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Caine Moss and Alon Rotem work for international law firm Goodwin Procter.
Congratulations! A big-name serial acquirer is preparing a term sheet to purchase your company. While your attention may naturally focus on negotiating the purchase price and closing the deal immediately, here are 6 things you can do before signing the term sheet to streamline the deal process and maximize the return for your investors and your team.
1. Why are you selling? Why are they buying?
These are threshold questions that will drive the entire M&A process. You and your board should contemplate if now is a good time to sell your business (and at what price). Achieving alignment between founders and investors before the company receives a term sheet is one of the most important things you can do to reduce friction during the term sheet stage. Once you and your board agree on the parameters and timing for a sale, consider establishing a strategic committee comprised of a subset of directors to work with management and your stockholders. This committee will be closest to the deal negotiations, will liaise with the legal team and advisors on behalf of the board, and (ideally) will be able to make decisions quickly to maintain deal momentum.
Whether the buyer is looking to acquire your company because of its killer IP, strategic value, customer base or engineering talent (aka an “acqui-hire”), understanding a buyer’s motivation will inform how the deal is structured. For example, in an acqui-hire, a buyer want to may allocate a significant portion of the deal consideration to employment retention packages with merely token consideration leftover for investors. Conversely, a buyer targeting your strategic value is less likely to optimize around retention but instead may serve up incentive-laden earn-outs tying the purchase price to the achievement of future milestones.
2. Have you conducted a market check?
Try to get a sense of what your company is worth before the term sheet is signed to ensure you are maximizing value for your company’s shareholders. Depending on the dynamics of your market and the time you have to negotiate your term sheet, you may want to engage an investment banker to spearhead the process. Conversely, if your company is in a concentrated space where all the major players are known, you may decide to conduct a market check yourself. But if your product offering straddles different markets, it could be attractive to buyers in different market segments (for example, a fintech or healthcare IT company) and in this case a banker can be helpful. There are many good bankers out there who specialize in market sub-segments and add significant value by creating a market for your deal and enhancing process efficiencies.
3. Should you establish a Management Bonus Plan?
If you have gone through several rounds of financing, the liquidation preference of your investors may be higher than the enterprise value of your company on an exit. Since its equity stake would be worthless in a sale, management may not be motivated to drive toward a sale transaction merely for the benefit of the investors. One way to re-balance the incentives of the management team is to implement a management bonus plan (MBP), which contractually allocates a portion of the sale proceeds to the management team before anything is paid out to the stakeholders. While some investors may balk at a perceived land grab by the management team in some contexts, these plans can be an effective tool to get management to drive toward an exit and support the sale process.
4. Are your employees coming along?
If the acquirer values your key employees, then its critical to make sure the terms are acceptable to them. Does your company’s culture mesh with that of the acquirer’s? How long will the acquirer expect them to stay? Under these circumstances, it’s likely that a significant portion of the proceeds will be held back for employee retention purposes. Additionally, to retain competitive advantage and to reduce post-merger attrition, buyers typically impose non-competes on key employees which can last several years after the acquisition. Employees are also customarily asked to sign release agreements to protect the buyer from employment law skeletons that may be hidden in your company’s closet. Try to get out in front of these issues with management and with the acquirer, because the longer these issues remain unresolved in a sale transaction, the less leverage a seller has to negotiate a desired outcome.
5. Corporate housekeeping
After your company receives a the term sheet, it may be limited in its ability to make option grants because of potential tax implications associated with your existing strike price. Accordingly, try to deal with capitalization table issues (like clearing out a back log of option grants and formally terminating stale advisor relationships) before a formal offer comes in the door. This will serve the added benefit of increasing the acquirer’s confidence in your corporate governance and HR practices.
Likewise, you will want to clean up any outstanding intellectual property issues. Now is the time to settle or resolve any open disputes with third parties so you are able make clean representations regarding your IP in the definitive agreement. At a minimum, ensure that all patent filings are current and confirm that all of your employees and consultants (current and, if possible, former) have entered into inventions assignment agreements. Just like being able to present a clean capitalization table, having a handle on your IP affairs will affirm that your house is in order – which can pay dividends by shortening the due diligence period in a sale.
6. Lawyer up
Sophisticated buyers use every tool and tactic in the M&A playbook when making acquisitions. To optimize your outcome, you will need a seasoned M&A attorney who is an expert in deal strategy and who knows the market for deal terms – both what to fight for and what to concede.
Caine Moss is a partner in Goodwin Procter’s Business Law Department and a member of the Technology Companies Group. Mr. Moss has significant experience working with software, telecommunications, Internet, and financial services companies through all stages of their growth. In addition, he has broad transactional expertise, particularly in the areas of venture capital, public and private mergers and acquisitions, and representation of issuers and underwriters in public equity offerings.
Alon Rotem, an associate at Goodwin Procter. Alon practices in the Technology Companies Group and represents clients in a variety of corporate transactions, including mergers and acquisitions, securities offerings and other general corporate and securities matters, as well as in intellectual property transactional and commercial matters.
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