An “exit” or “Liquidity Event” is generally when the investors and shareholders start to get paid. The two most common types of exits are (1) acquisitions, and (2) IPOs.
Exits are major legal transactions. If you have been diligent about your legal hygiene, these transactions will be relatively quick and smooth. If you have not been keeping legal records, organizing your executed contracts, documenting your equity grants, then the transaction can become quite expensive.
The Founder’s Guide To Selling Your Company. Justin Kan, 2014. A more detailed guide from the Y Combinator partner.
M&A Case Studies: WhatCounts Sale Process. Fred Wilson and David Geller 2011. Do your diligence on the buyer. Only deal with a buyer who shares your values. Get the deal worked out in the Letter of Intent (LOI) stage. “For a relatively small company to be acquired it’s safe to estimate something between $50-$100K in legal fees.”
The Economic Logic Behind Tech and Talent Acquisitions. By Chris Dixon, 2012. A big company can build a competing product in-house, but then they run the risk of delays, cost-overruns, and failure. After adjusting for these risks, it’s often cheaper for a big company to just buy the team and product from a startup.
M&A: Talking to Corp Dev
Don’t Talk to Corp Dev. By Paul Graham, 2015. “Corporate Development is the group within companies that buys other companies. If you’re talking to someone from corp dev, that’s why, whether you realize it yet or not. It’s usually a mistake to talk to corp dev unless (a) you want to sell your company right now and (b) you’re sufficiently likely to get an offer at an acceptable price.” But see Actually, Founders Should Engage Corporate Development from Jamie McGurk at A16Z.
A Classic Startup Horror Story: the M&A Bait and Switch. Venture Beat, 2012. Paul Graham comments, “This sort of scenario is unfortunately very common. The antidote is never to allow acquisition talks to be the main thing you’re focusing on. We advise startups who get approached by acquirers to treat it as a background process, and not to take things seriously until the very last stage. If acquisition discussions are just a side show, you can easily terminate them if anything goes wrong. Which, interestingly, probably decreases the chances of things going wrong. M&A guys can smell it when you really want a deal, and that makes them want it less.”
Acquihire is the purchase of a company mainly for the value of its employees, not its product or technology. It’s often a way to provide a “soft landing” to startups that would otherwise fail and go bankrupt.
Acquihires can result in misaligned incentives between investors and the acquiring company.
Acqui-Hiring. By John Coyle and Gregg Polsky in the Duke Law Journal, 2013. The research article is discussed and summarized at Yahoo’s ‘Acqui-Hiring’ and Its Tax Implications. Victor Fleischer, NY Times, 2013.
Letter of Intent
Brad Feld’s “Letter of Intent” series provides several useful lessons on the M&A process. These posts were written by Feld in 2005-2006.
- Structure of a Deal.
- Form of Consideration.
- Representations, Warranties, and Indemnification.
- Confidentiality / Non-Disclosure Agreement.
- Assumption of Stock Options.
- Conditions to Close.
- Structure – Asset vs. Stock.
- Employee Matters.
Between the acquirer’s letter of intent (“LOI”) and closing the deal, there will be several weeks of due diligence. Investors will set up a data room, and you will need to upload essentially all of your corporate documents, contracts, intellectual property, etc.
Two major items a buyer will be looking for in due diligence are: (a) all of the startup’s intellectual property is properly assigned to the company and owned by the company, and (b) that the equity ownership in the cap table matches the equity ownership described in the founder, employee, and investor equity documents.
If you’ve been keeping these docs in a well-organized system, then due diligence is fairly painless. You can just transfer the docs from your current data storage system to the data room. If you haven’t been keeping good records, then due diligence is slow, painful, and expensive.
Your main deal doc (e.g., a Stock Purchase Agreement or an Asset Purchase Agreement) will include a schedule of exceptions. The main deal doc will say that everything is great and in perfect order. This is kind of a fiction. Then the schedule of exceptions will list out everything that doesn’t meet that golden standard. This schedule is the reality of your company. Hopefully the schedule of exceptions is pretty short.
Initial Public Offerings
In the last few years, IPOs have become somewhat disfavored. Going public comes with a substantial regulatory burden. Startups tend to stay private longer, and aim for an acquisition rather than an IPO. An acquisition can be just as lucrative as an IPO, and with much less headache.
What’s in an IPO? My Experiences Through Grubhub’s Offering from Start to Finish. By Mike Evans, 2015.