Troubled Tech Company Due Diligence Tips

"The considerations and observations listed below are by no means exhaustive, but may provide some guidance (or at least food for thought) if you are looking at acquiring a tech company, particularly a distressed tech company.

"1. Test the target’s accounts payable, accrued expenses and liabilities...
When considering the acquisition of truly distressed companies, the acquirer should also confirm that all 401(k) withholdings of employees have been properly deposited, and that all tax withholdings have been accounted for and forwarded to the appropriate federal or state agency.

2. Quantify the “Transaction Cost” of a successful transaction...
Buying companies is expensive, and when an acquirer is buying a distressed company Although this list is not exhaustive, the “one off” transaction costs include:

(a) Target’s attorney’s fees (for which payment at closing will be expected).
(b) Target’s investment bank or business broker’s success fees, if one was engaged.
(c) Cost of target’s fairness opinion, if one was obtained.
(d) Acquirer’s attorney’s fees (probably due in the ordinary course, not at closing).
(e) Possible costs associated with any consents required from target’s accountants.

3. Quantify the “Business Cost” of a successful transaction.
Similar to transaction costs, there are a number of “one off” business costs associated with an acquisition that should be quantified during the due diligence process. These include:

(a) Payments due under change of control agreements or severance agreements post acquisition.
(b) The cost of buying out leases or other costs associated with discontinuing certain operations of the target or consolidating the operations of acquirer and target.

4. Review customer contracts or licenses for out of market terms...
Terms to be aware of include:

(a) “Fixed price” contracts that require completion of a project and all warranty work at a single price.
(b) Unlimited liability of the target for work performed or intellectual property licensed to a customer.
(c) Non-competition clauses which limit the target’s ability to provide services or products to other clients in the same line of business as the customer.
(d) License terms which authorize the customer to re-license or resell target products or intellectual products built for the customer by target.
(e) Terms which permit or do not prohibit customers from hiring target’s employees.
(f) Terms which allow customers to cancel agreements or obtain other relief from target in the event of a change in control of target.

5. Confirm that intellectual property and human capital are in place...

6. Test and confirm the sales pipeline...

7. Review (and renegotiate) severance arrangements with target management...

8. Identify third-party agreements to be restructured...

9. Test the proposed acquisition structure...
At a minimum, one of the factors considered in pricing the offer should be the analysis of the market stigma facing the target’s business.

10. Do Not be afraid to abandon the transaction..."

Read more in this article by Jude Sullivan from which the foregoing is quoted.