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Avoid Getting Burned by Today’s Hot M&A Market

March 20, 2015

Targets must generally have proven concepts, revenues and positive cash flow before they’re taken seriously today.

Last year, we saw record-breaking deal volume in the rapidly evolving technology sector. Internet-specific and software companies were among the hottest markets, as evidenced by the $19.7 billion megadeal between Facebook and WhatsApp last October. In 2014, VC and P/E firms invested $11.9 billion in Internet-specific deals and $19.8 billion in software deals — the highest levels of investment since 2000 — according to data compiled by Thomson Reuters.

Research firm IBISWorld expects that the technology sector will continue to be a “hotbed of M&A activity” for 2015 as companies attempt to keep pace with new technologies and leverage R&D costs. Geographic boundaries are also expected to diminish, as firms from Brazil, China and Japan expand their investments in U.S. technology companies.

M&A Drivers

Several factors fuel M&A growth in the technology sector. Mature markets — such as semiconductor and PC manufacturers — are consolidating to share overhead costs. High growth tech companies often find it’s easier and more cost-effective to acquire another company with proven intellectual property (IP) than to re-create similar technology in-house.

Other deals bolster the acquirers’ talent base by adding skilled developers. Additionally, startups in the seed or early stages may turn to equity investors for additional funds and expertise to take their concepts to the next stage of development.

Due Diligence Questions

P/E and VC firms can achieve higher returns on investment if they know how to identify bargains and viable business propositions. Vetting out the best deals in the marketplace requires answering tough questions, such as:

  • What synergies and economies of scale can the combined entity realistically achieve?
  • How much more time and R&D costs are needed to bring the target’s products to market?
  • What are the useful lives of the target’s key IP assets?
  • How secure are the target’s key IP rights against theft, breach and emerging technology?
  • Is the target’s projected cash flow over the next three to five years reasonable?
  • What’s the investment’s projected payback period and internal rate of return?
  • Have key employees signed valid and enforceable employment and noncompetition agreements?

What differentiates the current market boom from the dot-com bubble that burst in 2000 is the level of due diligence investors are conducting before closing. Targets must generally have proven concepts, revenues and positive cash flow before they’re taken seriously today. KLR specializes in the technology sector and can help investors find deals that best fit their portfolios.

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