Archive for the ‘Mergers and Acquisitions’ Category

AlphaTakes – Structures for a Company Sale Transaction

In this AlphaTakes video, Matt Storms discusses the most common types of deal structures for a company sale transaction.

Here are the key takeaways from this video:

  1. There are a variety of ways to structure a company sale transaction.
  2. The most common types of deal structures are an asset sale, stock sale, and merger.
  3. The most common types of merger structures are a direct merger, a forward triangular merger, and a reverse triangular merger.
  4. Making a sale transaction tax free is often complex.


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A Company Sale NDA is Different

A common misperception is that all Confidential Disclosure and Nondisclosure Agreements (NDAs) are virtually the same. In other words, many people think that it doesn’t matter whether an NDA is for a vendor, customer, employee, strategic, or potential sale transaction—a standard NDA should be sufficient. The truth is, they are and should be different. This is especially true in the company sale context.
Here are some ways that company sale NDAs can be different:

(1) Definition of confidential information

The description of what constitutes confidential information in typical NDAs does not include a number of things that a seller often wants kept confidential in the sale context—most notably, the fact that the seller is considering selling the business or that the buyer and the seller are interested in a sale transaction.

(2) Permitted use of confidential information

A general use restriction seen in “standard” NDAs is often insufficient as a limitation on use of confidential information shared in the company sale context. Moreover, if the buyer is in private equity or is another type of financial sponsor, a limitation on using the confidential information only in connection with the consideration of a potential acquisition of the seller may not be adequate. It often does not limit the disclosure of confidential information to other potential buyers as part of a “clubbing” deal, which sometimes is counter to the seller’s desire to create competition among suitors.

(3) Who the buyer can share the information with

Many NDAs typically restrict disclosure of information by the recipient to those within the recipient’s organization who “need to know” for the stated purpose. Often, in the company sale context, buyers need to also share that information with financing sources, investment bankers, transaction consultants, lawyers, and others.

(4) Non-solicitation of seller’s employees and customers

While it is uncommon to see restrictions on solicitation of a party’s employees and customers in the typical NDA, it is more common to see the matter covered in a company sale NDA as those relationships are more vulnerable in the sale context, especially if the employees and customers know that the seller is interested in selling.

(5) Antitrust requirements

If the buyer is a competitor, provisions and processes should be included that address antitrust concerns.

(6) Seller point person

It is somewhat common to see an individual within the seller’s organization designated as a point person for whom the buyer must work through to obtain confidential information. The intentional procedural bottleneck is designed to ensure that relevant people within the seller’s organization are appropriately briefed, that certain people within the seller’s organization are not contacted by the buyer, and to some extent, keep track of the confidential information that is disclosed.

(7) Seller’s form of NDA

A common issue in many commercial transactions is whose form NDA should be used. In the company sale context, however, use of the seller’s form of NDA is the norm. Also, it is more common to see the NDA in the form of a letter, countersigned by the potential buyer, rather than the standard form of two-party agreement.

Because of some of the unique issues that arise in company sale transactions, sellers should craft the form of NDA they use with those unique issues in mind and not rely on forms or templates used in other contexts.

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Letter of Intent Deal Terms for a Company Sale

Following the nondisclosure agreement, the letter of intent (LOI) is typically the first step in formalizing the company sale process when a company auction process is not involved.  The LOI stage is usually an exciting time for the seller—the seller is full of optimism, there is no deal fatigue, and the new relationship with the buyer has not yet been tested by heated discussions.

The LOI can accomplish a lot.  At a fundamental level, it establishes whether there really is a deal on key issues.  Often times, first time entrepreneurs and those who have not been through a company sale process are willing to proceed with a lengthy “no shop” or “no talk” exclusivity requirement, based only on a non-binding agreement on price.  While purchase price is obviously an important term, it by no means is the only important term.

In most deals, a seller in a company sale process has the most leverage at the LOI stage of negotiations.  The seller has not invested a lot in the deal and it’s the easiest point at which to just say “no” to a request of a buyer.  Rarely, however, do terms get better for the seller after the LOI stage.  On the flip side, buyers will typically take aggressive positions after the diligence process or on the initial draft of the purchase agreement.  They know sellers have committed a lot to the deal and at some point in the process, become committed to making the deal happen for a variety of reasons.  Often, a seller is willing to concede more at a later stage than what the seller would have been willing to do earlier.  As a result, it’s typically a good idea for a seller to get tentative agreement at the LOI stage on key terms that inevitably have to be negotiated.

From a seller’s perspective, here are some of the areas worthy of consideration of including in the LOI:

  • Deal structure, especially if the seller is looking for capital gains treatment
  • Items that affect net proceeds at closing
    • Escrow holdback amount and time period for the escrow, or a statement that there will be no escrow
    • Working capital adjustment amount or a statement that there will be none
    • Earn-out (if any) or a statement that the listed purchase price does not include one
  • Duration of the survival period of seller’s representations and warranties
  • Basket and cap for post-closing liabilities
  • Indemnification cap exclusions
  • Employment requirements of key individuals or at least which individuals or types of individuals the buyer intends to retain, post deal (e.g., 80% of software engineers)
  • Targeted closing date

Buyers will often resist some of the provisions under the guise that, “we don’t know enough information at this point, so we prefer to agree upon those terms after the diligence process.”  The same thing though could be said of the purchase price.  The reason to negotiate the points earlier is that it places the burden on the buyer to change them later.  Once a term is in the LOI, the parties usually tend to feel sort of a “moral” obligation to adhere to those terms.  Buyers frequently need a major diligence finding to justify a modification to a term contained in the LOI, even though those terms are usually nonbinding.

Including more deal points in the LOI also helps to limit surprises later that may surface, such as, “we always require sellers to have no indemnification cap for breaches of representations related to intellectual property.”  Moreover, without touching on the key deal points at an early stage, it’s hard to determine whether the parties have a basic meeting of the minds, even with the assumption that there will be no material surprises in the diligence process.

As with most other things, deciding on the appropriate amount of detail in the LOI is a balance.  On the one hand, it requires including enough detail to help ensure that there really is likely a deal, while also, from the seller’s perspective, taking advantage of the leverage that a seller typically has at the LOI stage.  On the other hand, the seller should not put too much pressure on the buyer at the formative stages in adding too much detail and unnecessarily elongating the time period of the LOI stage.  Striking the right balance is the first step in a successful sale process.

by Matt Storms | Permalink | No Comments


AlphaTakes – Determining the Size of the Stock Option Pool

In this AlphaTakes video, Meechie Pietruczak discusses calculating the number of shares in an emerging technology company’s option pool.

Here are the key takeaways from this video:

  1. Emerging technology companies usually create stock option pools to compensate and incentivize employees, directors, consultants and other independent contractors.
  2. The size of the option pool is typically calculated as a percentage of all capital stock, which is often in the range of 10 to 20%.
  3. The size of the option pool may have a significant impact on the price per share paid by an investor.

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AlphaTakes – Convertible Debt Financing Term Sheets

Convertible debt financings are a common type of bridge financing for emerging technology companies.  In this AlphaTakes video, Matt Storms discusses term sheets for convertible debt financings for an emerging technology company.  He provides a summary of the common key financial and procedural terms that are typically negotiated.

Here are the key takeaways from this video:

    (1)  The convertible debt term sheet for an emerging technology company should be relatively simple and short

    (2)  The key financial term in a convertible debt transaction is typically the size of the discount off the next round’s price or the warrant coverage amount

    (3)  The key procedural terms in a convertible debt transaction typically include the definition of a “Qualified Financing” and the ability to change the transaction documents with less than unanimous approval of the noteholders



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AlphaTakes – Liquidation Preferences

In this AlphaTakes video, Matt Storms discusses the basics concerning liquidation preferences. He provides a summary of the different types of liquidation preferences that are typically negotiated in emerging technology company transactions. He also provides a spreadsheet illustration of the effects of the different types of liquidation preferences.

Here are the key takeaways from this video:

    (1) A liquidation preference is a right to all or a portion of the assets of a company upon its sale over the rights of others

    (2) The three most common types of liquidation preferences for an emerging technology company are

    (a) non-participating preferred (most common in early stage deals)

    (b) participating preferred

    (c) participating preferred with a cap

    (3) Liquidation preferences are important


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Announcing AlphaTakes—Videos for Emerging Technology Companies

We are excited to announce that in coming weeks, we are starting a new video series called AlphaTakes. The goal of the initiative is to provide clients and others with background on the variety of recurring issues that emerging companies face through their development, from startup to sale.  Our hope is that the videos will supplement the existing articles for emerging technology companies that is already contained on our website.

Technology Company Startups

For startups, we plan to cover topics such as the incorporation process, allocating founder shares, common mistakes of startups, and calculating the stock option pool.  We have a number of other ideas as well, based on the questions we receive from entrepreneurs.

Scaling Technology Companies

For operating companies that are scaling, we plan to have videos that go over the different types of financing structures, common mistakes of software companies, the Series A Financing term sheet, liquidation preferences, and anti-dilution provisions.  As bringing on employee talent and contracting are important for scaling companies, we also plan to touch on issues related to employees and contracts.

Emerging Companies Considering Sale

For companies considering a potential sale, we plan to cover common sale transaction structures, how to prepare for a potential company sale, letters of intent, and use of investment bankers.  We also will look at some of the commonly negotiated terms in sale transactions as well as recurring issues that arise during the sale process.

If you have any suggestions on potential topics for us to cover in AlphaTakes, let us know!

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