In this blogpost, Aditi Sampat, Advocate, Nabco Enterprises Pvt Ltd and a student of the Diploma in Entrepreneurship Administration and Business Laws by NUJS, writes about the need for due diligence in acquisition,  important points to be kept in mind for due diligence of a software company which is being acquired.

aditi

The need for due diligence in acquisition.

The need for conducting adequate due diligence is necessary to the future success and longevity of the acquiring company. Sufficient time should be taken by the potential buyer to be as thorough as possible to ensure a competent investigation of the target company.

The purpose of due diligence with regards to acquisition is valuation and risk assessment. There are three primary areas that are assessed for the above –

  1. Legal
  2. Financial

The risks of inadequate due diligence involve

  1. Unanticipated costly integration.
  2. Inheriting unanticipated legal liabilities which were not covered.

According to Jim Hoffman, who is a pioneer in Information Technology Due Diligence, the due diligence related to Software and Information Technology is a mere afterthought when compared to the above areas that are assessed for valuation and risk assessment.

Nevertheless, there is an emerging trend wherein it is becoming increasingly difficult to ignore due diligence related to Information Technology and Software since the same has become integral to the functioning of every business.

Hoffman additionally also adds that Due Diligence for Software Company, which is being acquired is easier than legal or financial due diligence.

In his words “Software due diligence is more focused on spotting and anticipating future hurdles and costs. Unless the technology is not scalable with the business or not the presented technology, almost anything can be resolved.”

Due diligence of a software company which is being acquired:

  1. Ownership of the product – Whilst conducting due diligence of a software company who claims to have a certain product, the acquirer must ensure that the software company does have a functional piece of technology and the corresponding customer base as claimed by them. An expert should be appointed to review the target company’s specific software program.
  1. Determine the Technology’s Compatibility – Ensuring compatibility with the acquiring company’s technology. If the target company uses proprietary technology, the integration will not be easy. Instead, there will be serious repercussions on the maintainability of the software and retention of key employees at the target company.
  1. Whether the Technology can be supported -Questions pertaining to the ownership of Intellectual property rights, patents and trademarks. Also, questions pertaining to whether there were any signed Non-Disclosure Agreements. In addition to the above, review of the third party software and open source licenses

What is a Non-Disclosure Agreement?

A non-disclosure agreement is a legal contract between two parties who agree on sharing confidential material, knowledge, or information for certain purposes, but also wish to restrict access to it by third parties.

What is Third Party software?

A third-party software component is a reusable software component, which has been developed to be either freely distributed or sold by an entity which is other than the original vendor of the development platform.

What are Open Source Licenses?

Open source licenses are licenses allow the software to be freely used, modified, and shared.

  1. Uncover Licensing Risks – Typically a Startup or a Small Technology Company has not been properly licensed all its production and development software. In the wake of getting the product developed and sell it in the market, a number of licenses would not have been obtained. The same would be required to be obtained before the completion of the acquisition.
  1. Review as to whether the technology of the target company is scalable – Where each acquisition plan is unique, it is extremely important to ensure that the technology of the acquired company is scalable and can integrate with new marketing and sales structures of the acquirer company. In the event that the technology requires a complete re-architecting to accommodate scaling, this would become an important aspect to include in the takeover contract.

What is Scalability of Software?

Scalability is the capability of a system or a network or a process to handle increased volume of work or enlarging its potential to accommodate the corresponding growth due to the increased volume.

  1. Identify Key employees associated with Technology – Conducting interviews of the employees of the Target Company. Ensuring that key players remain employed post acquisition by offering retention bonuses. The same required to be incorporated in the acquisition agreement so that employees of the Target Company are motivated to stay and keep the technology sustained.
  1. Appropriateness of Current Level of Resources – Reviewing whether the systems of the Target Company are outdated which could lead to large investments for the Acquiring Company. The Investment so to be incurred should be included in the agreement between the acquiring and target company.
  1. Discover Hidden Projects – There may be several experimental projects which the Software team of the company could be working on which may not become a part of the target company’s product. The technical expert must make connections between these projects and the strategy and technology of the acquiring company. More often than not, these projects are discovered during employee interviews at the time of due diligence.
  1. Review of the SDLC, that is, Systems Development Life Cycle–If the acquirer company is acquiring the team and are dependent on the target company for the software code, then the former would be interested in the continuance of the systems which are in existence and are functioning.

What is Systems Development Recycle?

It is a term to describe a process for planning, creating, testing, and deploying an information system.The systems development life-cycle concept applies to a range of hardware and software configurations, as a system can be composed of hardware only, software only, or a combination of both.

Conclusion

The need for Due Diligence for a software company to be acquired is of prime importance and should be started at the earliest time frame in the process of acquisition. However, it is very important to have a software expert as a part of the due diligence team to understand and point out the technical background involved in the process of acquisition of the target company.

Sources

  1. http://stackoverflow.com/questions/814071/what-typically-takes-place-during-the-due-diligence-phase-of-an-acquisition-of-a
  2. http://www.axial.net/forum/9-reasons-it-due-diligence/
  3. http://www.axial.net/forum/it-due-diligence/
  4. https://www.quora.com/What-is-a-good-list-to-go-through-during-the-due-diligence-process-of-an-acquisition
  5. https://en.wikipedia.org/wiki/Non-disclosure_agreement
  6. https://en.wikipedia.org/wiki/Systems_development_life_cycle
  7. https://en.wikipedia.org/wiki/Third-party_software_component
  8. https://en.wikipedia.org/wiki/Scalability

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