelihood of liability. But skillful negotiation around factors like an independent board of directors, solid financials, good corporate governance, et cetera, serve to mitigate risk and increase buyer confidence. One of the advantages of having multiple buyer candidates in an orchestrated engagement is that escrow, like all structural elements of the dea,l can be negotiated. We've seen escrow completely taken off the table, to sweeten the buyer's LOI and win the deal.
Good advice, Rob. Note that escrow in a cash deal is obviously also cash. But there are still stock deals out there. And so we head back to Dan Bernstein on this important topic, Dan?
Taking on public stock in a transaction does not mean that you can immediately liquidate it. Stock has to be registered by the company before it can be sold on a public exchange. Companies can complete a shelf registration, basically registering stock to put on a shelf until they need it, and then issue it as fully registered. More likely though, your stock will be unregistered, leaving you with the option of selling it in a private 144A placement to an accredited investor at a discount to the market and with stiff fees. Or you can rely on the issuer to register the stock after you get it. If you do take unregistered stock, you should insist on either piggyback registration rights, which require the issuer to register your shares with the next set of shares that they register, or that they file to register your shares directly. Because the issuer has to remain in compliance with the SCC regulations, that may bar them from registering shares during a certain period. It can't guarantee when your stock will be registered and tradeable.
Good points. Next, we head over to Europe to hear from Managing Director of Corum Group International, Jon Scott, on shareholder approvals.
Shareholder approval thresholds can be an issue. Typically, the buyer will require that a specified percentage of shareholders sign off on a deal before closing. You want to keep this at a realistic level in the sales and purchase agreement, 80% or 85%, but never higher. If there are multiple shareholders who are inactive or ex-employees, one or more of them may hold out approving the contract by trying to exercise their appraisal rights and stop the deal. This could be disgruntled employees or shareholders who have unrealistic valuations in mind for their very small portion. You don't want the buyer to use this as last-minute leverage to lower the valuation of the transaction or to extract more favorable terms. I was in one transaction where we literally did not know if the dissident shareholders were gonna walk into the shareholders meeting and try to stop the transaction. Fortunately, this didn't happen.
Good insight, Jon. These approvals can vary from quite simple to exceedingly difficult. Next, we look at another tricky third party dependency, namely the assignment of third-party contracts. Dave Levine in Vancouver, Canada has this one. Dave?
Complications arise when a seller's customer license agreement includes a change of control or assignment clauses. Since you can't revise existing customer contracts you need to negotiate with the buyer to minimize the impact of this assignment process. Structuring the deal as a stout transaction and still have an asset sale, may circumvent the assignment requirement. If not, negotiate language in a purchase agreement to limit the approvals required before closing to a smaller universe of high-value customers, which the buyer's most concerned about anyway. The remaining assignment can come after the deal closes. Get out in front of your customers as early as you can and face to face if possible, to sell them on the virtues of the merger and why this is in their best interests.
Thanks, Dave. We've got a deal pending right now in which this has been a real challenge. Next, we go to Rob Griggs in Minnesota to talk about disclosure schedules.
The attachments or documents that come along with a contract always talk longer than anticipated. Those delays can kill a deal. Recently, we worked on two transactions where this was critical. One closed and the other did not. In one, the experienced PE buyer noted that disclosure schedules are always the longest pole in the tent. We worked with legal to harvest a list of schedules from the draft purchase agreement and held hours of meetings with the client, setting up a realistic timetable, itemizing the needed tasks for over 100 pages of requirements with input from 11 people. Even swamped by due diligence and running the business, that deal closed on time and at the target valuation. In the other case, the buyer had a 45-day window to complete the transaction. The sellers were initially optimistic about the disclosure schedule. Then due diligence matters took priority. A week before closing, it seemed evident that it wasn't going to be possible to finish the schedule. We asked for more time, but structurally it wasn't available. The window closed and the deal fell apart. If the disclosure schedules had been completed, then se would have closed that deal, too. So, get in early and push the buyer for an early draft of the purchase agreement. That will give you a disclosure schedule roadmap. Then get resources allocated early and get those schedules done.
Totally agree, Rob. As many of us have learned the hard way these things take more work than you think. Next, we go to Peter Prince in London, to talk about earnouts.
Earnouts are common contract components. They tie a payment to the sale of the part that the total transaction price to the company's future performance. In other words, the seller is required to hit financial targets, such as annual revenues, EBITDA, or customer growth, typically over one to three years. Often earnouts bridge gaps between the buyer and seller proposals for the total sale price. The earnout's key contractual terms for the seller include: control of resources, attainable targets, and clear definitions of expectations. Without these, a seller might not be able to meet the goals. We once created a 50-page earnout rule book governing how the seller could and would be in control of achieving his earnout. Using those rules, he did meet his goals and got fully paid. In another agreement we closed, the buyer and seller essentially agreed to agree on three million in earnout to the CEO, the main owner. Both sides of the vested interests, and it worked.
Thanks, Peter. Earnout discussions often turn into a whole negotiation within the larger negotiation. Next, we go to Bruce Lazenby in Ottawa, to talk about what happens between sign and close.
We often say that nothing good happens between signing and closing. As time lingers on there are many internal and external factors that can affect the deal. We managed a deal a few years ago in France with BMC, based in Texas. The deal got locked in US dollars, however, it was important to our client's VCs that the price be fixed in Euros, since that is how their distribution to their LPs would be made. The problem was that the investors weren't in a position to fund the hedge. And the M&A contract locked down the balance sheet, preventing the company from investing in a hedging strategy and on behalf of the shareholders. We solved the problem by renegotiating the balance sheet lockup in the contract, so that the company could hedge the deal consideration, and lock in a Euro value. Cross-border deals with always expose either a buyer or a seller, or both to foreign currency movement. And how the balance sheet is treated is always a critical part of the contract.
Thanks, Bruce. And finally, to close out our top 10, we have Jim Perkins in Arizona, to talk about closings.
Signing the contract is an important step, but it's not the final step. It is possible to sign the contract and never close the deal. You'll need to avoid contingencies to close it. Most importantly you will need to create urgency to close. And ideally, you will sign and close simultaneously. But often, there are items that need to be addressed between signing and closing. If these items will take more than a week, you might be better off postponing until they have been addressed and negotiated away. Buyers often ask for a six-month lock-up from signing. With the reasoning that they are committed to the deal and only wanted to make sure there is enough time to manage all of the moving parts and get to closing. The problem is that the schedule with always extends to use all of the available time, and then it'll be extended again. You'll want to set a deadline and work towards it and have enough teeth in the agreement that you have other options if you get stalled on your way to closing.
6 Tips for a Better M&A Contract
Very relevant, Jim. In addition to these 10, there are a few more general topics to consider. We start with Marc O'Brien in Silicon Valley, on choosing M&A counsel.
As an entrepreneur, you've only got one company to sell, so it's critical that the advisors and professionals that form your team are experienced and up to the task. M&A is not for the faint of heart and not an area you want people learning on the job. When it comes to your attorney you need someone who closes technology acquisitions day in and day out, that knows all the tricks of the trade. Geographic proximity is less important these days than you think. Many deals are done under Delaware law and rely on national standards and customs. The ability to look outside your local community, if no one fits the bill that you are looking for.
Thanks, Marc, couldn't agree more. Next, we go to Martin Lowrie in Boston.
Address the issues, don't avoid conflict even though it's a natural human behavior. Most people are conflict avoiders. Good deal makers, though seek out conflict, finding the issues where the seller and buyer are clearly going to be at odds. And dealing with them before they cause problems. If you end up with a bad contract, it may just be sloppy work. But often the bad contract is the result of avoiding what should have been a good negotiation.
Good advice, Martin. Next, some thoughts from Serge Jonnaert in Southern California.
Related to what Martin just discussed, don't let the issues die with the lawyers. As the CEO, you need to manage the lawyers, they work for you. Their job is to inform you of the risks so that you can make informed decisions. But you still make the business decisions, and you still, as CEO, carry all the risks. The lawyers only negotiate and reach out various legal and technical points, but for sure they will get to business issues that they are not authorized to compromise on. This could create an impasse, resulting in weeks of possible, costly, and stalemate negotiations. Instead, just ask them to create a list of open business issues, escalate them to you and your advisor, and then structure a negotiations framework where which those issues can be resolved.
Great advice, Serge. And now back over to Europe for Julius Telaranta in Berlin. Julius?
Keep it organized, a blocked obligation of work during due diligence. Questions on the due diligence list will require a response. Many of those same questions will pop up again as reps and warranties in the contract, again requiring at least study. Then, they will pop up a third time, because those are going to disclosure schedules. In other words, as you go through this initial diligence response, don't just dump data on the buyer and consider it done. Keep all your relevant information organized and cataloged in a virtual data room. It will save time and money.
Organization is definitely key. Next, we have Steve Jones in Salt Lake City, Steve?
When the purchase agreement or the contract is signed, the deal isn't done, as we've said before. It isn't done until it closes. Usually, there are contingencies that have to be satisfied after the signing but before the closing. These are the loose ends. Like a contingency based on code review ensuring that any third party products that are open source code, is accounted for. It is possible to have a simultaneous signing and closing. That's certainly ideal, but not common. As the seller, your goal is to have no contingencies, so don't let these drag on, or your deal can be delayed significantly, raising the possibility that it never closes.
Thanks, Steve. And finally, today, let's head down to Texas and hear from Allan Wilson in Austin, Allan?
As mentioned earlier there may be family members, dissident stakeholders, key employees and the like, that have a stake in the game. If they are not properly satisfied it can delay or kill the deal. I had one closing, for example, where the venture investor was Monday morning quota banking everything, creating a lot of stress for all parties involved. You know the type. We finally had to deal with him, otherwise, the buyer may have walked. Who needs that grief? In another case with a very loyal employee, we needed to be part of the deal with something special, as they'd never been a stakeholder.
Solid advice, Allan. As you can see, definitive agreements contain many traps for the unwary. Be careful out there. Back to you, Tim.
Thank you, Joe. And we are right at our half hour mark, so we'll follow up with the questions that have come in by email. Feel free to send those in as we close things out. Now we will go to our close. Thank you very much.