However many pivots and transactions you’ve navigated as the CEO/Founder of a startup, selling your company through the mergers and acquisitions (M&A) process presents an entirely new set of unique challenges.
Here are five essential steps you need to take before you can confidently present a prospective buyer’s letter of intent to your board of directors:
1. Get an NDA
Is a potential buyer genuinely interested in your amazing company? Or are they just fishing for industry information and/or business intel? It can be difficult to tell sometimes. Unlike when you pitched to a VC and were warned NOT to ask them to sign a nondisclosure agreement (NDA), you should be prepared to place your law firm’s M&A NDA form in front of a potential buyer anytime the conversation inches past casual niceties. An NDA will protect you from so-called anglers as well as disenchanted would-be buyers who break off negotiations just as a deal appears ready to close.
2. Know your value
A buyer can show up unannounced anytime. Which is why it is imperative that you accurately assess the market value of your company before engaging a suitor in a serious conversation. If there is a 409A valuation or round of financing in your recent history, that should place you in a good negotiating position. It also can be immensely useful to consult an M&A advisor or an investment bank — boutique or otherwise — to obtain a thorough understanding of recent transactions in your space as well as which buyers are seeking to acquire companies such as yours. M&A advisors may also provide value throughout the negotiation process, perhaps providing insight into the buyer, the buyer’s past acquisitions, and how the buyer assimilated other acquired companies.
3. Educate yourself regarding the M&A process
Every M&A deal is unique, yet most follow the same basic steps. To successfully navigate this process, it is important to understand each step and your role. (It also helps to recognize the fact that the buyer believes they are running the process.)
Keep the following in mind:
- Ideally, an M&A advisor will bring vetted potential buyers to you.
- A potential buyer could also approach your company. Many meetings/dinners will ensue to determine the level of interest in a deal — on both sides. (Remember to get that NDA!)
- If a potential deal moves to the next stage, the buyer will propose the structure of the acquisition — that is, a merger, a sale of stock, or a sale of assets. Your M&A tax advisor and corporate lawyer can help advise you as to the best structure for your company. Generally speaking, however:
- A sale of stock is often the simplest and most seller-friendly: The shareholders of your company agree to sell their shares to the buyer and your company becomes a wholly-owned subsidiary of the buyer.
- A sale of assets, on the other hand, is typically the least favorable to a seller. Customarily the buyer selects only specific assets to purchase and leaves all liabilities with your company. And because you are transferring specific assets, the timeline of an asset sale is often longer than a sale of stock.
- A merger — governed by state merger laws — is the combination of two companies in which one company (the “target”) is completely absorbed by the acquiring company and the target’s shareholders receive stock of the acquiring company. A merger is often proposed if there are so many shareholders of the target that asking each to sign the stock purchase agreement is unwieldy and time-consuming.
- If all goes well, the potential buyer will make a high-level offer for your company — otherwise known as the purchase price.
- The next step is the letter of intent (LOI). It’s important to spend the most time on this stage.
- Once signed, the buyer will commence due diligence on your company. A wise seller will simultaneously conduct his or her own due diligence on the buyer — and if your shareholders are receiving stock in the buyer as all or part of the purchase price, this is a must.
- Often in parallel with due diligence, the parties will commence negotiation of the M&A transaction documents. The buyer’s counsel will provide the first draft of each document for your counsel to review. (The more time you invested in the LOI, the less money and time you will spend on this portion of the process.)
- Once you reach agreement on the M&A transaction documents, the parties sign and the buyer funds.
- After the acquisition closes, you either go to work for the buyer — two to three years is customary — or move on to found your next startup.
4. Discuss the purchase price
Assuming you’ve obtained a firm understanding regarding the value of your company — independent of the buyer’s assessment — and done sufficient preliminary due diligence on the buyer, you are ready to come to an agreement on the purchase price. Understand the following, however: The price the buyer proposes is very likely the highest price you will obtain from that buyer for your company. M&A buyers can and often will use the due diligence process to find reasons why the price they agreed with you at this initial stage “does not hold up” post due diligence and may even attempt to renegotiate the price with you then. You can, of course, push back, accept the new price, or walk. There are also post-closing matters — for example, the seller’s agreement to indemnify the buyer for breaches of representations in the transaction agreement — that could result in a reduced purchase price.
5. Letter of intent (LOI)
After you’ve agreed in principle on the purchase price, the buyer will provide you with an LOI. Be sure to hire an experienced, pragmatic M&A lawyer to work closely with you from the beginning of the LOI discussions. As the seller, you will never again have as much leverage as you have at the time before you sign the LOI.
- Engage an M&A tax accountant to review the proposed structure. If you can’t agree on this, the negotiation is over.
- The buyer’s job is to get you to sign the LOI without much negotiation. They’ll tell you to “let the lawyers take care of the documents.” Make no mistake: This is directly against your best interest.
- Instead, you and your lawyer need to do a deep dive into the LOI terms and revise it — perhaps extensively — to ensure it reflects the best deal terms for you.
- There are several key provisions in an M&A transaction which, if not carefully negotiated at the LOI stage, could result in a reduction of the negotiated purchase price over the course of the months or years following closing. Among these:
- Holdback provisions
- Indemnification provisions and caps on indemnification claims
If there is an earnout, consider what the buyer has to commit to for you to successfully run the company after closing. A board seat? Certain budget? A specific team to help you run the company? Agreement on compensation, benefits, or equity for you and your team?
Gather a trusted team within the company — your internal or external CFO, for example — to help you with the sometimes-daunting task of continuing to successfully run your company while at the same time pursuing the acquisition.
Preparation makes the process smooth
A merger or acquisition is an exciting time that should be celebrated. Taking the time to educate yourself on steps to a successful M&A can help you spend less time stressing over the process and more time reflecting on your and your team’s accomplishments.
This article was written by Kathy Woeber Gardner, Partner at Montgomery Pacific LLP.
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