Study finds a 'surprising' lack of IP due diligence carried out for some tech M&A deals in Germany

According to the Tech M&A in Germany report for 2017, due diligence was identified as the biggest single challenge that businesses said they have to overcome when entering into M&A deals.

However, the report revealed that a significant proportion of German listed companies involved in recent tech M&A transactions did not carry out "technical due diligence" or specifically assess whether the deals would expose them to new legal compliance or intellectual property (IP) infringement risks.

The report's findings are based on interviews with leading business development managers, in-house lawyers andexecutives from German listed companies which had been involved in tech M&A deals in the past two years.

According to the study, 58% of respondents said their business carried out a technical due diligence when considering a tech M&A deal, while 57% said IP-specific due diligence was conducted. Compliance due diligence was carried out in 27% of cases, and a fifth of deals were also subject to confirmatory due diligence, as businesses sought to confirm details flagged in prior checks.

"At the heart of many tech M&A transactions is actually acquiring the specific IP of the target company. Accordingly, it is surprising that in 43% of the cases no IP due diligence was conducted," the report said.

It said the absence of technical due diligence carried out by some respondents "could indicate that there is still a strong seller market" in Germany. It said buyers may not want to "endanger the transaction process with due diligence demands that sellers may consider exaggerated".

According to the report, technology-related risks were identified in less than half the cases where technical due diligence was carried out. Of those risks, issues relating to IP rights, IT licences or rights of use, and know-how, such as trade secrets, were the most commonly found.

Despite this, the risks identified in technical due diligence were only accounted for in 31% of M&A agreements finalised by the companies, it said.

"There is still a lot of room for improvement for buyers," the Pinsent Masons report said.

The study did, however, identify other ways beyond due diligence that buyers in the German tech market try to mitigate risks in their purchase. Measures include requiring sellers to indemnify IP risks, holding back part of the purchase price as security, inserting an earn-out mechanism in purchase price provisions, and using material adverse change (MAC) clauses in contracts.

"In 83% of the cases in which a MAC clause was agreed, the parties agreed that, should conditions for materially adverse change be fulfilled, the buyer could consider the deal to have failed, and withdraw from the agreement," the report said. "The more moderate approach of simply adjusting the purchase price was agreed in 17% of the cases. This confirms that the hurdles for defining a material adverse change continued to be set very high."

The overall findings of the study suggest German remains primarily a "seller-friendly" market for tech M&A deals, the report said.

Pinsent Masons' Rainer Kreifels said: "The technology transaction pipeline in Europe is one of the fastest growing sectors, according to many market observers. In particular, Germany is very attractive to foreign investors. The number of German firms acquired by foreign buyers was about 900 in 2016. This is an increase of approximately 20% over 2015."

"Takeovers in the technology sector exhibited particularly strong growth, at about 150. The buyers were frequently foreign financial investors, and target companies and buyers alike increasingly included German listed companies," he said.