Bill Burnham has again a great post regarding the things startups have to pay attention to in order to avoid any problem when they will be negotiating their exit through a trade sale. Summarizing Bill’s 10 rules, and adding my own twists, I should state one thing – even if I agree with Bill, many of these points are easier said than implemented:
- Don’t take an investment from a company that could be a legitimate acquirer, and if you need to get a strategic investor involved, avoid side letters, right of first offer, etc. as much as possible
- Drag alongs are important (which essentially means that no single class of equity can block a sale)
- Limit the number of class of shares to 3, or recap to get down to 3. And if it takes more than 5 minutes to understand a cap table (who owns what) and a payout structure (who gets what, taking into account liquidation preferences, conversion prices and warrant exercises), it might be time to simplify them. The issue with that point is that there will always be someone whose interest is not to recap or simplify.
- Late stage investors can’t have it both ways: preference and protective provisions (meaning they can’t have a guaranteed return AND be able to block a sale)
- Make sure that Founders’ or susbstantial common shareholders’ termination are very “clean”
- Limit long term liabilities that an acquirer would have to negotiate their way out of (though this is easier said than done, typically on real estate of a certain size)
- An acquirer need to be able to cancel contracts or have them assigned to its name
- Don’t fall for the no shop too quickly, and push back on the quick fuse. Negotiate and clarify all deal points.
- Limit the acquirers’ access to key employees until an LOI has been signed (and that LOI includes a “no poach” clause)
- Talk about exit expectations before any investment, and on a regular basis – and make sure they are aligned.
- Don’t raise more money than you need just because you can – this will impact your exit potential because of the return expectation you will have created
On last thing: M&A discussions and negotiations tend to lead management teams to take their eyes off the ball (building the business), so only focus on approaches that are genuine and decline others (easier said than done in many cases).