July 2, 2019

How to buy an IT company. ILF lawyers talk scenarios and risks of such deals

Mergers and acquisitions in the Ukrainian IT sector are rarely public. Because of this, it may seem to many that the market is dead and that you can only buy or sell a company abroad. This is not the case: although it’s not particularly frequent, companies are still bought and sold in Ukraine. You can go about such a deal in several ways.

Thus, an IT company – one of ILF’s clients – had long been a monopolist in the development and sale of analytics and CRM systems. The company was founded a long time ago and managed to capture entire market segments. However, over time competitors started to appear. Smaller companies were taking advantage of their speed and adaptability, developing their products faster and adding new functionality.

After assessing the situation, our client decided to strengthen their position by buying several competitors and integrating their functionality into their own products.

The nuance of buying software developing companies is that you’re not buying the assets, but rather the team and intellectual property.

The difficulty in acquiring a team is that IT companies often operate as hubs or integrators that buy services from sole proprietors (FLPs) and create a specific technical product. Such FLPs are much more mobile than regular employees, and in the case of bad communication during a change of the owner, the buyer could quickly lose all advantages in the market.

In addition, such companies rarely work as a single entity that concentrates intellectual property rights in one place. As a result, prior to acquisition, a company could have a multitude of legal entities and individuals with a bunch of rights to snippets of code. Under these conditions, it’s  very important to conduct a thorough audit and restructuring of intellectual property rights in order to determine what exactly you are buying and who owns it.

There are several options for acquiring such companies:

  1. Buying stakes (corporate rights) from their owners. With certain companies, it can be tricky to trace back their history of debts, contracts and agreements. If this scenario cannot be avoided, a thorough audit of the company’s activities becomes top priority. Its goal will be not just to identify problem aspects of the company’s activities (which could affect the decision on whether to buy that company), but also to correct past mistakes so that the new owner could be confident in the business he is buying.
  2. Creating a new company and transferring to it the assets, employees and intellectual property rights. In this scenario, the company’s past commitments become less important, giving way to the following:
  • intellectual property audit: which product the company is using now and what product it has rights to (signed contracts and acts). If necessary, complete the document package with missing documents. This will help insure yourself against future lawsuits by developers and get a complete product for your use.
  • constant communication (both written and oral) with clients and the team. It’s important to explain to employees their rights and opportunities in the transition process clearly and in detail, and to discuss, on an individual basis, conditions for the transfer of existing clients.

It took ILF lawyers almost six months to close the deal from the above example, during which they:

  • re-signed contracts with employees, so that they simultaneously finished working in the old structure and began work in the new one.
  • conducted a technical audit of the software product: what’s to be transferred, what belongs to the company and what to the developers. We signed additional agreements and acts on intellectual property rights with those who were involved in the development process but never fully transferred their rights. Once all rights were transferred to the owner, the product was officially registered.
  • concluded a licensing agreement for a fixed period. That is, the old company transferred all its intellectual property but continued using it for some time. This allowed us to minimize the risks of halted development process, clients leaving or the company being unable to make good on their promises to the clients. This gave us time to negotiate with the clients and transfer them to the new company.

The deal allowed our client to avoid 3 significant risks:

  • unclear credit history (the purchased company transferred all its rights and is no longer an active market participant)
  • exodus of employees (new transparent work conditions have been established),
  • exodus of clients (the lawyers clarified the changes and what they would affect).