MBA Mondays - Business 101 for startups by Fred Wilson

Mergers & Acquisitions - Selling Your Company

It is Monday so it is time for another post. We are a few weeks into a series on mergers and acquisitions. The first week we covered the basics of mergers and acquisitions. Last week we talked about asset sales.

This week we are going to start a conversation about selling your company. I will kick off the conversation by laying out the key issues in a company sale. Then we are going to do something new on MBA Mondays; case studies. I will invite a few guest posts from entrepreneurs who have sold their companies. That will hopefully start next week.

I think the key issues for you, your investors, and your Board to consider when you are selling your company are:

- Price

- Consideration

- Reps, Warranties, and Escrow

- Integration plan

- Stay packages

- Governmental approvals

- Breakup fees

- Timing

Price is the amount the buyer will pay for the business. It is the most important issue and also the simplest.

Consideration is the mechanism the buyer will use to deliver the purchase price. The simplest form of consideration is cash in your local currency. That is also the most common form of consideration. Another common form of consideration is the acquirer's stock. That could be publicly traded liquid stock or it could be illiquid private company stock. Buyers can also pay with debt obligations, earn out plans, and a host of other esoteric and less common forms of consideration.

Reps and Warranties are the legal promises and obligations you will take on as a seller. A portion of the purchase price is usually held back and escrowed for some period of time to backstop the reps and warranties. The escrow is usually a percentage of the purchase price. Ten percent is common but I've seen as little as 5% and as high as 25%.

The integration plan is the way the buyer plans to operate your business post acquisition. Many sellers don't think this matters too much but I think it is critical. If you think about the interests of all the stakeholders in the business, not just the shareholders, then the integration plan becomes a very important part of the overall deal.

Stay packages are compensation plans put together by the buyer for your team. There may even be a stay package for you if the buyer wants you to stick around and most of the time they should. These packages are a combination of cash and stock that vests over a stay period. It is common that some of the consideration may be applied to stay packages, particularly unvested employee stock in your company.

The government, and not just your country's government, may be required to approve the sale. This is not common for small deals. Anything sub $100mm would be very unlikely to require governmental approvals. Really big deals, like billion dollar plus transactions, often run into these issues. Big powerful companies that the government worries may have monopolistic properties will usually face governmental approvals for their acquisitions.

If your business will face negative consequences if the sale is announced and then does not close, you will want to ask the buyer to pay a breakup fee if the transaction does not close. Most buyers will resist agreeing to breakup fees but they do exist in many deals, particularly very large deals.

Timing is another important issue that many sellers don't focus on. Sale transactions are very distracting for the senior team and often for the entire team. A long protracted sale transaction can be very harmful to the business and its stakeholders. You can put time commitments into the letter of intent to sell the company and you can expect the buyer to live up to them.

These are the most important issues in my experience when selling a business. For the next few Mondays we will focus on some real world case studies that will highlight many of these issues.

From the Comments

JLM added:

In the business of buying or selling companies, it is important to follow a precise and methodical process. Before the marriage can be consummated, you must get engaged and date.

To get engaged, you need a damn good Letter of Intent.

To get married, you need a good asset purchase agreement (when buying only assets, the preferred approach in my view) or stock exchange agreement (if you are swapping stock) or purchase/sale contract (if you are buying the whole enchilada, liabilities and all).

The LOI is the term of art for a buy/sell while the Term Sheet is typically the term of art for a capital investment. Slight difference. Kind of like the right fork to use w/ shellfish.

In the LOI, you cover the obvious things but there are a number of things which should also be added.

A good LOI will put a cloak of confidentiality over the entire transaction and add a "no shop" provision as well as spelling out the key terms of the ultimate contract including the exact identity of the buyer, price, payment terms, terms of any non-cash compensation, due diligence period, nature of due diligence, reps and warranties (huge difference), schedule for movement, approval requirements (regulatory, legal, Board, landlords for assignments of leases), general nature of the assets to be acquired, general nature of the liabilities not to be acquired, authority to enter into the agreement, confidentiality and "no shop".

The LOI is formulaic but perfectly logical. You want the scope of the LOI to make the Asset Purchase Agreement a walk in the park for the lawyers to draft.

Remember, typically two folks make a deal directly. The LOI is the document which results from that negotiation and is then the guidance for the lawyers to prepare the Asset Purchase Agreement. More deals have gotten screwed up when the lawyers get involved than any other consideration. Be aware of this phenomenon and stay in touch w/ the other principal.

Once both parties have had a nice first look at the Asset Purchase Agreement, begin assembling the Exhibits immediately. The schedules of assets purchased, assignments, liabilities not assumed and employment status of key employees are all potential deal killers.