Due Diligence during M&A in IT: what should companies prepare for?
Ukraine has a great number of successful IT companies. They have everything: an excellent product, thoughtful development strategy, high income. It would seem that the situation around investors could not get better. Yet it seems so only until the legal due diligence, or a legal audit as some say, has taken place. This procedure usually reveals certain unresolved problems in the company making investors abandon a transaction and review its initial conditions. To avoid this, companies should prepare for due diligence beforehand.
The first element to be tested in a legal due diligence is the corporate structure. Investors are more eager to deal only with a vertically integrated structure so they can only acquire a share in the upper company of the group. In Ukraine, however, most companies (especially small- and medium-sized ones) have a fragmented ownership structure with several formally unrelated juridical persons operating in the structure. If this applies to your company, then be ready to change your structure because you will be asked so during M&A.
Many companies experience difficulties with their authorised capital. Namely, with its payment. Not everyone can prove that the amount is paid in full. With no proof of such payment, a company must pay fines. Moreover, additional sanctions may apply. To avoid such problems, it is necessary to keep the primary bank documents confirming full payment of the authorised capital.
Let us not forget about the intellectual property as well
By acquiring an IT company, an investor is willing to buy all its key assets (program code, UX/UI design, logo, domain, trademark). Therefore, he/she will carefully verify who owns these assets in the corporate structure, to which extent such ownership is legitimate, whether the intellectual property rights are registered properly. Of course, the company will be required to submit all the necessary documents on time and register the right to intellectual property at a good hour if it has not been. In Ukraine, this procedure is considered optional, but it is better to complete it. It will be helpful if there are conflicts regarding the authorship of the program or some other software.
A registered right to intellectual property will allow owners to increase the company price at the expense of additional assets.
During the legal audit, many aspects of the company activities are subject to verification in addition to those described above. For example, labour contracts with the company staff, lease agreements, and other documentation get studied thoroughly. Any inaccuracies, errors, or problems detected, if present, will award investor with an argument to reduce the company value during the transaction. Worst case scenario is that he/she rejects the investment at all. Therefore, companies carefully prepare for the due diligence and solve any possible problems before it begins, not after.