Modern Due Diligence is more than a document review game played by lawyers and accountants. It’s an extremely involved & complicated process where every aspect of your product and business model is placed under a microscope.
With so many chances to step on a landmine, you need to be well prepared. To avoid having your deal blown up in due diligence, we’ve put together a list of 12 tips to help you survive due diligence.
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November 2019 Tech M&A Monthly - Introduction
Good morning, afternoon, or evening, wherever you are in the world. Welcome to the Corum Tech M&A Monthly. My name is Tanya Froehlich, Director of European Operations of the Corum Group joining you from Zurich, Switzerland. I'll be your host for today.
Before I get to our schedule, I'd like to point out the Q&A sidebar. So, feel free to ask us any questions you might have during the presentation. The slide deck will be made available to you. And you can email us at any time at firstname.lastname@example.org.
So, let's get started. Our agenda today includes reports from the field with Jeff Brown and Lonnie Schilling. After that, we'll go to the Corum Tech M&A report for this past month. Then, we'll finish with a special report on the 12 Tips to Avoid Due Diligence Disaster. So, hang tight. This is a topic every tech entrepreneur needs to hear about.
Before we dive in, I'd like to mention the upcoming London Tech Growth and Exit Strategies event on the 29th of November. This year's WFS features some excellent speakers like Accel, KKR, SAP, Unit4, London Stock Exchange, and many more. Check out WFS.com for more details. I'll be there directing the event as Corum is the platinum sponsor for the WFS. So, we do hope to see you there.
Now, let's go to our first report from the field with Jeff Brown in Texas.
Corum Group at TeXchange Lunch and Learn Event
We were fortunate to be part of a very exciting technology event here in Texas. TeXchange connects Austin's technology community, bringing together founders, business leaders, investors, and executives at the mid stages of their company growth for knowledge-sharing, development, and networking. The association runs a lunch and learn at the Capital Factory, which is Austin's leading accelerator and the center of gravity for entrepreneurs in Texas. It's centrally located in the heart of downtown Austin.
Corum was invited to be the featured speaker at the September Lunch and Learn. It was a packed house of over 90 entrepreneurs, investors, mentors, and acquirers. I prepared a fast-paced and detailed briefing on the state of play in technology M&A with a special emphasis on the technology trends and company operating metrics that are driving up enterprise value for sellers in this robust M&A marketplace. There was a dynamic session with lots of discussion, Q&A, and networking. Just another example of the rapid growth and high energy in the Texas tech ecosystem.
That's excellent, Jeff. Sounds like it was a great event. Now, let's go to Lonnie Schilling in New York to hear about his recent speaking engagement.
Corum Group-Flatiron Law Group Seminar: “M&A Reimagined”
Together with Flatiron Law Group, we recently hosted a seminar entitled, "M&A Reimagined" which described cutting edge M&A practices in pursuit of achieving an optimal outcome. We spoke about how to create an auction process leveraging over 30 years of M&A best practices which captures the entire life cycle of a deal, from preparation to post-closing integration. And we also spoke about how Corum leverages its vast relationships with tech buyers around the globe working with the most senior deal makers in M&A and bringing to bear Corum's leadership strength to drive an optimal outcome for the CEO pursuing an exit.
Wonderful. Thanks Lonnie. Now, let's turn it over to Elon Gasper and the Corum Research Team for our monthly tech M&A report.
November 2019 Tech M&A Report: Public Markets and Corum Index
Thanks. We begin with the public markets which rallied in October, then set new records in November on both the Dow and the NASDAQ. The S&P Technology Index lagging many of its large caps facing regulatory pressures and barriers of scale, which is no surprise after such a long bull market. Really, the wonder is that it's held the bear at bay this long, but that pressure means major companies need growth and innovation, only small ones deliver.
So, tech M&A marches on our October Corum Index showing that buyers did a few more transactions year-over-year, though fewer megadeals. Private equity stood out with platform deals up 40%. Those October megadeals stacked into three of our six sectors, including the relatively quiet Consumer space wherein online betting, Stars Group, was picked up for almost $3 billion by Flutter Entertainment, the renamed Paddy Power Betfair, turning its eye toward the increasingly legalized US market.
Looking into other deals, how'd the market treat the Horizontal sector, Stephanie?
November 2019 Tech M&A Report: Horizontals – Marketing Automation
Horizontal sales and EBITDA multiples showed little change in October, still down sharply from record highs set in July as the MarTech subsectors saw media monitoring company, Cision, taken private in a $1.5 billion megadeal by Platinum Equity, adding to the buzz of activity from PE firms in this space.
In marketing automation, AI-powered brand partnering firm, Wove Technologies, was pocketed by data and analytics company, Samba TV, in its third acquisition this year. Loyalty automation SaaS, SessionM, was acquired by MasterCard. And CrowdTwist with its AI-enabled brand loyalty SaaS, was purchased by Oracle to extend its customer experience cloud. Adtech platform, dataxu, was acquired for $150 million at 3.3 times revenue by OTT specialist, Roku, which is beefing up its suite of tools for advertisers as the streaming race heats up.
Tech M&A Report on Sales Performance and Payment Processing
In the Sales Performance space, activity management software maker, Olono, was bought by Boston-based InsightSquared, to bring real time BI to its AI-powered revenue operations platform. And Altify, a developer of revenue optimization solutions, was purchased for $84 million by Upland Software for its sales optimization solutions suite. UK firm Asure Software, divested its workspace management business for $120 million at 4.3 times revenue to FM: Systems, a facility management tech company.
Payment processing maintained strong deal flow as Toronto FinTech startup, Pungle, was picked up by Berkley Payments Solutions to facilitate real-time transfers. Phoenix processor APS Payments was acquired for $30 million by solutions provider, Repay Holdings, to broaden its B2B footprint. And finally, Frontierpay with offices in London and Singapore, was bought by British fintech, Ebury, seeking to expand in the Asia-Pacific Region.
How did Internet sector fair last month, Billy?
November 2019 Internet Sector M&A Report
Sales and EBITDA metrics diverged again in a trend that is now a year old, as markets prioritize business model profitability in this maturing market. M&A transactions and e-commerce attracted a notable level of Private Equity interest.
Online clothing retailer, ModCloth, formerly owned by Walmart, was pocketed by Chinese-funded brand investment platform, Go Global Retail. Germany-based online photo service, Saal Digital, was pocketed by French investment firm Ardian. And online cosmetic seller, Cosmetics Solutions, was acquired by Lee Equity Partners.
In the world of online communities, San Francisco-based bartender portal, Liquor.com, was bought by digital media company, Dotdash, becoming its fourth acquisition in the space this year. Cannabis content and engagement website, Civilized Worldwide, was snapped up by cannabis data provider, New Frontier, which is planning to merge it with recently acquired Zefyr, an advanced consumer data discovery and profiling platform.
In the booking subsector, Late Rooms, reportedly sold LateRooms.com and LateLuxury.com to its rival, Secret Escapes.
Finally, grocery ordering and delivery mobile app, Cornershop, was swallowed by Uber to get access to Latin American and Canadian markets.
How did Infrastructure do, Matt?
November 2019 Infrastructure Tech M&A: Cybersecurity
Reversing the previous sector's trend, Infrastructure results showed markets increasingly valued share as sales multiples bumped back up to April levels while EBIDTA metrics remain stable as they have all year. Security deals still got deal flow with a megadeal in the UK where veteran security giant, Sophos, was acquired for $3.8 billion at 5.5 times revenue by private equity firm, Thoma Bravo.
Elsewhere in cybersecurity, attacks stimulator, Threatcare, was purchased by a security management platform, ReliaQuest. And Beijing-based cybersecurity startup, Chaitin Tech, was bought by Alibaba. Network management firm, Centina Systems, was acquired by Ciena, seeking to enhance its software automation solutions. And Austrian network support toolmaker, mquadr.at was acquired by Constellation's Harris Computer Systems, extending its expertise and reach into the European market.
In the authorization and access control space, identity governance provider, SailPoint, rolled up two cloud security startups, Orkus and OverWatchID, for a total of $37.5 million to strengthen its cloud access governance. Microsoft continued shopping in the cloud storage ecosystem, adding Canadians self-service migrator, Mover, alongside a September purchase of discovery kit maker, Movere.
November 2019 Infrastructure Tech M&A: Development Tools and Megadeals
In the development tools subsector, AI-based risk management software provider, OPtimAIze was purchased by data management solutions company, Sonasoft. Open source web development PaaS Meteor was bought by Canadian PE, Tiny Capital. And game analytics backend, ChiliConnect, was pocketed by famed 3D platform, Unity, just two weeks after its similar purchase of DeltaDNA. And Jira automation startup, Code Barrel, became the year's third acquisition announced by Australian dev tools titan, Atlassian plus.
Here's the first megadeal of November. Health tracking pioneer, Fitbit being acquired by Google for $2 billion, competing with Apple in Health and Wearables, while getting hands on some more data on all us Fitbit users.
And that's our October report.
Special Report: 12 Tips to Avoid Due Diligence Disaster - Introduction
Thanks, Elon. Now, let's go to Joel Espelien for this month's special report.
Due diligence has become a key stage for financing and M&A transactions alike. In the M&A world, Due Diligence typically refers to investigations by the buyer or investor during the time between signing of the non-binding letter of intent or LOI, and the signing of the definitive purchase or merger agreement.
The challenge for privately held technology companies, many of which have little or no experience dealing with buyers or outside investors, is that while Due Diligence cannot make a deal, it can definitely break a deal. As the old sell-side saying goes, "nothing good ever happens during Due Diligence."
Modern Due Diligence is more than a document review game played by lawyers and accountants. However, it's an extremely involved and complicated process where every aspect of your product and business model is placed under a microscope. With so many chances to step on a landmine, you need to be well-prepared.
To avoid having your deal blowup in Due Diligence, we've put together a list of 12 tips to help you survive. Corum deal maker, Steve Jones out of Salt Lake city, will start us off.
Due Diligence Tip #1: Understand the Buyer Checklist
Key thing to do is first understand what the buyer's Due Diligence checklist is. This is a document that they use to list out all of the areas of your business that they want to discover before final purchase. A lot of the time, that checklist is really overly comprehensive and includes things that are not relevant to your business. So, you don't have to blindly just reply, but it's critical that you understand what each question and each topic is trying to address and it will differ depending on the transaction, whether it's stock or an asset purchase.
It's also important to understand the priority of that list. Some of that information is very sensitive and could be damaging to your company if the deal doesn't go through. So, a lot of the sensitive information might be discovered by engaging with a third party. For example, when doing source code review, very often a third party will come in and review your architecture and the code to ensure that it doesn't have third-party products or open source and that will be done by a third party.
There are so many things that can go wrong in the diligence process. We call it the due diligence minefield, so it's important that you understand what those look like long before you get to this phase. If you'd like to get a copy of an example due diligence checklist, email us at email@example.com. We'll be happy to send you one, but it's important to know how comprehensive and thorough this is going to be.
Good advice, Steve. One of the things we're seeing with international buyers and non-tech buyers is that they have different due diligence checklists and processes, things we just don't see with traditional software companies.
Now let's move on to Dan Bernstein in Seattle.
Due Diligence Tip #2: Prepare Your Data Room in Advance
Get a secure data room set up in advance. It will help you get ready for what's going to be requested down the road. In fact, best practices these days are to set up a data room from the start of your company. It's never too early to start in this process even as even something as simple as finding articles of incorporation can hold up a deal. If you get all that kind of critical documentation securely stored in a place where you can give potential buyers appropriate managed access, it will help immensely. It's important that whatever vendor you select provides a secure data room with dual access authentication, and an ability to manage QA and information requests. Format the data room according to a typical due diligence checklist used by an acquirer, populate it with your documentation, and then refresh it on a quarterly basis.
Good stuff, Dan. It's interesting. The buyers today are asking more and more to have clients be ready and prepared, which is why we spend so much time on this phase of the process.
Now, let's move on to Rob Griggs in Minneapolis.
Due Diligence Tip #3: Deal with Accounting Problems Ahead of Time
Issues around financial reporting or accounting are bound to arise during due diligence. Most buyers try to ensure the financial information is presented based on US GAAP, and typically hire an independent accounting firm to review the books and records. Here are some traps to watch out for.
First, buyers prefer accrual accounting and will make the necessary adjustments to convert books kept on a cash basis to accrual.
Second, most software companies bill in advance for sales or will bill for an extended period of time. Revenue needs to be recognized over the period of time it is earned.
Third, the nature of addictions provides tax credits for R&D costs. These credits should not be reflected as revenue or a reduction of the R&D costs, but recorded as other income in the income statement.
And fourth and finally, capitalization of R&D costs. GAAP and other accounting standards allow for the capitalization of R&D costs, but buyers typically don't like this accounting treatment and will ask for performance statements without this accounting treatment. And sometimes, they will adjust the purchase price for these capitalized costs.
Thanks, Rob. And now, let's go across the pond to Scotland and hear from Managing Director of Corum Europe, Jon Scott.
Due Diligence Tip #4: Control the Timing of Disclosures
Due diligence is a full disclosure process so you never want to intentionally hide problems, but you can control when you disclose certain sensitive items and also in the manner which you choose to disclose. For one, if you have any bad news to deliver, do so when you can also offer up good news to soften the impact. And for sensitive disclosures that use customer names, sales pipeline data, or a source code review, push this disclosure to the very latter stages of the process you're most confident the deal is likely to close. Gaining access to seller team is a key part of the buyer diligence process. Your team is one of your most valuable assets, and one, you don't want to see compromise in the event the deal goes south. Our advice here is to limit access before the deal closes to only a few staff members deemed critical to the effort and keep that number small, protecting yourself against adverse impact in the event the deal fails to close.
Great, Jon. The timing of those disclosures is crucial. There will be some problems, but make sure that you think about when you want to talk about them and what the solutions and remedies might be with the buyer. Work as a team with them to solve problems.
Now, let's move to number five from Ivan Ruzic.
Due Diligence Tip #5: Run Parallel Due Diligence & Final Agreement Process
After signing the letter of intent, you should begin two parallel processes. That is, going through due diligence and at the same time having the lawyers put together the definitive agreement, the legal contract. Working in parallel allows any issues discovered during due diligence to feed into the drafting of this agreement. This lets you avoid digging up the same information multiple times and also lets you deal with issues as they come up rather than suddenly having to deal with a large number of problems all at once, typically towards the end of the transaction. For example, if the agreement initially has no provision for legal issues but a legal issue surfaces during the due diligence period, the contract can be ordered to account for and deal with that issue. Having both these processes moving forward will also keep pressure on the buyer to follow through and get to signing and closing on reasonable timeline.
Thank you, Ivan. Now over to Jaber Tannay in Paris.
Due Diligence Tip #6: Get a Draft Agreement Within Two Weeks
Due diligence can fail if the buyer hasn't managed to get the deal done on schedule. Delays can be blamed on no coordination of agendas, conflicting priorities, lack of solving identified problems, poor management of third parties, or postponement of government approvals. The seller needs to manage the due diligence process to ensure it runs as efficiently as possible. If the buyer is drafting the agreement, which is usually the case, it is essential that the buyer puts forward it's draft SPA within the first two weeks of the due diligence. Having this deadline keeps the buyer focused on carrying out due diligence reviews and internal assessments. If the buyer hesitates towards committing to a schedule for issue in the draft SPA, then this is a warning that it isn't planning on closing on time and that it is looking to extend that your diligence and exclusivity period.
Merci, Jaber. Now we go to Houston, Texas to hear from Jeff Brown.
Due Diligence Tip #7: Appoint a Due Diligence Coordinator
Due diligence is such a critical part of the M&A process that is tempting for you as the CEO to want to control it personally. Once you consider all that has to be done and the amount of work involved, you'll conclude that it's better to assign it to a focused member of your staff. That individual will be working with several external teams for up to two months, all intent on digging into the company's records, including legal, HR, accounting, products and technology, and others.
There are reams of documents to assemble sometimes going back to the beginning of the company's history. Many will have to be converted from paper to digital format, some will require interpretation and analysis. There'll be innumerable phone calls both on and possibly offsite. Key employees may have to be interviewed. Meanwhile, it's critical that you keep the company on track, so please appoint a trusted responsible coordinator.
Now, let's hear from Arnaud Viviers down in Atlanta.
Due Diligence Tip #8: Inform Only Key Employees
When should you inform key employees of a potential M&A event? The best rule of thumb is to only inform employees that have a need to know during the process. Obviously, this likely includes your CFO and CTO. In other words, only involve those who will be part of the due diligence process by needing to speak to the potential buyer or will be involved with the preparation of documents. Going beyond this guideline might feel like a fair and loyal thing to do, but the less people that know, the better. This is the case because an M&A process is distracting and you need employees focused on hitting the goals of the company and not taking their eyes off the ball.
Finally, the process can slow down or even come to a stop and the more people that know, the more distraction you have to manage. If things do slow down, those in the know can become nervous about their jobs. By not keeping disclosure limited, the word can escape outside the company and be used against you by competitors.
Good stuff, Arnaud. Keep that information confidential inside and outside the company. Now, back to Europe as we hear from Julius Telaranta in Berlin.
Due Diligence Tip #9: Watch Working Capital
Most often, the term sheet doesn't specify how much working capital gets left in the business, but it will describe an approach for figuring that out and that gets sorted out in due diligence. Buyers don't want your debt, but they do want the cash that's on your balance sheet and all your receivables. It helps them pay for the investment. It really comes down to how much liquidity is to be left in the business to run it during the short-term. Issues like quality of receivables, payables, collection rates, bad debt, prepaid expenses, unrecognized revenue, payroll bonus, and vacation accruals all need to be sorted through and amounts for each agreed. There are often a lot of things that are not on the balance sheet of a young software company and they are difficult to value or measure unless taking on a step-by-step approach. Working capital is a moving target so keep a close eye on the way the details are worked out in due diligence.
The bottom line: reserve any excess cash, because the buyers will want it, but they may not want to pay you for it.
We're moving to our last three speakers now, starting with Serge Jonnaert in Southern California.
Due Diligence Tip #10: Use Your Accountants Effectively
As Rob Griggs described before, the most important time to deploy your accountant is before the due diligence process begins, but there will always be important issues for them to tackle during the process as well. They can be useful in helping you populate the data room ahead of time.
Make sure the lines of communication between your accountant and buyer's due diligence team are open and clear. You want your accountants to be able to respond to buyer requests quickly. You don't want to be the side that is delaying the process. Consistent communication is necessary, especially when it involves accounting standards. There may be an audit required or an opinion needed, so find out early from your buyer if these will be needed.
Absolutely right, Serge. If you're going to have some tax issues with your family trusts and that sort of thing, look at those early, not late in the game.
Now for number 11, Allan Wilson.
Due Diligence Tip #11: Use Your Lawyers Effectively
One of the most important things you can do to survive due diligence and achieve deals success is to properly deploy your lawyer. This starts with selecting the right attorney. Don't just hire the guy you went to school with or your neighbor. You need to have someone who understands tech M&A and specifically, the issues surrounding IP. Start talking to attorneys early. Don't wait until you're in the middle of a deal.
One you are in due diligence, be sure to manage your lawyer properly. You don't want lawyers making business decisions, but to know how to frame risks and potential issues that may arise during due diligence, and to help structure a negotiation where they can get the problem solved, or a contract that handles any escrows or holdbacks to your benefit.
Great. Thanks, Allan. And to finish our list, we go to Dave Levine in Vancouver, Canada.
Due Diligence Tip #12: Use Your Intermediaries Effectively
Your intermediary's role begins with preparation to ensure that you get through the due diligence phase. Further, they are invaluable during context, structure, negotiation, and valuation. They can help offload with proper preparation, buyer research, and document production, allowing you to focus on running your business. They will prepare you for the questions only you can answer. They should serve as a buffer between you and the buyer by taking the heat when negotiations get contentious.
Finally, an intermediary who is deeply experienced in tech M&A will understand when the buyer is behaving in line with industry norms and when things are threatening to go off the rails.
As with your lawyer and your accountant, this starts with selecting the right intermediary: experience in the industry, intimately familiar with the due diligence process, and with a deep knowledge of the buyers.
Thanks, Dave. These are just a few tips that will help you survive due diligence. This process comes with a lot of tough questions and there are no easy answers. Every company is unique and there's no one-size-fits-all checklist that will work every time. This is not the time or the place for anyone to be learning on the job, including you as CEO. Modern due diligence is a complicated game of 3D chess and in order to play the game effectively, you need to know the rules. That's where an experienced advisor comes into play. Don't let your deal die in Due Diligence.
If you have questions, give us a call.
Really solid list and so critical to a successful exit. That's it for our broadcast. Thanks for joining us. We look forward to seeing you again next month. Now, let's go to our close.