GovTech M&A:

Buyers are aggressively targeting companies with differentiated technology and strategically-positioned intellectual property.

An ever-growing demand for cyber and data security, coupled with a drive for analytics and intelligence, is pushing buyers to rapidly seek innovative GovTech companies for purchase.

GovTech companies who have taken necessary measures to protect their intellectual property assets, and who can demonstrate an ability to monetize such assets, are receiving considerable attention from prospective buyers.

For growing GovTech companies looking for a potential exit, understanding the risks associated with intellectual property is becoming increasingly crucial at an earlier stage. Notably, a prospective purchaser will want a GovTech company to establish that it has taken a careful approach to protecting its intellectual property, which should include implementing appropriate licensing arrangements with customers and partners, understanding the scope of government retained rights, using robust proprietary rights assignment agreements with its employees and contractors, and ensuring that its source code does not include open-source materials that would give any third party a right to use such code.

Sellers are reimbursing due diligence and other fees in exchange for a lack of exclusivity.

It’s sometimes referred to as a “break fee.” The seller says to the buyer, “I’m not going to commit to you yet and I’m going to stay on the market and continue speaking with other potential buyers. But, if I don’t choose you to buy me, I’ll reimburse your due diligence and other pursuit costs.”

This is a trend happening with seller auctions in other markets, and slowly starting to appear in the GovTech space. While buyers of course prefer exclusivity as soon as possible, this arrangement is one way to bridge the gap for a buyer to more comfortably stay in the process if the seller is not ready to commit.

Sellers are not encouraged to make this a standard practice; many buyers will demand exclusivity and companies therefore need strong leverage (strategically-positioned intellectual property, perhaps?) to play this card.

More deals are being done with an insurance policy as the only source of funds to cover indemnification for inaccurate reps and warranties.

In a sale, the reps and warranties are “promises made” about the condition of the target company, for example, the company is not in breach of its contracts or the company is not a party in any material litigation. Indemnification is the enforcement mechanism, a payment due to the buyer, if the reps and warranties turn out to be inaccurate after closing, and the buyer suffers damages.

Typically, the source of funds for indemnification is held in escrow by a third party. The buyer may also sometimes hold back a percentage of the purchase price for a period of time as the source of funds (more favorable to the buyer), or the seller may avoid such a holdback or an escrow forcing the buyer to recover directly from the seller post-closing (more favorable to the seller).

An increasingly growing option is the use of a reps and warranties insurance policy, which can provide a buyer with a source of recovery for a seller’s breach of its reps and warranties. Use of a “reps policy” is becoming more common when a seller is running an auction process or when the parties cannot agree to terms for post-closing risk allocation. Third party escrow is still the most typical approach in GovTech deals, but the more widespread use of reps and warranties insurance is a welcome addition.

Private sellers are positioning themselves in auctions with aggressive documents which, in some cases, are similar to public company deals.

Consider it a “public company risk allocation” trend for some private sellers running auctions where they are in the driver’s seat. In a very competitive auction for the sale of a company, a private, middle-market GovTech company might be able to have the buyer agree to extremely limited or no post-closing indemnification provisions in the sale agreement.

This is a risky move for buyers and typically only available to sellers with considerable leverage.  Buyers in these types of auctions may want to strongly consider a reps and warranties insurance policy.

What’s to come?

Pay attention to the distributed ledger technology (i.e. blockchain) as it continues to develop - particularly its implementation into various commercial applications - and the usage of digital currency and its regulatory environment.