Building Value Behind the Scenes: Why Preparation Matters

October 18, 2012, Posted by Ron Lissak

“By failing to prepare, you are preparing to fail.”

-Benjamin Franklin

Ol’ Ben wasn’t talking about software M&A when he made this famous statement, but experienced entrepreneurs will recognize the wisdom of his words because they understand that good M&A preparation can mean the difference between an excellent outcome, a merely good outcome, or even no outcome at all. Or take the example of Gary Player, a South African, and probably the greatest international golfer of all time. When playing once in the U.S., someone turned to him and said: “I’ve never seen anyone so lucky in my life.”  Player’s curt response: “Well, the harder I practice, the luckier I get.”

Talk to any CEO who has just sold his or her company and you’ll undoubtedly hear stories of the high and low points of the process that follow a common pattern: initial excitement, followed by worry, lots of hard work, tension, more hard work, sometimes a bit of table pounding and threats of walking, and finally the building momentum leading up to the close.

What is also true is that from the date the term sheet is signed through the final closing process, the buyer and its advisors (lawyers, accountants and often investment bankers) are on a mission to reduce the buyer’s risk, often uncovering issues along the way that may justify a price reduction.  Intellectual property is a favorite target of close scrutiny, with some acquirors hiring special IP counsel specifically tasked with finding gotch’yas during the diligence process that could enable the buyer to re-trade the deal.

But savvy sellers need not go into battle unprepared. In fact, with good advisors, you can be ready for almost anything that will come up in a typical M&A diligence process, including:

  • Reviewing all customer contracts to make sure they are all in good order and accounted for properly
  • Ensuring that all current and former employees (and contractors) have signed confidentiality and invention assignment agreements
  • Examining customer and vendor contracts for red flags, especially change of control provisions, most-favored-nations pricing provisions, overly broad indemnities to customers, and weak limitation of liability provisions
  • Reviewing leases for any hidden liabilities and consent requirements
  • Analyzing financial projections and assumptions to make sure they will stand up to scrutiny
  • Performing a thorough code review in order to uncover open source dependencies or 3rd party license exposure

Yes, this is a lot of work to do before you even know if there is a deal to be done—especially since you have to do it in your “spare time” without giving up your day job. In fact, that’s the number one reason most sellers take short cuts that they come to regret later on. But for veterans who have ‘been there and done that’, there is no question that getting the company’s house in order can be critical for valuation, timing, and deal certainty–and in many cases all three.  In short, while M&A prep is anything but glamorous, it can make all the difference in the world.

When the M&A timeline is determined by external forces and the preparation phase gets compressed by necessity, there may not be time to run all the traps.  When a CEO receives an attractive inbound acquisition offer with a short timeline, the correct response is never: “But I don’t know if we can pull together all the due diligence material in time.”  That’s all the more reason to get started early.

As experienced deal guys, we’ve seen first-hand the high correlation between company preparedness and transaction success.  I think it’s safe to say that in another life, Ben and Gary probably would have been great “deal guys.”

About the author

Ron Lissak is the Managing Partner at Catapult Advisors, an investment bank providing M&A and capital raising advice to leading software and internet companies.