Posted by Kris Tabetando | December 19, 2014
So you’re looking to acquire a technology company. You’ve looked at dozens of prospects, identified a suitable candidate, and both the buyer and seller have executed a letter of intent.
Now we get to the due diligence phase. This involves a thorough legal, financial, and strategic review of the company. Due diligence is absolutely essential and must be treated with the utmost care in a technology mergers and acquisition transaction.
The seller’s team will prepare the business documents that the buyer’s team requests. The buyer’s team will review these documents and ask pertinent follow-up questions.
This due diligence process will either confirm or refute the value proposition that the transaction strategy was built on. It will determine whether the deal makes sense or not.
DUE DILIGENCE TAKES TIME…
In most M&A transactions, due diligence takes up the bulk of the time involved in executing a transaction. It is time-consuming, but absolutely necessary.
It is in the due diligence phase that emotions run high between the buyer and the seller. Personally, it’s my favorite part of the transaction. Where emotion is involved, intelligent people stop thinking logically. If you can keep your head when everyone around you is losing theirs, there a great deals to be obtained in the midst of the emotional storm. You can extract value during the emotional noise.
Emotions run high during due diligence. The seller becomes defensive when his business operations and past decisions are scrutinized, undervalued, and criticized by the buyer. The buyer becomes frustrated when the seller does not share all his business documents in a timely manner. The seller becomes increasingly angry as the buyer keeps asking question after question over a period of time.
Regardless of how stressful the process can be, due diligence is a necessary evil. No deal should ever be consummated without proper due diligence.
LEGAL DUE DILIGENCE & BUSINESS DUE DILIGENCE
There are primarily 2 types of due diligence: Legal due diligence and business due diligence.
The legal due diligence team focuses on the legal issues involving the target business and transaction. These include a variety of matters from reviewing intellectual property rights to employee and supplier contracts.
The business due diligence team focuses on the financial and strategic issues involved in the transaction. These include diverse matters such as reviewing the business operations and confirming that business synergies are real.
In this piece, we’ll focus on legal due diligence of a technology business. We expand on business due diligence in a separate article called Checklist for Performing Business Due Diligence of a Technology Business.
CHECKLIST FOR LEGAL DUE DILIGENCE
Like a pilot in an airplane, always have a checklist. Never go into due diligence without a detailed checklist. Do not assume that you’ll simply remember what to ask for.
Depending on the size of the transaction, legal due diligence is generally conducted by the buyer’s legal counsel. When in doubt, always consult a legal expert.
Every technology business is unique. As such, a checklist should always be customized to fit the specific transaction. The checklist below will cover most areas. But it must be tailored to fit your particular deal.
- Corporate Records
– Certificate of incorporation
– Corporate by-laws
– Minutes of director and shareholder meetings
– Shareholder register
– Business licenses & permits
– Shareholder agreements
- Financial Records
– Accountant or auditor reports to management
– Debt agreements such as revolving credit, term loans, and shareholder loans
– Correspondence with creditors
– Owner personal guarantee agreements
– Business or owner guarantor agreements
– Tax returns
– Tax assessments
– Correspondence with tax authorities
– Private placement memorandum, information memorandum, or business plan
– Annual balance sheet for the last 5 years
– Annual income statement for the last 5 years
– Annual cash flow statement for the last 5 years
– Financial projections for the next 2- to 5-years
– Informal schedule of top management compensation
– Overseas operations records
– Industry financial analyst reports
– Schedule of long-term investments
- Employment Records
– Employment contracts
– Consultant and advisor agreements
– Resumes of top managers
– Union contracts and collective bargaining agreements
– Worker health and safety records
– Relevant employer compliance records
– Employee benefit plans including severance plans, Employee Stock Ownership Plan (ESOP), medical and dental plans, insurance plans, stock option plans, pension & retirement plans, and profit sharing plans.
– Human resources policy and training manuals
- Supplier, Vendor, or Partner Records
– Supplier, vendor, and partner contracts
– Vendor licensing agreements with web data analytics, web marketing, and web server providers
– Consignment agreements
– Research agreements
– Joint venture agreements
– Non-compete agreements
– Letters of credit
- Tangible Assets
– Real estate lease agreements
– Real estate mortgage and title insurance agreements
– List of tangible assets
– Liens on tangible assets
– Real estate tax bills
– Real estate survey, appraisal, or engineering reports
- Intangible Assets
– Copyrights such as software code, databases, and website content
– List of domain names
– Domain name financing agreements
– Domain name appraisal reports
– Customer and registered user databases
– Customer/user data security policies and processes
– Email marketing opt-in and opt-out policies and processes
– Email server blacklist check
– Search engine penalty check
– Technical processes
– Product licensing agreements with customers, partners, and affiliates
– Franchise agreements
– Employee invention policies
– Legal opinion letters related to any pending litigation
– List of material pending litigation over $5,000
– Past legal settlement agreements
– Open and closed domain name Uniform Domain-Name Dispute-Resolution Policy (UDRP) cases