Chapter 30The $$$ Expectation Alignment Conversation

This is what you get at the close of the deal. This could be cash, stock or a blend of the two. If the acquiring company is private, the stock offered would be illiquid until a liquidation event like IPO or a M&A. Depending on when their last fundraising event was, the valuation could be stale and you also need to discount the value against the risk of a future liquidation event. Another thing to consider is, if you have raised capital in the past, there is a liquidation preference stack that needs to be adhered to if your company is bought. The preferred would get paid first and the common stocks only get paid after the preference stack is cleared. So model out the scenarios on how much money/stock you would actually get for different considerations.

Cash is almost always preferred as considerations for a M&A. The only exception to the rule is that if the acquiring company is a high-flying startup with private stocks coveted by investors and is not available to the public market, then it may make sense to pick private stock over cash. In such a case, the acquiring company may also ask you what your preference is when it comes to stock vs cash. As for blue chip publicly-traded companies, their stock is as good as cash, with the caveat of a lock-in period typically placed after an M&A so that the stocks could not all be immediately sold. So there is a discount to be put for the valuation based on stock-price.

Sometimes depending on the balance sheet of the acquiring company, they may not have the cash balance to complete a deal, and would try to maneuver a creative financing exercise like debt financing, promissory note, or a SAFE (Simple Agreement for Future Equity) in order to convince you to take the deal. These types of financing could get rather complicated quite quickly and could be disastrous for you as the seller. If the buyer brings up these topics at this conversation unsolicitedly, it goes to show that the buyer is in fact short in cash and your alarm bells should go off and try to vet whether you are better off staying independent or left holding the bag when the deal closes.

Finally, when a deal is complete, you will need to pay the lawyers, the bankers, any outstanding debt, and invoices as well. So be sure to factor those in when modeling your payout at closing as well.

One thing to note when it comes to the buyer when it comes to M&A is that they would much rather pay all of the money to the team retained for the acquisition, than paying a single dime to others who are on the cap table but would not be working for the acquirer, like the investors or ex-employees who had exercised their shares. The logic is simple, the buyer would like to use the least amount of resources possible for this transaction, and to them, the money is better spent to motivate and incentivize those who are kept in the transaction. Of course, no investor would agree to this and the deal would not pass a board vote. On the other hand, if there is no retention and the headline purchase price consideration does not clear the preference stack, the founders and employees get nothing from this deal, and while the investors may be happy to take this deal with a small loss, this would also not pass a board vote because the founders would not agree, and the employees would not agree to work for the acquiring company. So this is where the negotiation comes into place to ensure that all the parties are taken off in the transaction, and you need to find a sweet spot between the considerations and retention that all the parties are motivated to take the deal.

The buyer would typically offer a two to four year retention bonus for the team as a way to incentivize everyone involved to stay for the integration. The difference here is that retention will be treated as ordinary income and is subject to a higher tax withholding, compared to stock purchase at closing which would be considered as capital gain as long as the stocks were exercised and held for more than a year.

There are instances that the buyer also pushes for a performance-based bonus structure, also known as earnout in the retention. This means the team would only get paid when certain sales or milestones are met. This needs to be avoided, not just because it's unfriendly to the team, but understand that market change and strategies deviate, you as the founder would never want to have your incentives tied on some target set years ago when the company already abandoned the strategy and moved to something else.

So now that we've explained what considerations and retention are, how would you answer what your expectation is? Your answer to this question is largely a function of how much leverage you have in the negotiation. While buyer will scrutinize your balance sheet, your P&L, and past fundraising history, and potentially pencil in a valuation from their analysis, understand that everything in an M&A is a negotiation, and a deal cannot be completed unless you, your cofounders and your board agree on that price. Let's take a look at how you answer the expectation question based on which scenario you are in, which dictates how much leverage you have.

Simply tell the acquirer that you have competing offers in the market and they should put their best offer forward if they would like to acquire your company. Do not disclose who else you are talking to. Also do not tell them what the best offer is until they have provided a number themselves. If you give the number too early, you may end up leaving money on the table as the buyer may be willing to offer much more or send the wrong signal that the number you give is what it takes to close the deal. Do not get into negotiations just yet at this point even if they provide you with a number, if anything, you can thank them and tell them politely that you'll discuss their proposal with the board and defer the negotiations at a later time.

Similar to the first scenario, let the acquirer know that you have a pending fundraising offer and the purchase price would be a whole lot more expensive once you sign that term sheet. Politely ask them to put the best offer forward and you'll discuss the proposal with your board. Again do not offer any numbers.

Let the acquirer know that you are excited about the opportunity of working together, but at the same time, the company is doing very well. You are completely comfortable with running the company independently and have the full support from your board and your team. The acquirer would need to put together a really strong offer in order to be considered. I would again refrain from providing a number at this point. But if they insist and press you on a headline price, use the models that you used in the past and come up with a ceiling for a purchase price that you would be comfortable with if the final sale price is half of that initial quote. So say that your absolute minimum is $10 million for the cash price at closing and $6 million for retention, then tell them that you are looking for $20 million at close and $12 million for retention. Note that once you give the numbers, the actual payout will always be less or equal to what you quoted, regardless if the company all of a sudden achieved bigger milestones or landed new customers. So definitely think carefully before providing a number.

This is the case where you have no leverage, and would take any offer out there. But that is not true. Think about how much you would get paid in the open market, and the freedom to pick and choose your next job or endeavor. You can always put a price on that. In such a case, you tell the acquirer that you are absolutely ecstatic of the opportunity working together, and would be interested in what offer they had in mind. At the same time, you would want to make sure that the offer takes care of the team and keeps everyone motivated during the integration period, and is also a good outcome to the investors. And ask them to put together the best offer. And again, if pressed on giving a number, calculate the opportunity cost for you to work for the acquiring company for two to three years, and multiply that by two, and then work that out in the considerations or retention.

Personally, I don't believe it's a good idea in this conversation to bluff and claim having offers when there are no offers or saying that you would stay independent when you have to wind-down. The acquirers are sophisticated, they will conduct more due diligence, and they will talk amongst competitors. And very rarely would a company buy another one just because they think there is competition. When deals don't work out, and often they don't anyway, you want to live to fight another day or potentially sell to the same buyer in the future when the right circumstances arise. Hence, it's better to follow through this process truthfully, not all companies find a home, and that's okay, but your reputation and integrity matter a whole lot more in the long run.