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Why software deals are proving irresistible to a diverse range of investors

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Parker Nigel
Nigel Parker

Partner

London

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Daren Orzechowski

Partner, Global Co-head of Technology

Silicon Valley

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Dario de Martino

Partner

New York

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Adam Chernichaw

Partner

New York

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Saranpaal Calais

Senior Associate

Sydney

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12 January 2022

Software-focused transactions, involving an increasingly diverse range of participants, are now dominating the technology M&A market.

Our data shows that some USD490 billion was invested in software-related transactions, accounting for 43% of the total technology M&A deals globally in 2021.

Established technology companies are continuing to invest heavily in this area, particularly as they move to cloud-based, subscription or enterprise-focussed services. The collaboration and communication software sector has seen tremendous growth during the pandemic, which has led to increasing consolidation within this still-fragmented subsector. Salesforce’s USD27.7bn purchase of Slack is a key example of this trend, which was just one of a series of recent deals done by the cloud computing giant.

Private equity is increasingly active, attracted by the healthy profit margins and steady revenue streams from Software-as-a-Service-based business model and the synergies in building a portfolio of assets in this area. Thoma Bravo’s recent USD12.3bn acquisition of Proofpoint is the biggest PE cloud deal to date.

In addition, non-technology companies are increasingly turning to software acquisitions to accelerate their digital transformation and move into new markets. Siemens’ acquisition of France’s Wattsense, the building management group, fits that bill, extending the German giant’s capabilities in smart buildings.

The consensus among commentators is that this is a market poised for continued strong growth.

Overcoming complexities

Key drivers for software deals include:

  • Diversifying product portfolios;
  • Accessing IP and new technologies;
  • Obtaining technology to create operational efficiencies;
  • Reaching new customers and entering new markets;
  • Acquiring people, particularly software developers and engineers, where talent is scarce; and
  • Meeting new regulations and acquiring licences to operate in multiple markets.

Yet software remains a complex area for investment. Established players and new entrants face significant due diligence and post-completion integration challenges.

Understanding the origins of a target’s software product portfolio is essential, including how the software was developed – whether it was done in-house or with third-party contractors, or whether it was licensed or acquired. If this history is not properly understood, the value of the software could be severely undermined or the business could be subject to additional risk – if, for example, the target did not in fact own the software or if it was subject to third-party interests. It is for this reason that experienced buyers will often make it a signing or closing condition that certain software and IP issues revealed during due diligence be remedied.

It’s not uncommon for people once associated with a company to claim a share of IP in software they have helped develop when transactions are underway or nearing close or even at post-completion.

Further, transactions involving a change of control may trigger “escrow-type” arrangements whereby end-customers may have the right to access or buy a copy of the code. Certain licences may also be terminated due to a change-of-control event. Past versions of the code may also have been sold or licensed out in the past, undermining its value.

Similarly it’s vital to conduct technical due diligence of the source code for the software being acquired, not only to check ownership but also to ensure it is of high quality, scalable and not vulnerable to cyberattack. This technical due diligence sometimes involves buyers staging penetration tests on the target’s software platform, with the target’s permission, to ensure appropriate security standards are met. 

Use of open-source code, once slightly frowned upon, is now widely accepted in the industry, but brings with it risks. For example, certain open source code, if used in particular ways, requires disclosure and licensing of the code to the public – which would obviously undermine value. Again, careful checks need to be undertaken to ensure it has been properly licensed and used responsibly.

Documenting and addressing issues such as these can be tricky and failure to do so could directly impact the value of a transaction. It is imperative that technical and legal teams work closely to manage these risks, especially if the target is a young company with a relatively underdeveloped approach to managing and mitigating risk.

Acqui-hiring

Many deals are motivated by the need to bring new talent on board via transactions rather than conventional recruitment methods.

Buyers are increasingly using earn-outs to reward the founders and to keep them invested in the business. These arrangements can cause post-closing conflict unless very carefully framed, yet since the pandemic, and with company valuations soaring, these now tend to be bigger in value and longer in duration.

The regulation governing software products is evolving fast and often transactions are impacted by new legislation and rule changes.

This is a particular issue in the Fintech sector, where there are a host of regulations to be met and licences to be obtained before completion, particularly where the software is being deployed across multiple jurisdictions.

In key areas, notably the booming gaming industry and in the evolving development of virtual worlds like the metaverse, the commercial and regulatory complexities can be even greater.

Here inputs from disparate content creators and even brands featuring in these virtual worlds may offer new opportunities to monetise a product but must be backed by robust commercial agreements.

Achieving real value

Following a software-driven acquisition, one of the biggest challenges can be integration with the buyer’s existing operations and product portfolio. Successful integration of the existing and often overlapping information technology infrastructures of the acquirer and the target can unlock significant value.

More importantly, realising long-term value, to meet purchase price expectations, will require careful execution and tight collaboration between the buyer and the target, particularly in integrating products and go-to-market teams.

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