Managing IP Risk in Acquisitions
Anyone who has done a lot of M&A deals has likely experienced not having the projections of the business aligning with the original belief of the company’s potential. Here are some areas where your lawyer can help you make sure your projections align with reality.
1. Make sure you ask all the questions you think you shouldn’t ask
Sellers sell for different reasons – often due to decline in the business or their interest in the business. From buyer’s perspective, they’re purchasing the business because they’re of the mind that they can grow the business and profit from. So it’s important to understand => where is this business placed in the market?
For example, if business is intellectual property based, ask questions about where the IP of competitors are in relation to target acquisitions IP. Seller may see that competitors are closing in quickly and want out, and seller would likely only reveal this information if directly asked. Ask during due diligence and early on.
If you miss your forecast, that’s your #1 loss, so get as much information as possible from the seller, which lawyers will support you during due diligence in that regard. Given that one of the most important parts of due diligence is document requests, where risk is assessed, then lawyers can request documents pertaining to that identified risk and then craft representations and warranties that address that identified risk.
Asking the hard questions will uncover those items that will ensure that your lawyers can draft respective representations and warranties addressing the risk.
2. Due diligence-ing of potential employee legal risks
What is often seen by M&A and transactional lawyers is that many business owners have no controls or protection whatsoever within the business. Oftentime legal for a lot of entrepreneurs is overlooked. Especially if the business is suffering, legal tends to be considered, haphazardly, a bit of unnecessary spend.
So it’s important to due diligence separation and claims issues within the business you’re looking to acquire. What is the past history with partners? Look into the past history of the business. Anytime there’s a separation, there needs to be a release agreement and payment. Yes, representations and warranties may cover this, but if to the seller’s knowledge there wasn’t any potential claims or litigation, you don’t want to wait until there’s a lawsuit to address this.
3. Due diligence-ing of potential IP risks
For SaaS businesses often Intellectual Property leakage is going to be a concern. So in the term sheet from the date of the term sheet, there needs to be a no IP policy out from the date of the term sheet. That means nobody is downloading anything, and if there’s an IT department, they need to be working with the attorneys to ensure that nothing is being downloaded to USB sticks through IT’s checking of the company’s electronic transaction history records. This is a data security best practice. For buyer’s, if its found that things have been downloaded, it’s an opportunity for the buyer to negotiate a discount to the purchase price.
4. Incentivizing staff loyalty
It’s important to incentivize staff loyalty during the sale or purchase of a business. One way to do this is to issue an equity incentive plan if there’s not one in place, or make sure that there’s some milestones in employment agreement to incentivize people to stay to ensure there isn’t IP leakage. You don’t want people to be leaving. You want people to stay. A lot of people think that the sale of a business means they’re going to be let go so they quit. All those people are going to work for your top competitors.
If you’re an amazon brand for example and have staff that has helped you to hone in on the data of your customers and maximize profits, well, those staff members can easily go and replicate your company because they have all the data to do so.
5. Get detailed info on employee performance
For example, when you’re acquiring a company, you’re going to want to understand the history of the sales people from the company you’re acquiring. It’s often said that 20% of the producers produce 80% of the results. Your best bet is going to be finding out who those 20% of the producers are in the company you’re acquiring. This is the level of due diligence you’re going to want to do before acquiring a company. Analyze each employee’s history, from a financial perspective, not just looking at net sales.
6. Pension plans sometimes tend to have the biggest risk for acquirers
One of the biggest places to find gains is to restructure pension plans by changing from defined benefit plans to defined contribution plans for companies with 15-25 employees. This requires lawyers to look through all the pension plan documents. Often, pension plan risk is assessed by accounting, but those numbers tend to be off because they’re assumptions. It’s the lawyers that review the plans and can provide the exact details with respect to information that accounting needs to assess the exact amount of risk that pension plans pose. Especially with older companies, there’s a lot of risk of non-payment of the pension plans.
There was a big story in the news, Lord Green bought one of the biggest grocery chains in the UK and he axed the pension plan to 0, and resold the company. He ended up having to pay over 300£ million in settlements as a result of his mismanagement of the pension plan slashing upon acquiring the chain.
7. Trademarks – don’t overlook this
If you’re purchasing a business and looking to continue operating that company you’re acquiring, trademarks are going to be an important piece of the acquisition because trademarks are ownership of the brand name and/or assets. So ensuring that trademark due diligence occurs is important to understand the status of brand ownership. If you end up acquiring a company that doesn’t own their trademark, and it just so happens that someone else owns the trademark and brings suit against you after you acquire the company, well, that could’ve been avoided by simply due diligence-ing the trademark ownership status.