Valuation concerns impact terms for tech company acquisitions

International law firm Pinsent Masons today launched its new What’s Market? Technology M&A Trends Report 2011. An increased concern on the valuation of businesses being acquired, lengthening deal timescales, to over 5 months in some cases, and constant activity in the start up market are amongst the emerging key trends the firm sees continuing in 2012.

In 2011 Pinsent Masons advised on over £340m of mid-market M&A transactions in the Technology Sector. By studying the details of these 30+ transactions, and combining it with its market experience it has been able to provide a comprehensive analysis of the factors currently driving technology M&A.

“The technology market is built on constant innovation, with many of these new ideas and advances coming from entrepreneurial, smaller and mid-market companies,” said Andrew Hornigold, Head of Technology Sector, Pinsent Masons. “Consequently M&A activity relating to these businesses serves as a bellwether for the entire sector. While current economic conditions are obviously leading to increased caution from buyers, it is important to note that M&A activity hasn’t dried up, with the constant level of deals in the start up sector being particularly heartening. We expect these trends to continue into 2012 as companies seek to build value by acquiring the innovation they need to meet changing market needs in areas such as the Cloud, applications businesses and the convergence of software, hardware and services.”  

The Pinsent Masons report highlights trends in five key areas: 

1          Concern with valuations

Buyers and sellers continue to be concerned with accurate valuation mechanisms, with around 80% of deals surveyed containing either a performance related price adjustment mechanism or some kind of a locked box or asset management structure. Earn-outs were used in over ten per cent of deals, particularly those involving technology services business, which rely on key personnel to drive continued revenue. 

2          Higher levels of value protection

Analysis shows higher levels of value protection through proportionately larger warranty caps amongst deals at the smaller end of the mid-market (between £5-10m in value), where warranty caps settled at 75.5% of the consideration paid on average. This percentage then decreases as the deal value increases, falling to under 50% (48.6%) in deals over £30m. Escrow accounts were used on approximately a quarter of deals. 

3          Focus on incentivising management

On deals involving equity investments management incentivisation structures have almost invariably been implemented. This normally involved the vesting of shares, subject to continued employment.  However legal drivers, such as entrepreneur’s relief tax planning for capital gains on share disposals may well impact on this trend over the next 12 months.  Restrictive covenants preventing management working for competitors are now hovering around the 2-3 year mark, being highest at 2.95 years in deals between £20-30m in value. 

4          Lengthening deal timetables

Deals are taking longer to complete, with generally speaking timetables expanding as the value of the transaction increases, with increased due diligence the major driver. Deals worth over £30m are taking, on average, over 5.3 months from instruction of lawyers to completion, which drops to an average 3.2 months for acquisitions in the £5m-£10m range. However smaller deals (below £5m) are taking disproportionately longer to complete (on average 4 months), most likely due to the number of parties (clubs of individual angel investors, institutional investors and founders) involved. 

5          Peaks in March and December but constant start up activity

March and December were the busiest months for tech M&A activity, both in volume of deals completed and aggregate deal values. This was undoubtedly driven by a desire to complete acquisitions and disposals before tax, accounting and calendar year ends.

However while larger deals saw peaks of deal completion, activity in the start up and early stage company market (up to £5m) was constant, showing both expansion of the sector and the appetite for acquiring innovative businesses. 

To download and read the report please visit http://www.pinsentmasons.com/PDF/WhatsMarketTechnology.pdf