Mike Brown's date stared at him in shock as he told her he’d have to cut their evening short after only 30 minutes. She must have assumed the rendezvous had gone terribly wrong, but that wasn't it. Brown — a veteran of both Facebook and Twitter, where he built their corporate development teams — had just gotten a text message from his CEO. It turned out all of the major companies in Silicon Valley were after the hot startup his company was hungry to buy, and his CEO had just made a handshake agreement with its founders. He’d also promised that the acquisition would be done in 48 hours. Now it was up to Brown to make it happen. Fast.
In the end, his company paid up and sprinted to complete what turned out to be an incredibly strategic talent acquisition. The entrepreneurs sold their company with a terrific outcome – a solid financial return, little distraction from business as usual, and good new jobs for the team. But talent acquisitions come in many shapes and sizes. And as more large companies starve for technical star power, the rate of acqui-hires is only accelerating. One might think this would give entrepreneurs more leverage, but that isn’t always the case.
Brown – who, incidentally, ended up marrying that blind date — may be sitting on the other side of the corporate development table, but he’s uniquely qualified to offer advice to founders looking to sell and to help entrepreneurs optimize for M&A success.
The Right Approach
In a talent acquisition, someone has to fire the first shot: the company interested in what someone smaller is doing, or a startup looking for a new home. For founders, motivations run the gamut.
“It could be that the company is running out of money and needs to find somewhere for its employees to go,” says Brown. “Or sometimes a seller’s vision can be better achieved within a larger entity. You can change the world bigger, better, faster with more reach.”
He throws out the example of FriendFeed. In 2009, Facebook bought it for a widely reported sum of $47.5 million — a small amount from a VC returns perspective. “It had uniquely talented people, and Facebook recognized that,” Brown says. “They were doing fine on their own, but they knew they could make a bigger impact.”
One thing’s certain: If the startup initiates the conversation, they need to do it before they have a legitimate crisis on their hands. Brown has seen plenty of companies go hunting for a buyer after they’ve started to hemorrhage money. But this won’t land an attractive deal, especially considering that it takes two to three months — in an ideal world — for an acqui-hire to close. “You have to establish relationships with potential buyers when everything is still going well, when you don’t need help, as early as you can,” Brown says. “This is when engineer-to-engineer relationships become important. Then, if and when you need to sell, you might have an endorsement from a respected member of the buyer’s product or engineering team, which will go a long way.”
Engineers are key bridge builders in the process — but so are advisors and investors. It’s not out of line to ask your VC or others close to the company to shoot an email to a prospective buyer to warm up the lead. “There are a few bright stars in Silicon Valley, and it’s a small universe,” Brown says. “If you can work with a VC or an advisor who is one of those bright stars, you want them advocating for you."
On the flip-side, the corporate development team may reach out to a startup first, asking if they’d be interested in an acquisition. When this happens, the number one thing a founder needs to do is get clarity around the buyer’s intentions:
- Are they interested in the product or the technology at all?
- Do they want the whole team or just a few key members?
- Would the team stick together if acquired or be broken up and scattered?
Even if you’re not interested in selling, it’s critical to get answers to these questions — just for basic intelligence, Brown says. A lot of entrepreneurs assume they should say no to every offer, if only to strengthen their negotiating position. But that’s a mistake. “No one likes that sort of gamesmanship early in the process when there’s no relationship developed. Don’t say no unless you really mean it.”
As soon as a deal is initiated, everyone needs to agree on process. Brown describes it as a journey with built-in checkpoints. Speed might be important, but each side needs to show their cards in a deliberate, measured way, and in exchange for information from the other side. When this doesn’t happen, things go wrong.
“If you’re an entrepreneur, a buyer can take you on a very long journey if you’re not careful,” he says. “If you let them, they might interview your whole team, review your source code, take up all this time — and the offer might not even be good. This can be really emotionally taxing for all your stakeholders. So the better course is to be measured: make sure you only pull in your employees, investors, etc. when you really need to. And make sure that all these checkpoints are tied to getting information from the buyer.”
During this phase, an entrepreneur should be sure to get answers on price, what they or the team will be working on after the fact, who they will report to, how much freedom they’ll have to innovate, whether there is already a roadmap, and if they’ll get to define their own spec. Get these data points nailed down before exposing more members of your team to the process, Brown says. At the same time, as a seller, you need to be prepared to provide information at checkpoints too, including:
- Why is your technology special or unique?
- How does your product or team compare on a nuts and bolts level with your competitors?
- How truly unique are your team’s skills on the open market? And how many team members actually fall into this special category?
- What infrastructure have you already built that could be helpful or repurposed?
- Do you have any patents that would be impossible to get elsewhere?
“The trick is to establish a clear timeline where both sides are sharing information at defined checkpoints along the way. This is the only way each side can fairly determine if it’s worth moving forward,” Brown says. Rushing can lead to bad decisions and unequal terms. Often, Brown has seen entrepreneurs pull in all their employees only to see the deal disintegrate soon after.
“It’s a huge deal to get employees involved,” he says. “If I’m a CEO and I tell my employees that there’s a talent acquisition in the works, then they might think, ‘Oh my gosh, I might not be around in a few months. Maybe we’re out of money. I better start looking for a new gig, instead of working so hard on this project.’ It’s like your company is a snow globe and you’re shaking it up.”
This isn’t only a concern for the seller, either. A buyer doesn’t want to raise the alarm at a startup if it means a bunch of people are going to leave, complain, or neglect the technology. The main remedies for this are speed, clarity, and a conscientious approach on both sides.
You have to view information as currency you can trade to learn more. Eventually you’ll get to the point where everyone is on the same page.
On the seller’s side, this process is also the time to heat up competition — if that’s an option. Not every startup has the benefit of being a hot commodity. Even so, it’s possible to mention multiple buyers as a bargaining chip. “Having more than one credible buyer is the best way to increase deal value,” Brown says. “This is why it’s so important to already have relationships developed with companies that could become buyers — even when you’re not remotely interested in selling. That way, when you get a call from one buyer, you’re able to turn to your alternatives in relatively short order to get those processes spun up.”
Again, this is where engineer relationships are so critical. “Take advantage of these connections,” Brown says. “That way your senior engineer can call up his counterpart at a buyer, and they can go directly to the corp dev team to get things started.”
It’s a good idea to divulge other interested buyers at an early checkpoint. Just make sure you can speak with confidence. “What’s not a good idea is lying. If a seller tells a corp dev executive they have an offer from Dropbox, or something like that and it’s not true — well, corporate development is a very small world. Ruining a deal is one call away at that point. But if it’s true, and you’re in an early enough stage where you haven’t signed any NDAs, saying, ‘We’ve got a few other people interested’ is a smart strategy.”
Another lower-risk approach is to have an advisor, board member or influential engineer hint at the fact you have other buyers in the ring, Brown says. Pick someone that other people will listen to, and whose maybe been through successful sales in the past. That’s a fairly safe tactic to bring other buyers into the conversation, or even a bidding process.
The destination of this arduous journey is to get to a good term sheet, but it’s always helpful — and potentially more lucrative — to get to several term sheets at once.
Understanding the Terms
Term sheets are long and complicated. To boil it down, Brown says there are roughly five areas sellers should focus their attention: price, vesting, indemnification, earn out, and hold back. Several of these have to do with retaining employees. But the one overarching concern: taxes.
In order for an entrepreneur to truly understand what she’s getting, she needs to focus on after-tax value. And that depends on the type of deal being struck. Acqui-hires can be structured one of three ways:
- Merger: Buyer takes on all assets and liabilities, which could include debt. This requires the most work, but all the proceeds are taxed at lower capital gains rates.
- Asset Purchase: Good for the buyer because it let’s them cherry pick what they want and leave the liabilities behind. This can also be a tax friendly option if the buyer and seller can prove that the majority of assets were purchased and that they’ll keep running in some form. Then the seller can also take advantage of capital gains rates.
- Employment Release: Often seen in talent acquisitions, this means that the acquiring company is basically hiring the startup team and compensating them as employees. It’s fast and easy, but leaves sellers out in the cold paying regular tax rates.
From the seller’s perspective, a merger is preferred, but asks the most of the buyer. That’s where the other terms come in to potentially sweeten the pot.
Price can seem obvious — it’s a mix of cash and stock — but a lot of sticky questions can come with a quote. “What is the buyer saying its stock is worth? A seller needs to know what’s realistic and what’s ambitious. If the buyer is using stock and telling you its worth a million dollars, ask why they think that. Then ask yourself, do you believe them?” Brown says.
Employee retention is often built into company sticker prices. “If I’m a buyer, I could say I’ll buy your company for $1 today but offer you millions in contracts to stay on, or a meaningful salary package over the next four years,” says Brown. “The hard thing about retention is that it can cause friction between founders, investors and key employees.” With retention structures and contracts, a buyer can make sure the money goes where they want it to go — to a promising junior engineer they want to keep on, for example, instead of the office manager who technically owned 20% of the company’s equity.
On top of that, it could mean investors getting lower ROI. Brown’s advice for founders in this instance is to be upfront and honest: “Your investors had the courage to take a risk in backing you, so don’t hide things from them — be clear about what the deal says. They’ll figure it out,” he says. “In most cases, if they run a decent sized fund and have been through this before, they’ll be entrepreneur friendly. Relationships and reputation have value. Yes, I’ve seen investors block deals for more money, but ideally they’re more interested in supporting the founders.”
Vesting also plays a huge role in retention. Essentially, it dictates how much stock the seller can expect to get in the acquiring company over a certain span of time. This is where entrepreneurs have to think very carefully about their employees and what they want their own lives and careers to look like. “It could be that you don’t really want to stay at the buying company for very long, so you can make that clear, and maybe they’ll still be willing to buy you with a shorter vesting schedule. Or maybe you think the company you’re selling to is wonderful, and that you can see your self becoming a leader there.” In that case, you’d want to accept a longer vesting schedule with a bigger payout.
Indemnification is standard to most acquisition deals, but a foreign concept to many first-time founders. “Indemnification says that before someone buys your company, you’re going to tell them a bunch of stuff that could impact the value of the deal,” Brown explains. “This could include who your employees are, who your contractors are, who wrote your code, your liabilities. It’s designed to protect the buyer.” It also creates a pool of money — generally 15 to 20% of the deal price held back over a year to 18 months — to cover the buyer if something unexpected comes up, like an expensive IP lawsuit. For the seller, this is extra incentive to be transparent. Otherwise they risk having money pulled out of their deal.
Earnout is value that’s ear-marked for after a deal’s gone through, contingent on the seller delivering what was promised upfront. Contractually, the buyer can pay more or less for the company depending on what happens after the team joins. “Let’s say I own an ice cream company and I buy your snow cone company,” Brown says. “I promise to pay you $100 if you sell 1,000 snow cones in the first year. If you sell more, you get $200. If you sell less, we’ll only give you $50.” Any earnout clause is an alarm bell, in Brown’s opinion. “Things can get really messy if earn out is a significant portion of a deal’s value. Priorities change. Strategies change. Sometimes a company can shift its whole roadmap, making it impossible to deliver on what was promised, and then the earnout never gets paid.” His advice for sellers: “If this comes up, make sure the terms of the earnout are crystal clear and unlikely to change. You don’t want to end up in a dispute over this money.”
Hold back is a term used to describe specific employee retention clauses. “There are times in talent deals when the buyer really needs to keep only one or two people who were the stars of the show,” Brown says. “Hold back creates a separate cache of money in the deal that the buyer can take back if these employees leave within a short time. They’re essentially telling the seller, ‘We’ll give you $10 today, but if Johnny leaves in six months, you’ll have to give $2 back.’”
Hold back clauses can bring the disparate needs of buyers and sellers into sharp relief. “The unmotivated or uninvested seller wants a huge pile of either cash or stock on day one with no obligation and tell everyone see ya I’m going to Bermuda,” he says. “Then of course, for the typical buyer, the perfect deal would be that the seller get some value on day one but earn most of it over time to motivate employees to stay. From these two ends of the spectrum, you have to meet in the middle.”
In coming to agreeable terms, Brown has a few pieces of concrete advice for entrepreneurs:
Know who your champion is. Deals can involve any level of the company. Sometimes the seller is meeting 1:1 with the CEO. Sometimes with the CTO, VP of Engineering or head of the relevant department. If this isn’t the case, it’s a sign the seller isn’t high on the priority list.
You need a strong advocate inside the buyer, and the higher you register on their org chart, the likelier it is you can get more value for your company.
“If the CEO or other senior people want to meet you and be involved with the process, you have more negotiating leverage. Same goes for influential engineers. If one of them says they absolutely need your team to ship their product, that’s great.” One thing you shouldn’t do is go hunting for a sponsor. “If you insist on meeting with the CEO, you can probably make it happen, but it won’t make you or your company more valuable,” Brown warns.
Know your true value. “Imagine a two-by-two matrix where one axis is uniqueness of expertise and the other is the number of people with that uniqueness. The closer you are to the top right of that matrix, the more negotiating power you have as an entrepreneur in an acqui-hire situation,” Brown says. “If you’ve got only one unique guy, a buyer can probably find that elsewhere. If you have five guys, or you’ve cornered the market on a specific expertise, that makes it very difficult for a buyer to find an alternative, and you’ve got a lot more leverage.” You have to view your company realistically through this lens, and then know how to spin it to put yourself in the best position. Figure out how common the skills your team has are, make an argument for their scarcity, and use that to anchor an agreeable price point.
Know where your product stands to negotiate vesting. Most of the time, it’s unclear at the start of a deal whether it’s product or talent-focused. Buyers don’t give up that information so easily. But there are tells. Vesting, especially, depends heavily on whether a buyer values a seller’s technology or not. If it’s all about the talent, then the entrepreneurs are probably looking at longer vesting schedules of four years or more. “In this case, the buyer’s only doing the deal because they want you to look and perform like any other employee at their company,” Brown says. “This might not be what you want as a seller.” That said, If you can make an argument for how your product or technology might be useful, you could negotiate shorter vesting.
Driving Toward a Definitive Agreement & Close
Term sheets make room for negotiation, all with the objective of arriving at a definitive agreement. This is the point where one offer is selected, and light appears at the end of the tunnel. But a seller shouldn’t let down their guard just yet — deals can and often do fall through before papers get inked.
Now’s the time to step on the gas. “I strongly recommend speed for both the buyer and seller on definitive agreements. When things drag — that’s when they start to go wrong.” To make this happen, Brown recommends having all your paperwork in good order, rallying all of your stakeholders in advance, and of course, having a good lawyer. “Sometimes people will bring in an expensive New York lawyer who might not have the experience with Silicon Valley sellers. I’ve seen this cause friction. There’s a handful of Valley names that know how to get these deals done — John Bautista at Orrick, Caine Moss at Goodwin Proctor, Ted Wang at Fenwick — they can be invaluable.”
You want to have your financial statements already audited and your software licensing agreement at the ready. You also want to make sure that the term sheet you ended up with is as detailed as possible so no surprises come out during the definitive agreement process. “This is especially important if there’s a no-shop clause in the term sheet. If you’ve signed off on that and you don’t like what you’re seeing in the definitive agreement, you can’t walk away or talk to any other buyers until that no-shop expires.”
To ensure a painless process, it’s also critical to have all your advisors, investors and other stakeholders in agreement ahead of time. This is the best argument for keeping key members of this group involved in the acquisition from its very earliest stages.
The last thing you want is to be herding cats to get signatures and dealing with heavyweights with strongly different opinions. That’s the kind of thing that can jeopardize a whole deal.
There’s a level of specificity that comes with definitive agreements that forces both parties to discuss everything they haven’t before. It’s easy for one side to make inaccurate assumptions because something wasn’t spelled out in the term sheet — only to find out there’s a deal breaker buried in the details. “Termination without cause is something you see come up as a hot spot issue,” Brown says. “You’re suddenly asking questions like what happens if you fire me a year from now for no particular reason? What protection do I have that you won’t screw me over now that you’ve taken my team? A lot of founders are nervous about this particular issue.” Building in protections like that is something you see at the definitive stage that can set everyone on edge.
Then there’s customer contracts. During the term sheet phase, a seller might not have gone into specifics about its customers. Suddenly, in the definitive agreement the buyer discovers they have to continue serving customers due to prior commitments. “I’ve seen this issue almost scuttle a deal because the buyer didn’t want to put in the effort to maintain customer relationships,” Brown says. To smooth the way, sellers need to understand exactly how and when they can terminate customer relationships — and ideally bring it up during term sheet talks.
Generally speaking, the gap between definitive agreement and close is a lot less treacherous. During his career, Brown’s never seen a deal go bust at this stage. But that doesn’t mean it can’t happen. His major pointer: “The founders and corp dev executive on the deal need to get together and create a cash flow statement. The goal: define all cash ins or outs that will happen before the deal is done. Otherwise, what can happen is that the entrepreneur says, ‘Oh, we had to spend $200,000 more than we thought, sorry,’ and the buyer has to eat it. If the buyer doesn’t want to eat it, they might pull that money out of the deal. Then all the payouts to investors need to be changed, potentially blowing things up.” The upshot: get that cash flow statement in writing with everyone’s stamp of approval.
One of the last hurdles is communications strategy. Sounds simple enough, but given that a single leak can ruin a nearly done deal, it’s not to be overlooked. “The seller and buyer need to work closely together to nail down a clear plan to communicate the deal to users and customers — and coordinate their timing,” Brown says. “As a founder, you don’t want to hurt a buyer’s interests by letting the information out early. Especially if your acquisition is part of a future product announcement, they may want you to stay quiet for a while.”
Communications isn’t all about the buyer, either. There are good reasons for the seller to work hard on a strategy too. “There’s a tendency with an acqui-hire to assume the seller hasn’t been successful independently. This can be bad for the company and its people’s image. If the communications can be spun to give the seller credit for being a hot company, there’s some value in that.”
Know Your Priorities
As a seller, there are often too many people you have to explain yourself to and reassure that you haven’t wasted their time or money. To navigate these relationships, Brown recommends having a firm grip on the following:
- Finances: Look beyond the dollars and cents. Drill into terms like time-based vesting, indemnification, and what happens to everyone financially if people refuse to join the other company or if they leave early.
- Impact: If you want your vision to live on, make sure it’s part of the deal. “I’ve seen acquisitions where the founders and team were split up immediately. If you want to keep working on the same ideas, ensure your team will stay together,” Brown says.
- Clarity: Founders have to understand the intent of the buyer inside and out. “Whatever time a seller spends on financial issues, they should spend twice as much on getting clarity around what things will look like after the dust settles. Who will report to who? What will happen to the tech?
- Culture fit: Often overlooked, at everyone’s peril. “I’ve been part of acquisitions where there was some culture fit risk at the outset and it came out in challenges down the road — people not working well together, creating a tremendous number of problems,” says Brown.
Culture is a major consideration in talent acquisitions. If there’s a clash, people leave, and that negates the deal. Is the startup team willing to do things the way the buyer does things? And is the buyer willing to make room for the unique talents and cultural characteristics the seller brings with them? One thing Brown warns against is arrogance. “I’ve seen teams come in and say, ‘You bought us for a reason — because we know better than you.’ This really rubs people the wrong way. It’s true, the seller offers something different, but they should also care about what has made the buyer so successful, and what aspects of the culture they can adopt to be part of that success.”
When it comes to attitude, how a seller negotiates can be very telling. “Occasionally you see selling founders who are clearly thinking, ‘How little time can I spend at your company before I can get the hell out and start my next thing?’ They just want to dump their company for the money,” Brown says. “A buyer is going to be looking at the negotiation process for insight into your motivations, and this will change how they think about you.”
As a coach to an entrepreneur, I’d say fight hard for what you believe in. Don’t sacrifice things that are important to you and your values.
Seller Mistakes & Hacks
No matter how seasoned an entrepreneur or founding team might be, mistakes get made. In Brown’s experience, these are some of the worst:
Not sharing enough. “If you’re trying to get bought, don’t be hyper paranoid and withhold information. It makes it almost impossible to figure out if there’s a good fit,” says Brown. “Sometimes you see sellers who say, ‘We can’t tell you that’ about everything. Even when you ask them about the people who work at their company, they won’t tell you because they’re afraid you’ll poach them — which is very unlikely.” In short, while it’s important to be deliberate and share information at appropriate checkpoints, it is possible to be too careful.
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Being a house divided.“A seller not being united in what it wants is a difficult situation. Sometimes investors have their own agendas, or the founders each have different goals. As a buyer, you find yourself negotiating with a multi-headed monster. Even if you have a wonderful rapport with the entrepreneur, you could have a rogue investor or board member out there complicating things.” You want to make sure you’re communicating with one voice, especially when lawyers get involved. If there’s too many people on the seller’s side of the table, it’s a really bad sign.
Retaining a banker. “For small companies, this is rarely useful — especially if you have a strong set of investors or advisors around you, ones who have been through the process before. They know what’s appropriate and what’s standard.” On top of that, a banker’s role is often to package a company as an appealing buy. This doesn’t make sense for a talent acquisition when direct relationships are the deciding factor. “Retaining a banker could look like you’re putting lipstick on something that shouldn’t need it,” Brown says. “Bankers can dress up the technology or the size of your market, but those things don’t really resonate with buyers looking for talent.”
So what can you do to give yourself the best shot?
Clear communication. Both buyer and seller should know how the deal is supposed to progress and what stage they are at. They should know how the other party is feeling, and what they can reasonably expect going forward. As a seller, you want to be responsive, courteous, direct. And involve your communications team or representatives early to fend off speculation or leaks that could kill a deal prematurely. “Remember, a lot of this stuff is press-worthy,” Brown says. “You want to control how you share information on all sides. Always know what you absolutely shouldn’t share.”
Set expectations early. Besides figuring our who your sponsor is within a buyer — and how high up they are on the totem pole — setting expectations is a good way to find out if a buyer is serious or simply kicking the tires. “As soon as you initiate a conversation about selling, ask the buyer what their typical process is like, or how they plan to approach the deal in phases. If they don’t have a plan, that’s a red flag.”
Don’t be afraid to walk. You can’t fake it either. “I once worked with a seller who was really headstrong and believed in his company’s worth,” Brown says. “We wanted the product and offered a price we thought was fair. But it wasn’t what he wanted, and he walked. He walked and I respected him for it — I thought it was cool. We ended up going back to him and he got what he asked for. Anchoring at a price you believe in and knowing it may not work out is a big part of getting what you want.”
And it’s not all about the money. “I worked on one acquisition where we had to fight over a startup bringing its pool table with them,” Brown recounts. “It was a big piece of their culture — all of their engineers would talk through their toughest problems over pool, apparently.” The corporate development team balked, and it ended up threatening the deal. “There are things about every company that you just have to know are core and deserve respect.”
The pool table was heavy to move, but worth it.