Failing to Prepare is Preparing to Fail When Selling Your Company
We know that M&A transactions often represent the end-game for companies after years of hard-work and success. In many cases, the decision to sell a company is one of the most important business events an entrepreneur will experience in his or her lifetime.
In our experience, clients are usually surprised by the all-consuming nature of M&A, and are sometimes caught off-guard when an issue surfaces during due diligence that could have been avoided or mitigated with some foresight.
Here are 5 key things that you should address before embarking to sell:
1. Clean, Scrub and Polish Your Cap Table.
If you have read our other posts, you know how seriously we take capitalization at all stages of a company’s lifecycle. The importance of maintaining a “clean” capitalization table is perhaps most acute when selling your company. The reasons for this should be obvious – buyers expect to buy 100% of the company, with no exceptions. Even the most solid potential deal can die a quick death as a result of undocumented promises for equity that emerge out of the “woodwork” once an acquisition is in process. As a result, it is critical to properly document each and every equity grant (including options), in order to present complete and organized capitalization records at the start of due diligence.
For more information on how to organize your cap table, see Startup Stock Ownership: Don’t Let Your Cap Table Become a Crap Table
2. Nail Down Your IP.
Ensuring that your intellectual property (IP) is in order is often as important as having a clean capitalization table, especially when selling technology companies. What does this mean in the context of an acquisition? First, you can expect a buyer to insist that all employees and consultants (in particular those folks that have touched the company’s IP, especially engineers) have signed proprietary information assignment agreements in favor of the company.
Please note, these agreements cover a lot more than confidentiality, and should not be (but are too often) confused with confidentiality agreements. For companies that own patents and/or patent applications, you should expect a buyer to review your patents to access their quality and to confirm that all patent filings and deadlines have been handled appropriately. For more information on protecting your company’s IP, see Protect Your Company’s IP with a PIA
3. Establish a Consensus Among Key Stakeholders.
At a minimum and as a matter of law, selling your company will require the approval of your company’s board of directors and a majority of your stockholders. In practice, however, there are often additional thresholds and requirements that must be met and the support of founders, executives and key employees can be a significant factor in whether an acquisition makes it over the finish line. This is often because a buyer will want the folks that have played a significant role in the company’s success to continue to work for the company after the closing. Even more, in some cases a buyer may be most interested in a company’s team (usually engineers, in what are sometimes called “acqui-hire” deals).
The failure to reach consensus among all key stakeholders is a common, potentially deal-threatening issue. For this reason, “drag-along” provisions, which are common in venture financings and which typically require that minority holders and other potential holdouts support a transaction provided that certain conditions are met, can be a helpful tool in an acquisition.
4. It is Never too Early to Prepare for Due Diligence.
We cannot overstate the role that due diligence plays in the success or failure of an acquisition of your company. Having said this, with some planning and a little outside help, you will not have a problem keeping your corporate house in order.
As a threshold matter, it is important to recognize the importance of making a strong first impression on your prospective buyer as due diligence commences. Just as you would not try to sell your house with a pile of dirty dishes in the sink, you should not try to sell your company without organizing and cleaning up your corporate documents. The corporate cleanup process can be very costly if you have not done a good job with the corporate housekeeping, and is certainly more expensive than proper blocking and tackling as you go. Stay on top of the corporate housekeeping and recordkeeping, so that your company is ready to move ahead quickly when the right deal presents itself.
For more information on preparing for due diligence, see Due Diligence: Is Your Startup Investor Ready? and Corporate Housekeeping – the Basics and why they Matter.
5. Learn the Process and Leverage the Term Sheet.
In our experience, sellers do not always appreciate the relative leverage that they may have prior to signing a term sheet (or Letter of Intent or “LOI”), as leverage typically shifts to the buyer once a term sheet has been executed. Sellers should strongly consider pushing for a more detailed, comprehensive letter of intent, in order to fully understand the buyer’s offer and in order to address critical issues early, and before agreeing to any exclusivity or “lock up” agreement. Obviously, achieving this goal requires leverage, which can be difficult to harness, especially when dealing with a large, experienced buyer. Sellers that can create a sense of competition at the LOI stage are best positioned to negotiate and “move the needle” on price and other terms.
For more information on leveraging the Term Sheet, please look forward to our next blog on the Sell-side M&A Term Sheet.
While each transaction is unique, selling your company is a process and much can be learned and achieved with preparation and good counsel.