We get a lot of questions from private companies asking what to expect if they were to get acquired.
The process of getting acquired is a lot like the process of finding a partner and getting married. While the details are different for each person, the overall process is usually very similar, and often not the fairy tale hook-up we dream about.
If you’re a private company thinking an acquisition might be in your future, this story is for you.
An M&A Love Story in Three Parts.
- Part I - Playing the Field
- Part II - Getting Engaged
- Part III - Tying the Knot
Today, we’ll cover Part II - Getting Engaged, even though Playing the Field is the most important step towards a successful acquisition. Like Star Wars, we’re not afraid of starting in the middle of our story.
Part II - Getting Engaged
This part of the M&A process starts with an Expression of Interest (a là dating) and ends with a signed Term Sheet (a là when your partner says YES). It should feel exhilarating. But sometimes, it feels more like negotiating a prenup. Let’s find out why.
The “Expression of Interest”
In this phase, your goal is to move the conversation from product demos and partnership discussions to a verbal commitment that the buyer is interested in acquiring your company within a certain price range.
This phase can often be awkward - like trying to find out whether your love interest wants to get engaged before actually popping the question out loud. It takes strong negotiation skills to guide a discussion towards an actual offer. If you don’t do it right, you could find yourself in a continuous loop of show and tell with the buyer.
As you work on securing an expression of interest, watch out for these three things:
1. Come to the discussion with convincing proof points of how you will help their business, rather than how they will help yours.
Companies often spend time showing potential buyers how much more they can sell through the buyer’s channel. That might be persuasive IF the buyer was already looking for a product like yours to sell to sell through its channel.
If your products are interesting but not something the buyer’s sales team has been clamoring for, then selling more of your product is less interesting to your buyer than selling more of their product. Can you show them how your business can help them sell more of their product? Now that’s a killer proof point.
2. If you have less than 9 months of runway before you run out of cash, don’t pretend everything is going great.
You should balance marketing your company with maintaining your credibility. In due diligence (discussed in Part III), the buyer will learn nearly everything about your company. If you overdo your marketing efforts in your “dating phase”, the buyer will eventually figure it out. It could be enough to break their heart – and your deal. Since everything will come out in due diligence, you are better off controlling the narrative up front.
3. If the potential buyer is a competitor, be careful about providing customer or financial data.
You’ll have to tell them your revenue numbers (otherwise they won’t be able to get to an offer) but instead of giving them detailed financials, consider giving them unit business metrics (gross margin ratios, conversion ratios, etc..). Instead of providing customer names (that you haven’t otherwise published), provide data about the % of revenue your top 5 (or 10 or …) customers contribute to total revenue.
Can you get to an expression of interest on your own? We believe that CEOs shouldn’t try to negotiate their way to an expression of interest themselves. If you have strong negotiators on your executive team, use them to negotiate with a buyer. Otherwise, consider hiring an M&A Advisor. To understand why, see our answer to this Quora post.
The Term Sheet
Once you have an Expression of Interest, you’ll begin negotiating a term sheet. A term sheet is like an outline of your prenup.
A term sheet with minimal terms normally takes a couple of weeks to negotiate. This kind of term sheet sets out the basic framework of the acquisition including how much the buyer will pay, what they are buying, and how they will pay for it. It will normally also include an exclusivity clause but it will stay away from outlining the more controversial terms of a deal.
However, there are situations where it is in your interest as a seller to have your term sheet cover more controversial terms. These terms are going to be negotiated eventually and might reduce the actual dollar amount you receive on the closing date. It’s better to know up front the real numbers you get on closing your deal. It also puts you in a better position to give your investors a realistic understanding of what they are getting on closing.
If you decide to take on these more controversial terms up front, we’ve seen term sheet negotiations continue for a month or more, so factor this timing into your overall timeline.
Here are the typical set of controversial terms we’re referring to.
- whether the Buyer will be deducting debt or liabilities of your company from its purchase price;
- if the purchase price includes shares, and the vesting terms for these shares;
- if the Buyer expects you to sign a non-compete agreement (normally yes) and if so, for how long;
- will the Buyer require a minimum number of your employees to sign offer letters before close;
- will the Buyer require some of the purchase price to be held back (normally yes) in case it determines after closing that some of your representations where inaccurate, and if so, how much of that purchase price do they want to hold back and when will they release it;
- what else could the Buyer sue you for after closing?
A great explanation of these issues is set out in this post by our legal friends.
This period of negotiating an engagement - from the time you have broached an acquisition discussion with a potential buyer to the time your term sheet is signed – can take two or more months. Be prepared to put a good amount of effort during that phase, and seriously consider lining up experienced external advisors and legal counsel to make sure you aren’t leaving money on the table.
In next week’s post, we will go back to the beginning of the M&A Love Story and discuss how to find the right partner by “Playing the Field”.