Ken Bender on Software M&A

Ken Bender is the founder and managing Director of Software Equity Group and has provided financial advice, exit counsel and strategic guidance to more than one thousand privately-held software and technology companies. Industry publications refer to him as "The Nation's leading expert in midcap software and Internet M & A transactions." In a live webcast on Thursday, August 24th, Ken will present an update on the software M & A market, including market drivers, trends and shifting buyer preferences.

Q: Are buyers particularly concerned with revenue recognition when they are looking at an acquisition? How much attention does it get?

A: It gets full attention. Revenue recognition is an important factor in the due diligence process and buyers today, in this climate of compliance issues and regulations, take a very conservative view of it. This it to say that they take revenue recognition and GAAP compliance very seriously and they want to ensure that any company they may acquire is similarly serious and compliant. So they scrutinize the financial statements and they ask a lot of questions. If there are any differences at all over particular treatments, the buyers get right to the bottom of them.

Q: On the sell side, do most companies come to the table with their compliance houses in order?

A: For the most part, yes. We ordinarily ask every prospective client about their revenue recognition practices very early on, before we engage. Most $10-50 million companies have reviewed or audited financials. Typically these companies are working with public accounting firms that are Sarbanes-Oxley and GAAP knowledgeable. Smaller software solution providers, usually under $10million and still on Quickbooks, may not be as knowledgeable, but generally we find even these smaller entities are GAAP compliant for revenue recognition purposes.

Q: How often do you see differences between buyers and sellers over revenue recognition treatments that were difficult to resolve?

A: Not often. In our experience there has been very little disagreement about interpreting GAAP as it applies to revenue recognition for software companies that operate under a traditional model selling shrink wrap software with licenses and service. That situation is well understood and the accounting is well established. It's the new business models that can cause problems. SaaS businesses, for example, which employ a subscription model and may involve third-party embedded software and royalties, often raise a lot of questions about which of several GAAP provisions should be used to recognize the revenue. We look to auditors and our experience with similar companies to help resolve those situations.

Q: Have you seen any situations in which revenue recognition issues broke the deal, or had a negative impact on the ultimate purchase price?

A: Not yet. Sometimes differences may result in financial restatement, but not in a complete end to the conversation. First of all, the subject comes up very early in the process. One of the first things that happens is an exchange of non-disclosures and the provision of financial statements followed by a series of discussions. These discussions, which would cover any revenue recognition issues, happen well before a letter of intent is issued and the purchase price agreed.

Q: What kind of advice around revenue recognition do you offer to would-be sellers?

A: Our standard advice is that if they haven't already done so, they need to engage an auditor that is very savvy about the software companies and IT providers, and that is really conversant and knowledgeable on GAAP, particularly as it pertains to revenue recognition. Usually those firms have read all of the rulings and follow them closely, and in our experience have provided sound guidance.

Q: And what's your advice to buyers?

A: Most sellers today are convinced they're GAAP compliant, but may not be - at least to the satisfaction of the buyer. The fact that those companies have audited financials, and make representations about their compliance, is no substitute for buyer scrutiny. That's what due diligence is about. Buyers need to look closely at the revenue recognition practices of smaller software companies they contemplate acquiring.

See more information on the upcoming webcast with Ken Bender, Midyear Reality Check for Software Mergers and Acquisitions.
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