Even in the best of times, most sub-scale startups treat documentation, process, and exit preparation as a chore to be done later. But as these companies (SellCos for rest of this article) look towards a potential exit, they will quickly realize how much work needs to be completed just to satisfy due diligence in an acquisition. Below is a list of steps every business should be taking now, and in the future, to ensure they are prepared.
Acquisition Structure and Why it Matters
Most sub-scale businesses will be acquired via an asset purchase. Rather than purchase the entire organization, including any past, present, and potential liabilities, the acquirer will pick and choose which assets it wants. For most SellCos this will primarily be the Intellectual Property (IP), but often customers will be included.
In an asset purchase an acquirer will not have as heavy a diligence burden as they would in a full purchase. But SellCos will need to ensure their assets are properly documented and compiled for the acquirer to review. Acquisitions are expensive for an acquirer and their bid will factor in expected diligence costs. A high cost of diligence, in either time or dollars, will lead to at best a lower purchase price, or more likely an acquirer not making an offer at all.
Intellectual Property Prep
Think of IP preparation in two different aspects – Can acquirers prove SellCos own their IP, and can an outside party easily review what SellCos have built.
Can SellCos prove they own their IP?
We ask this question to every client and every CEO emphatically states yes, confident they own their IP. But when we begin our review and ask for a list of all employees/consultants who worked for SellCo, including title, start date and end date few have a list prepared. When we ask for an electronic folder of all offer letters, non-proprietary agreements, and consulting letters, we get a mix of unsigned word documents and other forms. Very rarely do we find countersigned copies of these key documents. SellCos may believe that all employees sign these documents, but can they prove it. And if SellCos cannot produce countersigned documents, can they confidently represent to an acquirer that the software and processes are properly owned?
Now the good news – these are common issues even in the best run organizations. Even with great processes in place, physical signed documents can be misplaced, or countersigned electronic versions placed in the wrong folder. But SellCos can take a few simple steps to help limit this risk.
- Create their list of all employees and contractors from the inception of SellCo. Note missing countersigned documents and begin the hunt to find them.
- Once SellCos have exhausted their search, and if they are missing important documents, work with an attorney to determine if and how to remedy
- Create an ongoing process to ensure everything is properly countersigned and filed
- It can be a weekly or monthly process where an employee is assigned to update your employees list with all new employees or contractors, verify all their documents have been countersigned, and filed both physically and electronically.
- Assign a second person to verify they can find the electronic copy
- Keep a clean electronic folder of only final documents.
- Every offer letter and consulting agreement likely has multiple versions in MS Word or some form of PDF. Those working copies are fine to keep, but store the final countersigned agreements in both the employee folder and a separate clean folder
- This will make review and compilation significantly easier later
A few minutes of work each week or month can save time and money during an acquisition process.
At some point in the diligence process, the acquirer will want to review the actual code and architecture of the software. SellCos should:
- Be prepared to demo how the software works and how users typically interact with the solution
- Have a full system map showing the architecture of the data and tables
- Be ready to share some version of the underlying code. We do not recommend sharing full code, but enough for the acquirer to understand that it is well built
- Identify any 3rdparty software in the code
Remember that for the acquirer time = money. Better prepared SellCos that can quickly and easily share this information increase their chances of a completed transaction at a higher valuation.