Sell-side due diligence is a critical process for software companies looking to attract potential buyers or investors.
When going through sell-side due diligence, companies are subject to a thorough examination of their financials, operations, controls, legal matters and many other key areas to gather information, provide transparency and build trust. While due diligence is crucial for a successful transaction, it can often unveil some common issues that software companies must address.
1. Financial Discrepancies
One of the most frequent issues encountered during sell-side due diligence is financial discrepancies. These can include inconsistencies in revenue recognition, discrepancies in expense reporting or outdated financial records. Software companies must ensure that their financial statements are accurate, up to date and compliant with relevant accounting standards. This may require a thorough internal review and the assistance of the experienced professionals at Schneider Downs.
2. Intellectual Property Concerns
Intellectual property (IP) and intangible assets can make up a significant portion of the balance sheet for software companies, and potential buyers will scrutinize IP ownership, licensing agreements, contracts and any potential infringements during due diligence. Common issues include unclear ownership of code, open-source software usage without proper licensing and potential patent infringements. Companies must conduct a comprehensive IP review to address these concerns and ensure that all IP assets are adequately protected and accounted for.
3. Customer and Contractual Obligations
The relationship between software companies and their customers is often governed by complex contracts. During due diligence, potential buyers will examine these contracts to assess the company’s obligations, renewal rates and any potential liabilities. Common issues include vague contract terms, unfulfilled service-level agreements and disputes with key customers. Companies should review and attempt to standardize their contracts to ensure clarity and compliance with customer expectations.
4. Data Privacy and Security
Data privacy and security are essential for software companies, especially given the constantly changing regulatory landscape. Potential buyers will assess the company’s data protection practices, compliance with applicable regulations and the strength of its cybersecurity measures. Common issues include outdated security protocols, insufficient data encryption and lack of compliance with privacy laws. Companies should invest in modern security technologies and conduct regular cybersecurity reviews to mitigate these risks.
5. Operational Inefficiencies
Operational inefficiencies can significantly impact the valuation of a software company. During due diligence, buyers will evaluate the company’s internal processes, development methodologies and overall operational efficiency. Common issues include reliance on outdated technology, lack of automation and inefficient project management practices. Companies should streamline their operations, adopt agile structures and invest in automation tools to enhance efficiency.
6. Legal and Regulatory Compliance
Compliance with legal and regulatory requirements is essential for software companies to avoid potential liabilities. Due diligence will uncover any compliance issues with industry-specific regulations, employment laws and corporate governance standards. Common issues include unregistered business activities, noncompliance with labor laws and inadequate corporate governance practices. Companies must be aware of relevant regulations, stay ahead of any regulatory changes and ensure full compliance to avoid legal complications.
Sell-side due diligence can be a demanding process, but addressing these common issues proactively can significantly enhance a software company’s attractiveness to potential buyers. By ensuring financial accuracy, protecting intellectual property, fulfilling contractual obligations, safeguarding data privacy, improving operational efficiency and maintaining legal compliance, companies can navigate due diligence successfully and be prepared for a successful transaction. Being well-prepared for sell-side due diligence not only facilitates a smoother transaction process, but also lays the foundation for long-term success and growth. Addressing potential issues early on and maintaining a robust and transparent operational structure will make a software company more appealing to prospective buyers and investors, and ensure that the company is positioned to succeed.
For more information about Schneider Downs’ due diligence services, contact a member of our Transaction Advisory team.
About Schneider Downs Emerging Technology Services
Schneider Downs understands the ever-changing landscape and business challenges facing companies focused on emerging technologies and software. Our clients represent a wide range of organizations, from emerging growth companies to large mature companies, and we are well-versed in the unique challenges they face. Our team of seasoned professionals has experience working with emerging technology companies in all phases of their evolution.
To learn more, visit our Emerging Technology page.
