How do businesses obtain the technology they say is a key component of their growth strategies? For many, M&A, joint ventures and outsourcing are the answer. Here, we look at the popularity of these arrangements and their threats, and provide seven ways to mitigate the risks.
Enter into a joint venture with a technology company
Outsource a key business function to a technology company
In the next two years In the past two years
In the next two years In the past two years
Q. Which of the following, if any, had you executed in the two years prior to COVID-19 (2018-2019)?
Q. Which are you planning to execute in the next two years?
Tech M&A and partnerships grow in popularity
M&A, JVs and partnerships can help businesses to get ahead of the competition. It may be easier for them to incorporate tech into their products or internal business processes by forming a JV with, or acquiring, a company that has either already developed it or is better equipped to do so. They can also save money by outsourcing key business processes to a technology company.
To mitigate risks, legal teams should work closely with the wider businesses across the deal lifecycle – from pre-completion evaluation and documentation to post-completion operations management.
Acquisitions, partnerships and unforeseen risks
These deals come with significant risk. Technology acquired or developed through a JV, for instance, may fail or not perform as expected. A JV could break down because of a deterioration in relations or if ordered by government authorities – this is increasingly a risk where the JV partner is based in China. And a JV or outsourcing arrangement could create cyber vulnerabilities.
There is the fundamental risk that the technology of an acquired business or JV partner does not work or is less advanced than expected.
There is a risk that the JV breaks down because one party fails to deliver or relations sour.
A JV or outsourcing arrangement in which key business systems are interlinked could create cyber vulnerabilities.
Governments and businesses are increasingly concerned that a JV partner could pass important technology to a foreign power. This could not only derail negotiations at the outset of the deal, but also affect longstanding JVs that are now considered by government to be a risk. The Committee on Foreign Investment in the United States (CFIUS), for instance, ordered a U.S. robotic suit manufacturer to terminate its JV with two Chinese parties in June 2020. This instruction was notable because it related to a JV outside the U.S.– CFIUS intervention had been primarily focused on U.S. JVs.
Businesses plan to increase their deals with particular types of businesses, which can expose them to new risks.
Risks associated with acquiring and partnering with tech companies are increasing
Companies in our sector will increasingly enter into joint ventures with companies in markets in which they don’t currently operate in order to get access to the most innovative technology
Companies in our sector will increasingly enter into joint ventures with startups in order to get access to the most innovative technology
Companies in our sector will increasingly enter into joint ventures with companies in emerging markets in order to get access to the most innovative technology
It has become more challenging to assess all of the risks and liabilities associated with acquiring and partnering with technology companies
Q. To what extent do you agree with the following statements relating to acquisitions of and joint ventures with technology companies?
Some risks are particularly acute when businesses partner with or acquire these types of businesses. Startups may lack the resources to implement adequate cybersecurity protections. And businesses that are located in emerging markets may be subject to data privacy regulations that are not as strict as those in Europe or the U.S.
To spot and resolve issues that could be challenging once a deal is agreed, businesses need to spend more time and resources on due diligence.
But that is not yet happening.
The majority of businesses have not improved due diligence in relation to technology deals
Q. Thinking about the last technology business you acquired or collaborated with, which of the following, if any, did you do in relation to due diligence compared with previous deals of similar size?
Seven ways to mitigate deal risk
First, involve internal and external legal counsel at the earliest opportunity, and keep them involved once the deal is in operation to help identify and manage any risks.
Then, there are seven more ways to minimize the risks of these kinds of deals:
Plan ahead for divorce
Agree a process for winding down a technology JV if necessary, and establish how the assets and liabilities will be divided. This will increase the likelihood of salvaging key technology and staving off the threat of litigation. The documentation must clearly define the circumstances in which each party can terminate the JV, how they must inform the other side, the rights of each party to background and foreground intellectual property (IP) and licenses and how the financial accounts will be dealt with.
Consult IP specialists to review deal documents to ensure that IP can be protected in a dispute. And detail the dispute resolution mechanisms in the event that the parties cannot agree on how the JV will be dissolved.
“Many businesses don’t detail how a JV can be wound down. But not doing so creates multiple complex issues if the partnership fails.”
Nathan Searle | Partner, Hogan Lovells
Think carefully about director duties and shareholder rights
Consider carefully who will be the directors of a new JV and what their duties are. Typically, they will also be directors of the two business entities that formed the JV, so conflicts of interest may emerge. So lay out in the deal documentation the rights and responsibilities of each director and what happens to each director if the JV is terminated. It might make sense to appoint a completely independent director to manage the JV.
Clearly define key milestones
If technology developed by a target company or JV partner malfunctions and causes a serious data breach and loss of revenue, litigation could be brought by the individuals affected, by data protection regulators, or by both.
Technical and legal teams must work together in the due diligence phase to identify any issues with the technology that may not be covered by generic reps and warranties and design specific language. And they must consider the extent to which the business’s rights to seek compensation from their JV partner or the directors of the acquired company need to be protected if there is a problem. These teams must also work collaboratively when an issue arises.
“It’s vital to understand and define what constitutes technology failure. If you don’t, then M&A documentation will just include general warranties, which may not cover a specific failure event. Technical and legal teams must work together to craft this.”
Bill Regan | Partner, Hogan Lovells
Ensure that legal and technical teams work together throughout
A serious data breach or cyber attack that stems from a JV or outsourcing partner can lead to complex litigation. So assess how acquisition targets and JV and outsourcing partners protect their data and the strength of their data governance and cybersecurity incident-response plans. Find out whether the potential partner has experienced a breach before – and how it responded – and check for any outstanding regulatory or law enforcement enquiries or investigations.
Assess cybersecurity and data privacy hygiene
The value of technology startups is difficult to assess, so acquirers often make payments against particular milestones such as achieving sales targets or hitting profitability. Litigation can follow if the acquirer believes that the target has not made reasonable efforts to achieve a particular milestone, or if the target believes the acquirer has hampered its efforts.
Prepare for this by discussing at the negotiation stage what constitutes reasonable efforts and then defining this in the deal documentation. Legal teams should work with the business to actively ensure that these contracts are well managed so that risks are identified early and rights are protected. This protects the business and helps to avoid costly litigation.
Evaluate how government intervention creates litigation risk
In the U.S., CFIUS has become active in scrutinizing deals involving Chinese companies’ investments into technology businesses. Litigation may result if it is not clear who bears the risk of CFIUS intervention or if one party believes the other has not made every effort to obtain CFIUS approval. It can also happen if government pressure or intervention results in other commercial contracts not being met. CFIUS aside, carry out extra checks to understand how IP will be shared when entering into JVs with counterparties in other jurisdictions. You should also stipulate in deal documentation where any dispute will be heard and how judgment will be enforced.
“You must enter technology JVs with Chinese parties with your eyes wide open. You should assume that any technology will be shared with the Chinese government and come up with a plan B for enforcing judgments.”
Antonia Croke | Partner, Hogan Lovells
Take extra precaution when entering emerging markets
Assessing litigation risk in emerging markets is difficult because regulations and the degree of penalties for non-compliance may be less clear. Conduct a more thorough risk assessment when considering acquisitions of, and JVs with, companies located in emerging markets, including checking for anti-bribery and corruption risks, and engage directly with industry, data protection and other relevant regulators to check whether your plans raise any obvious issues. It is wise to devise a plan that stipulates who should liaise directly with regulators.
Establish in deal documentation the mechanism for resolving any disputes and stipulate that any dispute should be heard in a neutral, independent and efficient forum with courts that can ensure any decisions are enforceable in a reasonable time. Based on our work with clients, we are seeing arbitration used as the mechanism of choice for these types of transactions. This also increases enforcement options in a dispute with a partner whose assets are based in an emerging market where it might be more difficult to enforce a court judgment.