Key Issues in Negotiating a Software Company Sale

Deciding you want to sell your software business is one thing, getting a good deal from it is something else. 

Even once you’ve found a good buyer who you believe will be a good cultural fit and take the company you’ve worked so hard to build in a good direction, you need to be able to negotiate a good sale. 

So what issues do you need to cover when you’ve got the other party sitting across the table?

MOU / LOI

Before you get into the nitty-gritty, you will likely negotiate the framework of the deal itself. Just about every acquisition today will feature either a memorandum of understanding (MoU) or a letter of intent (LOI) that sets out the basis for the larger scale. An MoU is a preliminary agreement showing the parties’ intent on making a deal happen, while the LOI, while not constitute the actual sales agreement, but rather lays out the key assumptions and what precisely it is that the counterparties will be negotiating.

They will typically come in tandem with an exclusivity agreement that would preclude any other buyer from going for the sale while negotiations are ongoing. This is usually the only part of the LOI that is binding.

Points outlined in an LOI can include the transaction price itself, the payment structure of the consideration, details that still need to be negotiated, and any other requests from either party. 

Just because it’s not the final deal doesn’t mean there’s no negotiation involved at this stage, though. Drafts can be sent back and forth between buyer and seller so both are on the same page, and either can make changes and tweaks that will have to be cleared by the other before it is signed.  

The main thing is the transaction price, this will normally be negotiated in advance of the LOI being signed, but there will need to be work done to make sure it's a fair price - for example if the price is a mix of cash and shares - which usually comes with clauses stipulating that they cannot be sold for a number of years post-purchase - the seller will need to make do their own valuation work on the buyer to make sure their shares are fairly valued. 

Due Diligence

There’s no getting around this one. Any buyer will, and should, be able to get a full look under the hood to make sure everything is in working order. As a seller, you should do your best to make this process as easy and smooth as possible for the buyer - not only does this reduce the time to closing, but it also generates goodwill with the people across the table from you. 

Issues that will likely come up during due diligence include: 

Financial

• What are the near-term debt obligations and capital commitments? Is there enough liquidity to fund them?
• Are the financial forecasts reasonable and believable? 
• What is the company’s standing with tax and other regulatory authorities?
• How are the margins trending?
• How is working capital defined and how much is needed to keep the business operating?

Tech/Contracts/Legal

• Is the software owned solely by the company? Who else has a stake? Who were the developers?
• How are intellectual property and trade secrets being protected?
• Any ongoing legal issues?
• What customer and supplier contracts are in place?
• How locked in are the key employees?
• Any encumbrances related to the software, such as liens on the software, third-party licenses, commitments to provide services to third parties, or any restrictions on the use of the software.

Sales/Customers

• Rate of retention vs. Churn?
• Customer acquisition cost?
• Who are the biggest customers? Are they likely to stay on after the acquisition?
• KPIs like traffic, customer activity, and conversion rates.
• Are customers satisfied?

Other Points

Additional points that will likely come up during a sales negotiation include: 

• Escrow and Holdback: Even after the deal closes there can be holdbacks on the consideration depending on certain contractual covenants that may trigger a breach. Both the sum of the amount in escrow and any conditions that would revert it back to the buyer will need to be negotiated. 
• Closing conditions: You will also need to agree on the closing conditions for the deal since a signed agreement does not constitute a business changing hands. Things need to be signed off, and approved by various stakeholders including shareholders, financiers, and sometimes regulatory authorities, while material changes in things like financial circumstances or sales figures might also trigger a clause that shuts the deal down. 
• Indemnification: Indemnification for key legal terms will also need to be agreed upon. Will there be a break clause in case one of the parties backs out of the deal prematurely? What about any other key representation or warranties - what are you willing to put up to secure these? Getting these straight at this point will make the negotiations for the final agreement and due diligence easier.
• ‍Risk allocation: There is bound to be some ping pong happening in terms of who risks shifting and determining who will be responsible if things go wrong during negotiations. Be sure this is read over carefully.

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