Acquisition Learnings: Deal Structure
So due diligence went smoothly and you got a term sheet! Congrats!
Now obviously you should have your counsel evaluate the specific legalese, but here are some issues you should keep in mind when looking at the overall deal structure.
How much of the money is going to investors as opposed to the company? If the offer is valued well beyond the amount of investment in the company, then there are generally few concerns. But what if the buyout offer is LESS than the amount invested? Then it’s a bit of a catch-22 situation as the investors want to (and should) get their money back at the least, but the buyer will typically need to balance the amount toward the investors (so the board approves the deal) and the amount toward the company (so founders and employees will stay).
Be ready to discuss these issues. You can probably work out a pretty fair structure with your investors because they still want to make sure there’s a company (and employees left) to sell in order to close. Founders may need to give up any notion of their equity stake and do a fair distribution of the capital that comes, depending on whether the amount exceeds a certain threshold.
Understand very early on (be specific if you have to ask) whether the deal is centered around the value of the technology, the patents, or the team. Whereas the first two will push the deal to be more value up front, the latter will almost certainly be value held back in the form of retention. This means understand your positioning and don’t get taken advantage of (in the first two scenarios), but also don’t ask for absurd terms (huge upfront payments for the team).
If the deal turns out to be an acquihire, as it often is in the Silicon Valley when the buyers are large tech corporations, make sure you have a very clearly defined set of expectations.
Who’s Going? Figure out which individuals are critical to the deal’s success and which are added bonuses. This helps you set proper expectations early on with the buyer and structure the valuation properly. This also requires some upfront conversation with key members of your team. Nobody likes to be surprised at the last minute, so have an open and honest conversation and avoid trying to guilt trip key individuals.
What Capacity? Make sure each individual understands the level of the roles they’re heading into. There is often a significant variation in the titles from a small company and large company, so make sure to ask about the career paths and level setting guidelines because your employees will ask about this. You don’t want to mislead people about their relative seniority as there is already a big culture shock.
What Function? Probably one of the most key issues to figure out is the specific function for every individual. Startups almost always have their key employees wear multiple hats. That’s pretty unlikely at a larger corporation because there are structured teams and roles. Help your team members figure out what career ladders they are being slotted toward, and work with them to figure out if this is the right path for them. Once you start work after the deal is done, it becomes harder to negotiate major functional changes.
For How Long? Needless to say, inquire about how long the lock up is, if there is one. And try to push for a lower lock up and better vesting schedule.
Finally, we’ve come to the finances for the individual employees. This is just as crucial as the overall deal finances because this is where individuals who should be rewarded can have a say, and the structure of the retention makes a world of difference.
Signing Bonus. Buyers seldom like to give signing bonuses because they don’t want you to take the money and run. You should argue that your key employees took on a lot of risk and have worked hard for some kind of reward. Giving them nothing to go over and leaving all of the retention in cliffs is akin to them taking a brand new job, in which case they will just go to the market. Instead, argue that a small signing bonus can act as a big morale boost, and when combined with a reasonable retention schedule, will help keep employees.
Stock Cliffs. The most common scenario is that the buyer will offer each of the employees they want to retain a sizable stock offering, vested over 4 years with a 1 year cliff. This is a sensible option for the buyer because stock signals a combined interest. In some cases, you can try to argue that key employees have already vested the startup stock, so reseting from zero is very unattractive. This sometimes helps to push for a slightly accelerated or front-loaded vesting schedule, but it is still a tough battle to win unless the buyer really wants you.
Cash Cliffs. In some occasions, the buyer may be persuaded to split the retention into both cash and stock. Cash doesn’t have the same “alignment-of-goals” benefit but it is almost always asked for when the buyer is a private company. Again, you can apply the same arguments here to push for accelerated vesting or uneven vesting (55/15/15/15 or 40/20/20/20 vs 25/25/25/25).
Hope this all helps as you are thinking through the deal terms.
