Too many startups discover they’ve got an acquisition-blocking or acquisition-inhibiting issue after a price tag has already been agreed with the acquirer. It comes out during due diligence and the best outcome could be a reduced acquisition price, significantly increased escrow amount or something else not as palatable. The worst outcome could be a busted deal.
Trying to “set the stage” late in the game is usually very difficult and sometimes impossible. So why not think about it now and set some processes in place to keep things clean from an acquisition readiness standpoint? Here are a few things to consider:
Intellectual Property Ownership
In a nutshell, do you have clear ownership of your intellectual property? You need employee invention assignment agreements (EPIA’s) with all employees and your written agreements with contractors/consultants should assign all resulting work product to the company, either via a signed EPIA or specific language in their contractor/consulting agreement.
And if you brought anything with you from your prior employer or college studies, you’ll want to make sure they can’t make ownership claims to anything important.
I’d venture to guess that just about every software company today incorporates at least some open source code into their shipping product, and most probably incorporate a lot. This isn’t inherently a problem, but how the open source was used and how its use is documented is critical.
Do you know exactly where your development team has used open source code? Are you sure you really know? Have you ever had a code scan done to make sure? Do you know which license controls each use (GPL, LGPL, Mozilla, BSD, etc) and the differences between them? Do you know if improvements have been made and, if so, have they been properly contributed back? I dive into this whole topic much more in an article titled “Misuse of Open Source Software Can Kill Your Acquisition“.
Board & Shareholder Approvals
You can’t just issue a new employee stock options without proper approvals that are documented. Same for authorizing new shares and issuing them into the company, selling equity or convertible debt and other things. Often these actions require some combination of board and/or shareholder approval, which will be reflected in the minutes of your board meeting. Hopefully your attorney has already lectured you about this.
First, can you put your hands on every contract you’ve ever executed with a customer, supplier or business partner? Second, can you easily identify the contracts that grant some form of indemnification, change of control rights (ie – termination, source code escrow, consent, right of first ___) or most favored nation status? Can you quickly identify the contracts that were later amended after the initial agreement? From the very beginning, start an index and log of every contract and capture this sort of information for future use.
Have you ever researched the possibility that the secret sauce of your solution violates someone else’s patent? Your acquirer will do this research so you may as well know the answer ahead of time.
If your company isn’t large enough to justify regular financial audits by experts, discovering at the acquisition table that you’ve been improperly recognizing revenue, accounting for employee stock options, capitalizing software development, etc. can be a killer.
This obviously is not an exhaustive list but it at least represents some of the most common issues discovered after an LOI with a price tag has already been agreed. Even moderately-sophisticated acquirers (which mostly means their lawyers) really care about the things listed above. If nothing else, you must have all legal documents digitized and in a centralized repository for easy access (offer letters, EPIAs, NDAs, contracts of all types, company formation docs, board approvals and board meeting minutes, consulting agreements, stock option grants, business insurance, etc, etc, etc.). If you haven’t already done this, do it now. Click on the graphic to the right if you’re interested in my suggested legal archive hierarchy.
This topic touches on a few elements of what I refer to as “by-the-book” debt. There are many other accidental oversights and mistakes that can creep into your company in the early days, only to create a big mess later. To learn more about that and to take an online risk assessment for your own business, read my article titled “Accumulated By-the-Book Debt Will Eventually Come Due“.