They are an enterprise software vendor, and it just so happens that something I've built over the past few months (with the help of my 3 partners in the project, its a 4-way split) perfectly solves a difficult problem for them. Apparently they were on the verge of acquiring another company to do the same thing, but they prefer my solution (this is why they were able to move so quickly). This, however, means that there is time pressure as they will need to cut the other company loose.
This is so out-of-the-blue that we haven't even formed a company yet around the software we've written, but we have agreed an even 4-way split.
The prospective acquirer has said that they are willing to do the deal with us as individuals, although I'm concerned about the lack of Limited Liability in that scenario.
Basically, they don't pay immediately, but the faster they pay the lower the acquisition number (ie. they get a discount for paying quickly). Its something like $6M if it takes them 3 years to pay, but down to $2M if they can pay within a year (something they said was very unlikely given their current projections, which I've asked to see).
They want me to sign an LoI within a week that will give us 45 days to finalize the deal.
How typical is this deal structure? Any gotchyas I should watch out for? Should I try to negotiate on the numbers? (ie. try to go for more than $6M)
Not to be rude, but please don't respond unless you know what you are talking about, I'm perfectly capable of uninformed speculation all by myself ;-)
More generally, you are taking on the risk of your acquirer's business (they may fail to get traction in the market, they may fail to develop their product, etc.) without getting compensated like an equity holder. This is a bad situation to be in -- entrepreneurs do all kinds of things (take VC money, incorporate rather than form partnerships, etc.) explicitly to shift risk to OTHER people. Not only are you taking on additional risk by taking the offer, but you are also not getting reimbursed appropriately for that risk.
Other issues: - You get paid more if they take longer to pay => You're going to work for a company that you hope doesn't blow up tomorrow (because you get paid more if they blow up in 4 years). => This is a dangerous spot to be in; your incentives are not aligned with theirs.
- It might be tempting to think that the acquirer could pay you with the proceeds of their next round even if their business does not take off. But $6M in short-term debt will likely scare off VCs who might fund them in their next round...
> Other issues: - You get paid more if they take longer to pay => You're going to work for a company that you hope doesn't blow up tomorrow (because you get paid more if they blow up in 4 years). => This is a dangerous spot to be in; your incentives are not aligned with theirs.
Yes, I did point it out to them. Their response was a polite version of "that's our problem".
> - It might be tempting to think that the acquirer could pay you with the proceeds of their next round even if their business does not take off. But $6M in short-term debt will likely scare off VCs who might fund them in their next round...
I think if the business doesn't take off, we get our technology back and we keep whatever they've paid us to-date. It doesn't seem like a terribly bad worst-case-scenario.
But it's not actually just their problem, because you don't get paid if they don't succeed... I'm sure you've already realized this. :)
> I think if the business doesn't take off, we get our technology back and we keep whatever they've paid us to-date. It doesn't seem like a terribly bad worst-case-scenario.
Good point. Still the opportunity cost of your time to consider (all that time you spent watching them fail, you could be spending building your own business) and your technology's shelf-life.
Also, it might be difficult to build a business around tech that failed somewhere else (even if your acquirer's failure had nothing to do with you or your tech). I don't know the specifics of your situation, but I would imagine good early hires might be wary, potential investors would be skittish, etc.
The risk to us is relatively limited though, as we get the technology back if they can't pay for it. The main risk is that we won't have made progress on it during that time, but that could have happened regardless (given it's experimental nature, we didn't really have much of an idea how we would market it).
Key consideration about venture debt: the lender (you) is basically making a bet about financing risk. If the venture (your acquirer) gets a subsequent round of VC money, they will pay you back. If they do not get another round, they will not.
Venture lenders typically don't look at their borrowers' business fundamentals too much, but they are very careful about who else is investing with them and how many rounds the venture has raised. Basically, if a new venture is (1) raising their first round and (2) backed by a big-name VC firm (Kleiner Perkins, Bessemer, etc.), the venture will almost always get another round of funding and the loan is safe. Other investors are always willing to give a KPCB-backed venture another shot. If (1) or (2) is not true, the loan is much riskier.
Other crazy idea: this is HUGE validation, go raise VC against this offer and make it a real business.
Also, if they are truly in the enterprise space and can afford to acquire companies to "solve a difficult problem for them" they should be able to pay you serious money and $2m in first 12 months should be no big deal.
Another thought, If you are really going to get in the business of giving a $6M loan over 3 years with your 3 cofounders, you should consult a lawyer about more than the LOI. The entire corporate structure needs to be designed to make sure people get paid out correctly and that taxes are accounted for.
I'm fairly sure they don't have a contract with the other company, the time pressure is that they were about to sign an LoI with them.
> At the very least I would ask them to make a substantial (500K minimum) deposit against the balance up front. If the don't have the cash to do that, I would not deal with them as they probably shouldn't be doing acquisitions.
I'm not sure, they've been open about their financial situation and I understand why they've proposed the deal structure that they have.
> Other crazy idea: this is HUGE validation, go raise VC against this offer and make it a real business.
Problem is that I've already got other projects that would be extremely difficult for me to abandon.
> Also, if they are truly in the enterprise space and can afford to acquire companies to "solve a difficult problem for them" they should be able to pay you serious money and $2m in first 12 months should be no big deal.
Like I said, I'm familiar with their finances, and that isn't an option for them.
> Another thought, If you are really going to get in the business of giving a $6M loan over 3 years with your 3 cofounders, you should consult a lawyer about more than the LOI. The entire corporate structure needs to be designed to make sure people get paid out correctly and that taxes are accounted for.
Lawyers and accountants will all get to have their say before anything is signed.
What is the financial condition of the acquiring company? Not being able to come up with a couple of million should be a red flag. What is the reputation of the company and its principals. Unfortunately, there are plenty of players willing to string you along to get your product cheap, lock you out, whatever. Dont do anything without the advice of a lawyer.
I hope I'm just being a crank but I learned these lessons from Jack Tramiel the SOB that ran Atari. Fortunately, I walked away before I got burned too badly.
I wish you the best of luck.
They have been completely open about that. They are about to close a $2.5M round, and have $10M in revenues booked for next year.
> What is the reputation of the company and its principals.
Good so far as I can tell, they seem like smart, honest guys.
> Unfortunately, there are plenty of players willing to string you along to get your product cheap, lock you out, whatever.
With this deal structure stringing us along hurts them as they have to pay more.
> Dont do anything without the advice of a lawyer.
Roger that.
if you sign a deal w/ everything "on the come" they can jack you around pretty hard.
venture backed companies _consume_ cash, they usually don't throw it off (6m extra in a few years) until later.
Only if they actually pay you in the end.
The "can't pay $2M in a year" but "can pay $6M in 3 years" seems a bit dodgy. Is it wholly dependent on the success of your product?
Do you have to work for the company as part of the deal? If you have to "earn" your earnout, the salary numbers have to make sense too.
It gives them an incentive to pay me as quickly as possible.
There is no "earn"out, but we do need to provide them with some support - but we get to charge whatever we want for this (they pass the cost on to their customers). We certainly don't have to work full-time for them, and they know we can do this (we all have other gigs).
Why don't you to ask them to borrow $5M, pay you that amount now, then let them pay off the loan over 3 years? At 12.5% interest, total payments come to about $6M for a 3 year loan term.
It's a way of shifting risk from you to them. Somehow, I doubt they'll agree; but their response may be very informative and helpful for further negotiation.
The options this deal gives them make it extremely profitable to seek outside investors to lend them 2 million for a few years.
http://www.horizonpartners.com/users/show/skory
He specializes in brokering technology deals and has done some pretty major deals involving figures well north of what you are looking at now. I bring him up only because I recalled a Mixergy interview he did:
http://mixergy.com/sandy-kory-horizon-interview/
Import thing to know at this point: your focus should now be on a separate negotiation entirely. The one you will be having with a lawyer and/or broker to help make this deal happen.
What you have right now is tremendous leverage. You have a multi-million dollar business deal on the table. And that can get you top priority with lawyers & brokers. You can leverage that not only to get appointments and your phonecalls answered promptly - but you can leverage this to offset perhaps all or most of the up front costs you would typically have to fork out to deal with these professionals. What they'll be looking for however is a significant cut % of the deal so that is what you have to think about next. The ball is in your court. Goodluck.
The thing is that I've got a termsheet on the table that doesn't look half bad. What is my RoI on engaging someone like this if they are going to take a significant portion of this deal?
My bet is you'll never see the money. Either there will be a clause hidden in the agreement that allows them to reverse the sale if their project doesn't pan out. Or they are on the brink of bankruptcy. Either way, they are structuring the deal as if they know they'll only have to pay if the project is a home run.
Don't waste your time with HN. Get a lawyer.
You have not made it clear if you really need the money? Independence is good #5 ~ http://www.paulgraham.com/fundraising.html I also see potential founder fights #17 ~ http://www.paulgraham.com/startupmistakes.html and ...
"... Shielding your optimism is nowhere more important than with deals. If your startup is doing a deal, just assume it's not going to happen. The VCs who say they're going to invest in you aren't. The company that says they're going to buy you isn't. The big customer who wants to use your system in their whole company won't. Then if things work out you can be pleasantly surprised. ..."
Good luck #7 "Dont get your hopes up" ~ http://www.paulgraham.com/startuplessons.html
Then consider, who has the power in the negotiations?
Worst case scenario, they are paying licensees for a time.
You should go into this with a take-it-or-leave-it approach and call the shots so that it's what you want, and not what they want to give you. But you'll have to get a standard position from everyone of your partners, and the only way to do that is to say NO to dealing with individuals. The reason is divide and conquer. That's another thing they'll do.
Also DO YOUR RESEARCH. Who are the buyers? Can they give you personal guarantees to pay you even if what they're doing does not work out? Who is this mysterious competitor? Why didn't you know about them when you started your project? Again good lawyers will help you out here.
So form a company, set your equity, get the best legal advice there is, and do not have multiple positions on your side when you go into negotiations. Be prepared to walk when you don't get what you want.
Actually, after seeking a lot of advice I'm starting to think of the deal differently - I'll update the story so everyone can benefit.
They might very well be covered in debts and try to acquire you to generate more revenue. In which case, you take the risk of losing your product and your revenue.
I'd ask for money up front, like 30% of the total, to see their reaction and then negociate the financing.
They aren't struggling for survival, where did you get that idea?
> In which case, you take the risk of losing your product and your revenue.
Nope, if they don't pay the agreed amount we get the product back.
> I'd ask for money up front, like 30% of the total, to see their reaction and then negociate the financing.
I might seek more up-front, but I can see why that would be tricky from their side.
After signing the LoI there is 45 days to complete the deal during which everyone will do due-diligence.
i think a better question to ask would have been: anyone know a lawyer that would be willing to discuss this with me and give me a little advise?
I'm posting it here because I was told to: http://www.reddit.com/r/startups/comments/loylh/need_advice_...
> what advice can anyone here offer without knowing the exact details of the deal, doing a little research on the company, reading the loi, etc? i seems obvious that the only route of action to take would be to talk to a lawyer (or possibly two) that can advise you.
Just because I'm asking you lot doesn't mean that I won't also seek advice elsewhere.
Do it as a "stock" sale, rather than "asset" sale. You get double taxed as an asset sale: first as corporate income, then as dividends which are taxed at zero-basis (unless you were very smart about how you paid into the company), meaning the whole thing will be taxed twice and at bad rates rather than capital gains, which are modest. This is regardless of whether you lived in ramen for the last few years building it, which is probably as you described not having yet formed a company. The buyers will probably want to do it as an asset sale, because this reduces liability; they are buying only the assets, not the entire company. If you have customers, a stock sale has them purchasing the liabilities of those customers. And, they can depreciate the assets, not stock. But, you can state that you should get a higher price under an asset sale, or at least have it in your pocket when you ask them to give something up.
Make sure you have a good lawyer. I know a great one in Seattle, contact me privately if you want his information. You need to make sure you have good contracts.
Remember, the buyer will be less motivated in a year. Excitement and possibility have a bad half life. What leverage do you have if they decide to pay late, or tell you they cannot pay you the next year? This situation is happening to me with the first of my deal. The structure of my buyout was a three year deal, with a new company formed, with one of the buyers putting in a large cash payment up front to purchase 40% of the new company, and then the other buyer buying the rest over three years. He has been perpetually late, and I am unclear if taking him to court makes sense, or waiting it out as the payments trickle in. Make sure you have clauses which indicate what happens on late payments. It sounds like this structure is there basically, not sure if you are unhappy were they to pay you $2M early. Sounds like a fine deal to me.
I would recommend getting to know your buyers and their history. In the second startup I sold they were very motivated to pay me because they did not want to scuttle a round of investments. If you have good contracts and they start waffling on payments and you know they are trying to keep their nose clean at that moment that can be an additional motivator to following through on paying you.
Always a great idea to have a second buyer. Even if you have to make them up. Said a different way, look around and see who else would want what you have, and give them an opportunity to get in on the bidding.
Good luck!
1) until the final documents are signed, don't consider any offer to be a done deal. There are many reasons for it to not happen at this stage.
2) Keep the project running as normal, and try not to get too distracted by this. You have something of value, don't jeopardize that by taking your eye off the ball.
3) As others have mentioned, get a lawyer who is experienced with these types of deals ASAP -- before discussing any more terms. Without help, you may be leaving a lot on the table, or conversely souring the deal.
My opinion, the LOI in a week is fishy. A cursory glance at your situation should be enough to scare them off such a tight timeline until you guys have your shit together regarding corporate structure and IP ownership - right now, there is all kinds of risk associated with your acquisition because there are no formal relationships between your team's members. Nothing personal, but you guys sound like a litigation clusterfuck waiting to happen. Not just for them, but for their enterprise customers as well.
The $2m now or $6m later is also suspect. Notice that you've pegged the deal at the higher figure in your title? The four of you are thinking low Fuck You money, but do you think they're really going to cough up an additional $4m when they can't raise half that? And if you are worth $6m, you can bet your ass someone will probably loan them $2m pretty damn quick.
Of course that's assuming you ever get paid at all.
Ever heard the expression, "Borrow a thousand dollars from the bank and the bank owns you. Borrow a million from the bank and you own the bank?" These guys are going to own you.
Once you have several million riding on their success, their problems become your problems - even those outside the scope of your software.
So now for the answers to your questions:
1. Screwy deal structures are not uncommon in the industry I'm in, people getting screwed is not uncommon either.
2. The biggest gotchya's are greed and an unwillingness pass on a sketchy deal. If your team and project is really worth something, this won't be the last deal you ever see in your life.
3. The starting point for negotiation should be to put all the cash in your pocket today. The reason they are "able to move so quickly" is because it won't cost them anything to try out your software - and they can probably get you guys to throw in a bunch of effort to make things work without any additional cost as well.
Take it for what it's worth and good luck.
Unless it happens sometimes (that I never heard about), get a top lawyer in acquisition deals. Make sure that they at least understand the payment plan thoroughly and you must pay them a retainer because you will need the lawyer for 3 years to ensure the company does pay every time and not try to delay it, unethical-style. I think the deal is just extra costs on both sides. Your company is taking extra risk as other posters said because the buyer may go under and you'll be SOL, retainer or not.
Straight-up acquisition means only getting the lawyer for the purchase and to get company to pay one-off. Much cheaper. I would reject the deal due to the overhead but I do not know your full situation.
Disclaimer: I am not a lawyer, or had an acquisition, accountant, etc.
1) Time pressure to have the deal happen quickly (that's not your fault)
2) 6m vs 2m is a big difference. I would be very careful. I think asking for a fixed price (and letting them worry about how quickly they can pay back their lenders) is better. Their price difference is way too fuzzy.
3) "something they said was very unlikely given their current projections" yeah... Look, then they should be fine accepting a deal of say 4.5m (or whatever), because according to their current projections, they will end up paying that amount anyway.
If they refuse, then you need to ask yourself why they are doing so (perhaps they really do expect to later buy your company for $1).
4) Get your own lawyer. Their lawyers are for their interests, not yours. Personally, the thought of not even knowing how much you are being bought for (and that it could be dramatically less based on "X reason") is very bad to me.
If the product does very well, it'd be good to have some skin in the game. If it fails to grow as much, then you have secured some upfront cash.
Email in my profile if you want to talk. Send me a phone number if so. If not, best of luck.
BTW, this sounds sketchy to me based on what little I know.
- call everyone you know to find someone experienced who can advise you through this
- get an experienced laywer to review the deal, and also talk to a good tax laywer
- tell them you need 3 weeks before signing: you need to get an LLC and your internal agreements on paper before signing something.
Nobody is as downright arogant as the asker seems to suggest he is, without wanting to be provocative.
Go ahead take the deal, ignore the advice here and don't come back for any more.
