This article is part 4 of a 4-part series. In three previous articles, I reviewed the overall process of selling your tech company, discussed what you can expect during due diligence, and then went over five issues to watch out for that could kill the deal.

If you survive the negotiation and due diligence process described in my previous three articles and your deal closes, congratulations! You’ve sold your tech company. Now the real fun begins. If this is the first time you’ve sold a company, there are some things you need to know.

What happens during integration will depend on the model that the acquiring company intends to follow. There are a few common integration scenarios when a small to medium-sized company is acquired:

• The buyer may decide to continue to run your company on a standalone basis. In this case, there may not be a lot of change, at least in the beginning. For many entrepreneurs, this is the best of both worlds. You retain a decent level of control, but you most likely have access to additional resources. This is not an unusual first step in an acquisition.
• More commonly, the acquiring company is hoping to leverage your technology in its own operations, and plans to fully integrate you into the existing company. If this is the plan, I hope you like meetings.
• If you’re a hot startup or app developer, it’s very possible that the buyer wanted you for your people and not your product. In that case, your company may essentially be dissolved soon after the deal closes, and your employees will work on new projects within the new company.
• It’s not unheard of for companies to purchase an upstart competitor simply to shut them down and eliminate a perceived threat. If that happens, you and your employees may not have a long future with the buyer, and you probably also signed a significant seller’s non-compete agreement.
• If your company was acquired to replace an existing or outdated technology, you might find yourself in charge after the two companies come together, but don’t count on that happening — this is probably the least likely scenario.

As you can see, it’s important to understand the buyer’s integration plans before the deal closes. This should be part of the conversations leading up to the deal. You may need to balance payoffs for the owners of the company, jobs for your employees, the level of your personal control and your freedom to work in the same industry for years after the deal.

Too many entrepreneurs are surprised to find out what life is like after their company has been acquired. They’ve gotten used to working for themselves and they’ve forgotten what it’s like to be an employee. Maybe they were never an employee at all if they started their company in their college dorm.

Here are some things you’ll need to deal with to one degree or another regardless of the buyer’s integration model and plans. Think about this list long and hard before you decide that working for someone else is worth the financial rewards from selling your company:

Decision Making

Many buyers have good intentions for their acquisitions, but the employees from the selling company can end up feeling like second-class citizens. It’s not uncommon to hear comments like “WE’RE the ones who bought YOU” when the new people try to make suggestions or shake things up a little. It can be very hard, especially for the owners of the company who sold, to accept that they have less authority and influence than they previously did.

Bureaucracy / Policies / HR

Startups and small tech companies usually put a low premium on written policies, employee handbooks, expense reports, time sheets, etc. Many entrepreneurs feel like they’re swimming in a sea of red tape when they become part of a bigger company. Bureaucracy is often a fact of life when you’re acquired. Can you deal with it?

Meetings

Remember that even though you probably feel thoroughly investigated after you laid bare the details of your company during due diligence, the majority of the people working at your acquirer know very little about you. You’ll spend a decent amount of time after the deal closes telling people at the new company what you do. They’ll also want to know how your technology can help them in their areas of the business. Be prepared to do a lot of educating. At many companies, this means meetings.

Not Being in the Loop

After the deal closes, you probably won’t be in charge. There most likely is a new hierarchy of leadership and politics to navigate. Besides having less influence in general, you might not even be in the room when big decisions are being made. Can you accept that?

Financial Requirements and Responsibility

Many startups are focused on goals around market penetration, user experience and innovation. Can you see yourself successfully projecting revenue, living within a budget and making decisions around quarterly financial goals (if your acquirer is a public company)? You may find that your business needs to be focused on a completely different set of priorities. Can you be successful under those circumstances?

Selling your company can be very rewarding, but you need to go down the path with your eyes open. The best way to see the deal through to a successful conclusion is to be prepared. Understand the process, know what to expect during due diligence and run your business accordingly — well before the deal making starts. Understand the buyer’s intentions for integration and be sure their plans align with your goals, aspirations and needs. Get important commitments in writing.

I hope this overview of the process of selling your technology company has been as useful to you as it has been enjoyable for me to write. If you haven’t already seen the previous articles in the series, check them out below.

Be sure to read part 1: What to Expect When Selling Your Technology Company

part 2: Selling Your Technology Company: The Due Diligence Process

part 3: Selling Your Technology Company: Five Ways to Kill the Deal

This article is part 3 of a 4-part series. In two previous articles, I reviewed the overall process of selling your tech company, and then discussed what you can expect during due diligence.

While most acquisitions will involve due diligence around legal and financial issues, more and more transactions include IT due diligence — a deep dive into the technology supporting or in some cases largely defining the business.

This series is focused on selling technology companies, so we’ll review some of the issues that, if discovered in a thorough IT due diligence effort, can derail your deal. Before you even consider selling your company, you need to be sure none of these situations apply to you.

Software Licensing and Ownership Issues

If the acquiring company discovers unlicensed software, this can lead to a number of negative consequences. If the cost to properly license the software is too high, the deal price may be reduced or the deal may be killed because the financials no longer work. The buyer may also be concerned about the possibility of an employee reporting you to one of several software trade groups that provide a reward for software piracy whistleblowers. Finally, you can look either incompetent or dishonest to a knowledgeable investor.

Many small companies utilize outside consultants to develop all or part of their software when they’re starting out. If a proper work-for-hire agreement isn’t in place, the ownership of the software or source code can be uncertain. Your buyer may discover this and make it a prerequisite of the deal that you get your contractor to explicitly sign over the rights to the software. This can be a difficult or uncomfortable situation at any time, but especially on the eve of closing your deal where it means much more to you than to the contractor.

Security / IT Infrastructure

Many industries and business transaction types have specific security and regulatory requirements — HIPAA in healthcare, Sarbanes Oxley in finance, PCI for credit card processing, etc. It’s not unusual to find companies started by entrepreneurs with business experience in relevant areas, but without knowledge of the security and technical issues mandated for their industry.

They then hire software developers and DBAs who also don’t have the industry-specific security knowledge. This can result in a disaster during IT due diligence when these major gaps are exposed.

In healthcare, for example, it’s not uncommon to find small companies where the developers have not taken HIPAA best practices for security and data encryption into account when designing technology solutions. A savvy investor will evaluate the cost to remediate this situation, which again can end up as a significant purchase price reduction or an all-out deal killer.

Employee Issues

Do you have any skeletons in the closet when it comes to your employees? If so, you can be sure they will be identified during due diligence. At least some of your existing employees will be interviewed, and the person performing due diligence will know the right questions to ask.

Do you have non-compete agreements in place for at least your key employees? The time to do so is not while you’re in the process of selling your company, and they have you over a barrel.

Are there any key employees on medical leave? It’s surprising how often this turns up. I’ve seen more than one situation where the main architect of a company’s software was on medical leave with no hope of returning.

Are you the subject of the any existing or pending lawsuits involving past employees? Such a situation has a potentially high cost associated with it, and can make your investor think twice.

General Deficiencies

There are some miscellaneous issues that can, under certain circumstances, rise to the level of killing the deal.

More than one IT due diligence effort has determined that the target company had a complete lack of domain knowledge. Some companies receive all product ideas from large customers. A potential acquirer won’t view that as a long-term model for success.

Do your customer and supplier contracts take into account a potential change of control or contract assignment? If your largest customers can hold your deal hostage, it’s going to make your buyer think twice about your company.

Do you have all of your source code available? You’d be surprised at how often companies are running a key internally developed product or supporting technology without access to the source code. The company never had it because the tool was developed by an outside party who didn’t provide it, or it was lost in a computer or server crash.

Are there scalability issues with your software? Many technology company transactions are based on the economics of significantly expanding the acquired company’s user base. If IT due diligence discovers that your systems can’t support ten or more times the number of current users without a major rewrite or other investment, your deal may be in jeopardy.

How have you accounted for the costs of your software development and maintenance? Accounting principles have very specific guidelines for how to handle these expenses. If you haven’t had the advice of a good accountant, your numbers may not be as good as you think they are.

Flat-Out Lies

Don’t expect to get away with complete fabrications about your company.

I’ve seen companies for sale that touted huge numbers of website registered users and high Web traffic statistics. Five minutes of good IT due diligence can tell if these numbers are real.

Expect that the backgrounds of owners and key employees will be checked. A senior software developer at a company being acquired had a resume full of inaccurate employment history and college degrees. With today’s easy access to information, these misrepresentations are simple to find.

I once saw a target company’s deal PowerPoint that listed 25 customers as users of a newly-launched product. In reality, there were fewer than five. Even a cursory IT due diligence effort can uncover this.

Conclusion

If an investor finds a serious issue during IT due diligence, they may be concerned enough to walk away from the deal, and if not, they may want to reduce the price of the deal more than is necessary to address this single issue, since they’ll wonder if others exist.

The best way to identify these problems before you sell your company is to look at it as an investor would. IT due diligence checklists are available online for free. Use them to objectively evaluate your company. Is your company one that you’d want to buy? If not, get to work addressing the issues you discover.

This article is part 2 of a 4-part series. If you haven’t already, make sure to read part 1: What to Expect When Selling Your Technology Company.

Once you’ve signed a letter of intent with a potential acquirer, the due diligence process will begin. Up to this point, you’ve likely turned over summary financials and other high-level documentation, but now the buyer will want to get into the details. You’ve probably agreed via the letter of intent to fully cooperate with the buyer as they proceed with due diligence.

Initial Contact

Depending on the size of your company and the buyer’s company, the buyer will assign one or more people to their due diligence team. These may include accounting, financial, legal, operations, HR and IT experts. The team members may be employees of the buyer or consultants.

You can be sure that when the letter of intent was signed, if not before, the due diligence team began to research you online and has been reviewing some or all of the documents you provided during the informal due diligence stage.

Your main contact with the buyer will put you in touch with one or more of the members of the due diligence team to coordinate the effort. You’ll likely get an introductory phone call to review the buyer’s due diligence process and timeline. This call can also help to create a personal connection that can help to keep the process running smoothly.

You Need a Cover Story

One thing that should be discussed on this call is a cover story. Most buyers don’t want to tell all of their employees that the company is in the process of being sold. This can create distraction and stress for the employees. Some might even leave before the deal is done, which can put you in a difficult position whether or not the deal closes.

For these reasons, a cover story is a good idea. You’ll most likely need the assistance of certain employees to provide information during due diligence, and at some point there will be site visits to your company by the due diligence team. Common cover stories are that “the company is engaging outside consultants to review the business to identify possible improvements” or “a potential business partner is interested in more information on the company.” It’s best to keep it vague and not an outright lie, because your employees may have to deal with or report to members of the due diligence team after the transaction, and starting that relationship with deception is a bad idea.

Due Diligence Requests

After initial contact, the next thing you can expect is to receive one or more lists of due diligence requests. Requests will typically include:

• Detailed financials and projections going out three to five years
• Copies of customer and vendor contracts
• Bank records
• Corporate documents
• Insurance policy information
• Network diagrams and other IT details
• Information on patents and trademarks
• Employee records
• Customer references
• Details on any lawsuits involving your company
• Customer listings and customer support records

This is by no means an exhaustive list, but as you can see, the buyer will want to look at every aspect of your business.

Depending on the size of your company, there may be items on the list that don’t apply to you. The buyer will expect this, so just discuss them with your main due diligence contact.

The bar is set fairly high, but there are still things that are unreasonable for a buyer to request. For example, a recent online discussion centered on whether it would be reasonable for a buyer to have access to the selling company’s email system to review internal emails as they saw fit. This would be unreasonable. If the request sounds ridiculous, it probably is, and again, this should be discussed with the head of the buyer’s due diligence team.

Site Visit

When the buyer has had the opportunity to complete their own research and review your responses to the due diligence request list, a site visit is the normal next step.

Your due diligence responses will most likely generate additional questions. During the site visit, the due diligence team will want to spend time with their counterparts at your company to get answers to these questions.

It’s also expected that the due diligence team will want to speak with key employees they’ve identified, and possibly even a random sample of other employees. This is where having your cover story straight is important.

The site visit may last anywhere from a day to a week or more depending on the size of the transaction or the complexity of your business. Other onsite activities may include tours of facilities, product demos, and a review of your data center or hosting platform.

Due Diligence Report

After the site visit, the due diligence team will compile a due diligence report for the buyer. This will include details on your business, identified strengths and weaknesses, cost estimates to mitigate problems that were discovered, and usually an overall “go / no go” recommendation on the deal.

You probably won’t see the report, but you’ll definitely hear about anything in it that’s negative.

At this point, the buyer may decide to proceed with the deal as per the terms of the letter of intent, withdraw their offer, or negotiate further.

Conclusion

If you understand the things that are important to a buyer when they’re performing due diligence, you can objectively review the current state of your company before you’re involved in a potential sale. Look at sample due diligence lists — they’re freely available on the Internet.

Since this series is focused on selling a technology company, the next article will go into detail about IT due diligence, and how certain discoveries during that process can derail your sale.

This article is part 1 of a 4-part series.

Some entrepreneurs are planning to sell their company before they even start it. Others are approached by a potential acquirer with an unsolicited offer. In either case, understanding the process of selling your technology company and having good resources in place before the time comes to sell will lead to a smoother transaction and possibly a higher sale price.

This is the first in a series of four articles about selling your technology company. This article will provide an overview of the process. Future articles will explore due diligence (with an emphasis on IT due diligence) and integration after the deal closes. While much of the information applies to companies in all industries, the main focus of some of the articles will be squarely on technology companies.

These articles are focused on relatively small tech companies — usually well under $100M of annual revenue. Larger deals take on much more complexity than what will be described.

Connecting with a Buyer

How do you find a potential buyer? If you know you’ll want to sell, one of the best things you can do is to network with others in your industry or niche. Obviously, networking has many other benefits, but one of the most significant is getting to know the people you may later look to as potential acquirers. These relationships don’t develop overnight, so you should be networking years before you hope to sell.

Even if you’re not actively marketing your company for sale, you may appear on the radar of a competitor, private equity or venture capital firm, and you may receive an unsolicited inquiry about your interest in selling.

Starting the Conversation

Once you’ve started a discussion with a potential buyer, you’ll almost immediately need the services of a good lawyer who has worked on company transactions before. This isn’t a job for your brother-in-law the real estate attorney.

Before you get past the most basic of conversations about a sale of the company, it’s in both parties’ best interest to sign a confidentiality agreement. The buyer will understandably want to know more details about your business than you’d wish to provide without any protection, and the buyer will probably also disclose some of their future business plans at this stage. It’s important that both sides are protected as they exchange initial information, and you’ll want an attorney to review the confidentiality agreement.

Informal Due Diligence

Once a confidentiality agreement is in place, there is normally a period of initial, informal due diligence. This means the buyer is seeking enough information, from a 30,000-foot level, to determine whether your business is worth buying. Are you profitable? What are your products? What will your revenue look like next year?

At this stage, it’s not unreasonable for the buyer to ask for at least summary financial statements and projections. This isn’t full-blown due diligence, however. Even though you’ve signed a confidentiality agreement, you should be selective in the information you provide. Once it’s out, it’s out. Things like customer lists, contracts, future product plans, etc., are not usually required to be divulged at this point.

If in this process you determine there is some circumstance that might immediately cause the buyer to pass on the deal if they knew about it, such as a significant pending lawsuit or a government investigation, you might want to consider disclosing it to avoid wasting everyone’s time. Moreover, in these examples, you might want to postpone any serious discussions until they’re resolved.

On the other hand, if you just signed a new customer to a five-year contract that will increase your revenue by 20 percent, you should provide at least some level of detail as it could increase the price the buyer is willing to pay.

Suffice it to say this stage of the potential transaction is fairly delicate and the best strategy is determined on a case-by-case basis.

Advisors Are Important

This is another part of the transaction that can benefit from outside advisors. An accountant can be very helpful in putting together your projections and helping you to best present your financial information.

In addition, if you haven’t been through a business sale or purchase before, you may want to obtain a financial advisor familiar with your industry to help you with the negotiation process. This expert can educate you as to what’s reasonable to discuss and what’s not during the informal due diligence process, and guide you throughout the more detailed due diligence to come. They should also be familiar with how companies like yours have been valued in recent transactions.

The Letter of Intent

If the potential acquirer gets to the point where they want to move ahead with a purchase, they will typically present a letter of intent, or LOI. The LOI summarizes the terms of the proposed deal and will usually include items such as the purchase price, any earnout (future performance-based payment) details, and an employment agreement summary for key executives and staff. It will also normally indicate other terms, such as deadlines, exclusivity, and the fact that the business should be run in its normal fashion.

If you want to proceed with the deal and you didn’t get an attorney involved before, you’ll definitely want to do so before you sign the LOI. Without proper language, the LOI can effectively become a contract. If you don’t take it seriously, you may be sorry later.

After the LOI is signed, you’ll enter the formal due diligence phase. The next article will focus on what you can expect.

This article is a guest post from Francisco Lorca, CEO of EthosData.

Many M&A transactions utilize a virtual data room – an online, secure location to maintain the confidentiality and control of deal documents. The article explores the use of virtual data rooms in due diligence and other settings.

In recent years the usage of virtual data rooms has increased dramatically, both in M&A transactions and in other aspects of corporate document sharing. While North America remains the biggest user of the technology, Europe and Asia are rapidly closing the gap. The rapid growth in the adoption of virtual data rooms for M&A transactions is related to a number of key advantages. Data room technology offers the ability to reach across borders. It speeds up processes by reducing time frames and frustrations of document access during high-level deals, and it provides peace of mind to all parties involved.

Below are some examples of situations where the use of a virtual data room can help when sharing confidential information:

Investment Banking

The world of global finance is underpinned by a heavy reliance on security and confidentiality. During a merger, acquisition or initial public offering, for example, your financial and legal experts need extensive information-sharing capabilities while they conduct their due diligence. Data rooms improve the speed and communication of this by making it possible to alert all parties to the availability of new documentation. In the complex area of structured finance and securitization, it’s critical for players to comply with detailed SEC rulings on issues such as user access and the lifetime of the information. Using a service provider with the right resources completely transforms this process.

Fund Management

The ability to monitor the fund independently is always a winning factor for managers, whether they are working in private equity, venture capital or hedge funds. A virtual data room makes it possible for you to comply with transparency requirements while keeping control over the information. You can prevent confidential, sensitive material from leaking to your competitors or the press by restricting access and user permissions such as printing and downloading. At the same time, distribution of marketing materials, reports and other information is made much easier.

Virtual Board Room

Communications between your management team and the board of directors is also transformed beyond the traditional security and time concerns of using a physical environment. Data room technology enables you to share sensitive documentation with board members around the clock, regardless of their location, while still complying with the requirement for due diligence. This completely removes the risk of sending confidential items by email to personal accounts, concerns about breaching your company’s firewall, or the risk of compromising the legal requirements for corporate materials. Boards can use virtual data room options whenever they have issues to table, as a means for circulating the information and collaborating on the wording of the formal motion.

Legal Sector

During any legal process, administrators have great demands on their time and are not interesting in traveling through complex folder structures to track down documentation. Most legal issues involve more than just in-house parties, so shared access and collaboration are vital to enable the process of e-discovery, cataloging and storage of information relating to cases. Legal professionals can use an exclusive virtual data room to make case notes that are seen only by those to whom they grant access through the use of multi-tier permission levels.

Life Sciences

In the life sciences industry, millions of dollars are spent annually in the development of new medicines, environmental protection and genetic research. As a highly competitive, lucrative and global field, security cannot be compromised and documentation often needs to be shared across great distances. The intellectual property of material is used for licensing, obtaining funding for future research, and the success of a company is dependent on the knowledge available. Virtual data rooms are ideal for companies needing large quantities of secure, online storage.

With most business operating in a global framework, sharing documentation in a secure virtual environment can save your company the huge sums of money that you previously spent on traveling, or on sending information by couriers, as well as giving you peace of mind that the process is secure and efficient.

You can read more about virtual data rooms in our dataroom blog at blog.ethosdata.com.

About the Author

Francisco Lorca is Founder and CEO of EthosData Ltd, a global provider of virtual data room services. More information is available at www.ethosdata.com.

When considering IT-related intellectual property during technology due diligence, websites and domain names have been on the radar for many years at this point. However, in the age of social media and networking, it’s important to also review a target’s assets in these areas. This includes Twitter handles, individual and corporate accounts on LinkedIn, blogs, corporate Facebook accounts, Instagram and Pinterest accounts and accounts at whatever new social media outlet has risen to prominence in the last five minutes.

There are three reasons that social media is an important IT due diligence consideration. As usual, in this article the target company is referred to as TargetCo and the acquirer as AcquiringCo.

Use the Accounts to Gain Insight into the Company and Staff

During the company research phase of IT due diligence, it’s helpful to review the TargetCo website, press releases and job postings in order to gain a basic understanding of the company. Once you’ve gotten a high-level overview, social media accounts can provide additional detail.

For example, if TargetCo has a corporate Facebook account, you may find articles, conversations with customers, etc. You might better understand customer satisfaction with the company’s products, and what the customers consider to be the most important features.

You can check the LinkedIn profiles of TargetCo’s key personnel. You may identify personal connections to these staff members that you can utilize for references. You can also determine how much experience the IT staff has with the TargetCo technology.

Blogs are another great resource. Corporate blogs can show the history of product development at TargetCo, such as new releases and features. If the blog allows comments, you can use this as another way to gauge the concerns and satisfaction level of the company’s client base. Personal blogs of key IT staff members might provide a view of company culture.

Note that all of the research I’m describing involves publicly available information. Recently, there have been discussions of due diligence requests for company emails, employers requesting Facebook logins and passwords and other similar overreaching. Requests such as this have no place in a standard IT due diligence effort.

Identify Them to be Sure They’re Turned Over

In addition to the general knowledge you’ll gain by identifying and reviewing TargetCo’s social media accounts, you’ll also be in a position to list them as assets to be acquired in the transaction. AcquiringCo must be sure it has rights to these accounts after the deal closes. You may find that TargetCo has a popular Facebook page, but that it was started by an employee. If the account is an important part of the marketing plan, you’ll probably want to get the due diligence legal team involved to be sure TargetCo addresses the ownership issue.

This process will also identify the employees that manage these accounts. If social media is important revenue driver for TargetCo, and all of the company’s social media efforts are handled by a single person, that should be noted. An oversight in this area might lead to this employee being considered for termination after the transaction, with the result of terminating successful marketing efforts at the same time.

Identify Potential Hidden Value

One of the goals of IT due diligence is to identify assets of TargetCo that may have more value as part of AcquiringCo. This usually involves new products under development or other assets that can be combined with existing resources at AcquiringCo such as an underutilized data center.

Social media assets can also have significant untapped value. For example, if TargetCo has a Twitter account with thousands of followers, but the account hasn’t been leveraged to market the company’s products and services, this can be a great resource for AcquiringCo’s marketing department.

Conclusion

Just as social media has a growing impact in many areas of everyday life, so has it changed due diligence. Including social media and networking assets in your technology due diligence review is now an important and necessary part of the process.

Although IT due diligence has many benefits when it comes to determining and confirming the value of a technology transaction, it can prove to be at least as valuable in planning the post-transaction integration. Here are some ways IT due diligence can assist in the integration process.

Staffing

If the target company is being folded into the acquiring company, it’s critical to have a good sense of the strengths, weaknesses and personalities of the target company technology staff. This will allow you to make better decisions when planning an integrated IT or software development team.

If you determine through IT due diligence and integration planning that there will be skill gaps in the combined company, proper budgeting can take place and recruiting can begin sooner.

If a premise of the transaction is that IT staff cuts and the related expense reduction will be possible, IT due diligence can identify whether this is truly feasible. For example, are there key proprietary systems or tools used by the target company that are maintainable by only the person who developed them? That person had better not be on the list of people to be terminated after the transaction closes. IT due diligence can confirm whether staff reductions are feasible, and if so, the best way to achieve them.

If the target company staff will be required to conform to acquiring company standards in the areas of coding, security and other technology processes, training can be planned prior to deal close so the integration of the teams can begin right away.

Identify the Path to the Full Value of Anticipated Cost Savings and Economies of Scale

Many technology transactions assume that there will be expense reductions in areas such as telecom contracts, hosting, hardware, software licensing, etc. IT due diligence can confirm that these potential savings exist, and identify the path to achieve them.

Licensing is an important area to review. There may be a cost involved in transferring key software licenses to a new organization. Don’t assume that an “enterprise” license simply converts to the new, larger enterprise without additional license fees.

The transaction financials may presume that Internet connections or phone systems can be combined or that data center hosting arrangements can be consolidated. Such contracts are often costly to terminate early. For example, many telecom contracts contain a provision that effectively requires full payment of the remaining contract term at the time of early termination. IT due diligence can identify such contracts.

Similarly, a termination notice date for an expensive contact may arrive just after the transaction close date. If IT due diligence occurred prior to closing, this date should have been identified and the integration priorities planned to accommodate contract termination and the technical and operational steps required to achieve the expense reduction.

Provide Needed Planning Time

When a public company is involved in the transaction, it’s often difficult for the two parties to cooperate in the integration planning process prior to the deal closing. In the case of private parties, there may be more flexibility. In any case, at least the acquiring company can begin to make integration plans based on its due diligence.

The integration of even a small company may take three to six months. A plan for such a long effort takes time to develop. If the planning can take place prior to the deal closing, it makes it more likely that the integration can get off to a good start and ultimately be successful.

Depending on the intent of the integration, the following issues may need to be addressed in the integration plan:

• Post- transaction product strategy and offerings
• Physical space (offices, data hosting, etc.)
• Phone system and network integration
• Security and coding standards
• Technology conversions
• Risk identification
• Integration plan metrics

As you can imagine, it’s better to start working on these things prior to the transaction closing, and with a detailed understanding of the underlying technical issues at the target company. This understanding comes from technology due diligence.

Objective Opinion or a Head Start on Relationship Building?

There are pros and cons to having a third party undertake your transaction’s IT due diligence effort.

If a third party is used, you’re more likely to get an objective opinion as to the technology resources, staff and IT challenges facing BOTH the acquiring and target organizations.

If you use internal staff at the acquiring company, you risk a bias towards the resources and methodologies at the acquirer but you gain the opportunity to start relationship building prior to the deal. This pre- and post-close continuity can go a long way toward easing the nerves of the target company’s staff during the integration. To gain this benefit, it’s important to consider the issues around the onsite visit discussed in the IT Due Diligence Guide. You can read about the need for a good cover story that doesn’t create later distrust in the sample content from the book.

Either approach to IT due diligence can add real value prior to the transaction close.

Conclusion

A successful IT integration requires the acquiring company to hit the ground running. Without IT due diligence, you have two choices: you can start the integration immediately without a good plan or after a delay with a good plan. With a solid IT due diligence effort, you can start immediately with a good plan.

I recently wrote a guest post for a popular German M&A blog. You can see the post here:

http://blog.fredelia.com/2012/12/27/it-due-diligence-researching-the-target-company-prior-to-the-onsite-visit/

During an IT due diligence effort, it’s not unusual to find that the target company has made different choices when it comes to programming languages or operating systems.  Beyond these obvious disparities, however, there may also be cultural incompatibilities. These need to be understood, and when possible, addressed.  Otherwise, you may find that you’ve just acquired a company where every key employee will be gone in six months.

Here are some issues that you should consider while you go about the more technical work of IT due diligence.  They may not seem important in the scheme of things, but you can be sure they are VERY important to at least some of the employees at the company being acquired.

As usual, I’ll refer to the company being evaluated as TargetCo and the purchasing or investing company as AcquiringCo.

Tech Personality Types

If you’ve spent any time around software developers and other tech employees, you’ve figured out that they can be a colorful bunch.  Infoworld has a great article on programmer personality types.  Here’s a very accurate overview of IT personality types from ComputerWorld UK – my favorite is “The Human Roadblock”.

Many small companies take on the personalities of their strongest employees.  If you’re buying a startup where the mentality is to come up with an idea for a cool new feature, work 24/7 to develop it and then roll it out to see what the customers think, it won’t take too many times for those employees to run into “The Human Roadblock” before they figure out that AcquiringCo isn’t for them.

“Fast and Loose” Environment vs. ”Well Documented / Methodical”

In most startup IT companies, the overriding goal is to get the product to market ASAP.  To achieve this goal, things like well-commented code, backups and system documentation can go out the window.  Other formalities at AcquiringCo such as product management, system analysts and QA may also come as a shock to TargetCo’s employees.   If AcquiringCo is an established organization with strict processes in place for its operations, you can count on employees of TargetCo seeing these as nothing but needless bureaucracy.

High End Employees vs. Cheapest Available

Companies can have wildly divergent hiring strategies.  Some companies may prefer fewer, expert employees and others hire an army of lower level staff, hoping to find diamonds in the rough.  If you’re acquiring a company with the latter mentality, be aware that there can be a lot of turnover on the way to a stable workforce, so HR and recruiting resources need to be considered.  On the other hand, if you are that company with many less-experienced employees and you’re acquiring a company with a handful of industry visionaries, be aware that they may very well be unhappy in an environment where they aren’t challenged and inspired by their peers.

Software Development Methodology

There are many established software development methodologies, and new ones come in and go out of fashion frequently.  Software developers can become quite attached to their chosen method, sometimes almost to the point of evangelism.  If this is the case at TargetCo, and AcquiringCo enforces a different approach, this can be a sure path to tension.

Offices vs. Cubicles or Open Work Areas

Tech employees can be very sensitive to their working environment.  Their jobs often require a lot of concentration, and certain companies provide individual offices to most or all of their tech staff.  If you’re buying such a company and plan to make room for more employees by moving everyone to new office space with cubicles, to some employees that could be as bad as telling them they can expect a 50% pay cut.

What can you do about these potential cultural conflicts?

First, be sure they are mentioned in your due diligence report.  In my opinion, the job of the person performing IT due diligence is to identify any issues that can impact the success of the transaction, not simply the quality of the source code and age of the servers.  In severe cases, the cultural differences may be significant enough to abandon the deal.

Second, when there are real cultural concerns that may cause you to lose key TargetCo employees after the deal closes, it’s advisable to lock up those individuals with employment contracts or other incentives.  In addition to keeping the key members of the TargetCo staff around, if they’re happy they can be cheerleaders for AcquiringCo and this can help retain the rest of the staff.

Third, don’t change for change’s sake.  If there’s not a compelling reason to standardize software development methodologies, for example, don’t force TargetCo to convert.

Finally, after the transaction closes, place an emphasis on communication with the acquired employees.  While this should be the case in any transaction, pay particular attention to the cultural issues that were identified during IT due diligence.  If you need to make a change in a sensitive area, clearly explain why and emphasize other policies or benefits that may be new and positively received.  Consider surveys and town hall meetings so the employees can at least feel that they’ve been heard during the process, even if they aren’t thrilled with the outcome.

IT due diligence is about more than bits and bytes.  Cultural and people issues can be even more important than the technology when it comes to the ultimate success of the transaction, so it’s critical that they be considered during the due diligence effort.

My last post was Why Investors Ignore IT Due Diligence, so I thought I would follow it up with some real-world examples of issues that a thorough IT due diligence effort can identify. I’ve personally encountered the issues below over the course of many transactions.

As usual, the acquiring or investing company is identified as AcquiringCo and the target company as TargetCo.

Software Licensing / Ownership Issues

• TargetCo had unlicensed business software that required a six-figure investment to correct
• TargetCo software had been developed by outside consultants with no work-for-hire agreement in place, putting the ownership of the source code into question
• An important TargetCo software product had no available source code (it had been lost during a network upgrade and there was no viable backup)
• TargetCo did not own its software. It was in fact owned by a competitor. The competitor had originally developed the software on a contract basis, and then gotten into the same business after seeing the success TargetCo had and realizing it still owned the software based on a poorly-written contract
• TargetCo had obtained the source code on which the company’s products were based through questionable means
• A licensor of software critical to TargetCo would not indicate approval of the transfer of the license to AcquiringCo until TargetCo was acquired. AcquiringCo didn’t want to acquire TargetCo if it couldn’t get the license

Staff Issues

• The architect of TargetCo’s software was on medical leave with no hope of returning
• TargetCo had no non-compete agreements in place with key employees
• A TargetCo employee with a terminal disease was kept on the payroll to provide medical benefits and TargetCo expected that employee to be transferred to AcquiringCo

Flat Out Lies

• TargetCo’s registered users and website traffic statistics were completely manufactured
• A senior TargetCo software developer had a resume full of inaccurate employment history and college degrees
• TargetCo’s sales PowerPoint presentation listed 25 customers as users of a newly-launched product. In reality, there were fewer than 5

General Deficiencies

• TargetCo had a complete lack of business / domain knowledge. The company received all product ideas from large customers
• Many cases of poorly written software that required a significant investment to address
• Company culture issues. Often, a small technology acquisition would prefer that AcquiringCo send an armored car with their money, have a bunch of software developers hop out of the back, carry the money inside and start working, and then be left alone by AcquiringCo. Spending some quality time in person at TargetCo can help to understand the personalities and expectations at TargetCo

Security / IT Infrastructure

• Data storage and access strategies were inappropriate for the relevant regulatory requirements for TargetCo’s industry. Worse yet, the TargetCo developers had never even heard of the regulations
• TargetCo’s data center was located in a building that had recently been subjected to a flood that reached 5 feet up the walls on the floor below
• A data center with a tarp over the server racks because of a persistent roof leak
• The owner of TargetCo personally owned a large amount of the computer hardware used in the data center, and leased it back to TargetCo at a significant profit

Not all of these identified issues led to the transaction being abandoned, but some did. In certain cases, the deal value or terms were changed. In every case where the transaction continued, the fact that IT due diligence had been performed allowed the investors to move forward with their eyes open to the challenges and potential costs they were facing.