Prompted by the dynamic development of technologies, the IT sector in Bulgaria has provided the perfect backdrop for multiple deals and strategic moves in the past couple of years. With the main transaction model being for larger, well-established companies to acquire smaller startups, buyers need to consider two key aspects:
What assets are they actually buying?
How can they protect these assets?
Naturally, human capital is one of the key assets of an IT company. The teams are the ones who create and develop the core of the business – the IT products. Therefore, it is expected that the investor would aim to keep the key employees. In this regard, it is worth considering the following points:
► Changes in a company’s ownership and management often create uncertainties for employees, who may choose to join competitors. Such moves are likely to harm the purchased business.
► The seller may create (or may already have) a competitive business and may try to solicit the employees to join it.
► From a legal perspective it should be noted that the free choice of employees to change jobs is subject to a strong protection by the Bulgarian laws. Any clause inserted in the employment agreement prohibiting the employees from switching jobs may be declared void by the respective court in case of a dispute.
The aforementioned risks may be mitigated by keeping the entire or part of the management of the purchased company and initiating a gradual transition to a new corporate governance. In this way the employees will feel more secure, which would decrease the chance of them leaving.
With reference to future moves of the seller that can potentially harm the purchased company, this could be prevented through the inclusion of contractual mechanisms and clauses. Such clauses may include penalties or enforcement over securities provided by the seller in the context of the transaction.
Since software code is not subject to registration according to the local intellectual property laws, the ownership and the right to use the code by the target company should be reviewed in detail in every separate IT transaction.
Software ownership is regulated by the Bulgarian Copyright and Neighbouring Rights Act (“CNRA”). The software code is usually created by two main categories of developers – employees hired under employment agreements, and contractors hired under the so called “civil agreements”.
In accordance with the CNRA, the copyright on a product, created in an employment relationship, belongs to the employee, but the employer has the exclusive right to use the respective work without seeking the consent of the employee. This makes the software ownership matter relatively clear if the target company uses only employees for the purposes of software development. An important point is that under the CNRA, no additional remunerations are due to the authors, unless the initial remuneration turns out to be disproportionate to the employer’s profits from the product.
The authorship of software codes developed under “civil agreements” is often ambiguous. There is room for interpretation as to whether the civil agreement includes an assignment for software code development or is an agreement for the use of software or something in between. In order to avoid such interpretation, art. 42 of the CNRA allows the ownership matter to be fully settled in the respective assignment agreement, meaning that it could include that the transferable rights belong to/arise for the assignor.
As the main asset of an IT company, the software code should be examined in detail from both a legal (ownership, legality of the functions) and technical perspective. To ensure that the technical testing would be performed on the exact same code, which will be part of the transaction, different approaches are possible. Still a fairly unknown service in this regard is the so-called escrow on software code. With this approach, the code is deposited at an independent third party called an “escrow agent” and is released by this escrow agent only under certain circumstances. The escrow service is well recognised for material assets and is also gaining popularity with regard to software codes.
To sum up, IT transactions have certain specifics, which need to be considered in addition to the usual aspects of M&As. A good understanding of the heartbeat and pace of an IT business would provide the necessary base for a smooth completion and closing of a deal.