James Teare - Set Your Technology Business Up For Success

When it comes to your next round of fund raising, or the day you have planned to sell your technology business, will you be ready?

After the euphoria of agreeing heads of terms, start-up and scale-up businesses often come up against the reality that they have not prepared for the investor’s due diligence questions. While scrambling around to find copies of documents, or rushing to put them in place, the resulting delays can cause deal fatigue, a re-think on valuation or even collapse of the deal. By this point, the team has invested time and money in pursuing its preferred investor, and may have turned other potential investors away. The dynamic of any future conversations with investors may have changed, the preferred opportunity may have been lost and the management team may have lost precious time and momentum in reaching its goals.

Of course, it doesn’t have to be this way. Successful funding rounds, investments and sales happen all the time. Businesses at the bootstrapping phase can wing it and usually not encounter too many problems. They may even attract crowd funding and angel investors who are prepared to take a punt on the vision of the management team, or the promise of their technology. As the business scales, so does the investor’s perception of both opportunity and, crucially, risk. That is when the questions become more detailed, and the business must have the answers. Being prepared early in the lifecycle of the business will make all stages of investment smoother. But ultimately it will also protect value, ensure resources are used efficiently and secure the transaction.

In commercial and technology law, similar pinch points arise for software businesses, app developers and e-commerce sites when they receive due diligence enquiries from investors and potential purchasers. Here are some of the common issues and means to overcome them:

Ownership

It sounds like a given that you own your product, but it is surprisingly common to find that a business doesn’t own quite what it thinks it does. Developers often use software or code under license from the author. This saves time and investment. Apart from being common practice, it is perfectly good practice, if it is done right. The key is to understand whether the terms of the licenses permit the software or code to be used in the way the business is using it for as long as the business needs and, if the asset is to be sold, in a way that can be transferred to the new owner. By analysing terms to ensure that they enable the business to operate as intended and putting a plan together to deal with any issues to know what happens in future scenarios.

Intellectual Property

Software businesses rarely write all their code in-house. When using external consultants to write code, there is often an assumption that the intellectual property in that code belongs to the client. When a due diligence query prompts a check, it can be a difficult time to discover that it depends on the terms of the agreement with the consultant. Similar issues arise with licensed software and code. There may be terms in the licenses that infer rights on to other parties, such as requiring the company to make its code available to third parties. Even if the business took advice at the time that the agreements are entered into, it is a good idea to have a consistent strategy and to maintain a constant record of the rights the business has in software and code – and to know the options should the license be imperfect, due to expire or restricted from transfer to a buyer.

We have all seen entrepreneurs nervously seeking the approval of investors on TV – how many times do the investors ask if the entrepreneurs have protected the idea? More established businesses may be confident that they have protected their intellectual property, but often they have taken a narrow view of what constitutes intellectual property and may have missed one or more of registered rights, copyright, databases, design rights, name, logo, website and domain names. Where intellectual property is difficult or costly to protect, businesses can choose to treat confidential information as a trade secret. All of this will be of interest to an investor or buyer, making an intellectual property strategy a useful framework for knowing and recording the protections the business has in place, why the management team has decided on those particular protections and the advice that it has taken. In front of the cameras or not, if a management team knows its intellectual property portfolio inside out and can present it to an investor or buyer together with a rationale for the strategy, it will be in a much better position to keep the investor or buyer on side.

Data

A common mistake is to assume that data bought by the company or specifically sourced for the company is freely usable by it for any purpose. In fact, data providers often place restrictions in the license agreement that may mean that a business is using data in breach of the license, or worse, that it has trained a model using data in breach of the license. This can draw into question whether you have compromised the ownership of intellectual property in that model. It is also alarmingly common for developers to scrape data from websites, including text, audio, video and databases – all of which may be in breach of the website terms and the intellectual property rights of the owners – and to store it without appropriate labelling and metadata to enable it to be identified. If required to identify and remove data, or submit to an audit, it can be problematic to separate data, or identify where it may have been used. This is avoidable, and together with other guardrails, a clear policy and procedures for data sourcing can help to prevent this scenario from arising.

Transitional Arrangements

On a sale, or where an investor is eyeing a sale within the next few years, the purchase or investor may have a particular interest in transitional services. If a product or service relies upon data, hardware or software provided by or licensed by a third party, and a transitional services agreement is required on a sale, the business needs to know that it has the right to assign the agreement, or transfer the benefit of the agreement, to the buyer. Finding out that it doesn’t have that right can affect a crucial part of the deal, where the seller had agreed to support the transition and integration of the product or service to the buyer business and systems. The third-party supplier is likely to know that the transaction depends on their co-operation and will use it as leverage to get something that it wants. It is far better to have anticipated this and included the necessary rights in the agreement, but if the rights aren’t there, setting up for success should include reviewing terms and exploring options such as negotiating a change in good time before a sale, or reviewing alternative suppliers. This allows the business to plan ahead and avoid a common pinch-point in the deal process.

Target Markets

Often the priority for identifying a target market is the potential size of the market. Sometimes businesses add projected sales to their forecasts based on launching in a market, only to find that the prospective investor or purchaser asks some tricky questions about how they will comply with local regulations, or where they are in the process of obtaining a permit. Can they bring data into or out of that market (data transfer), or do they have to set up stand-alone servers in that market to comply with local laws (sovereign data). Setting up for success means:

1. Having an effective strategy for assessing suitability of overseas markets.
2. Demonstrating a comprehensive understanding of that market using knowledge acquired through applying the strategy.

These are only a few of the common issues faced by start-ups and scale-ups when embarking on an investment or disposal transaction - there are many more.

The first step to setting your business up for success with due diligence questions is to have a lawyer review everything that you have in place. They can work with you to create a strategy to ensure that you know:

1. What you have,
2. What you should have, and
3. What to prioritise to be investment or divestment ready.

James Teare has helped clients and businesses to be ready for investment and divestment for over twenty years, both in private practice and in-house. As a lawyer with a keen interest in technology, he has also developed apps and been through many of the issues faced by software development companies with his own business. James draws on both his legal knowledge and practical experience to understand clients’ businesses and tailor advice accordingly. He offers a fixed fee service for an initial assessment of a product or business and outline strategy for preparing for due diligence.