Chapter 43Term Sheet Signed, Start of a Thousand Paper Cuts
Congratulations, you have signed the term sheet and entered into an exclusive no-shop period with the potential acquirer. You exchange pleasantries with your future boss and chat about how excited the shared future looks like. Everyone is optimistic for a fast close and looking forward to working on the joint roadmap and drafting a press release. Nevertheless, I can't stress this enough, as you work with each respective party, the communication should be optimistically cautious that the deal could still potentially fall apart, and nothing is guaranteed until the money is wired to the bank. So brace yourself, this is the beginning of a thousand papercuts, and let's first look at the interactions with the key stakeholders and how to work through them in the next phase of negotiations.
1. Key Stakeholder Management
1. Cofounders
Up to this point, chances are that your relationship with your cofounders are tight knit and encouraging as you have been all aligned on getting to a term sheet and seeing the company land. However, as soon as a term sheet is produced and signed, as all the key terms are in broad brush strokes, naturally questions come up amongst founders on how to divide up the payout, what types of roles are acceptable, and personal risks such as reps & warranties or non-compete that hit one founder harder than the other. Still, it is absolutely paramount that you and your cofounders are fully aligned and work in complete harmony to close the deal as any fragmentations or acrimony spilled over to the buyer can spook them and call off the deal.
In the ideal case, the considerations clear the preference stacks by a mile, the result is a home-run outcome for the founders and early employees. The conversation becomes fairly easy between you and your cofounders. Liquidation follows through the cap table waterfall, you and your cofounders get paid accordingly. The retention at this point serves as an equalizer to incentivize those key employees who likely would cash out and leave on day 1 without enough retention rewards and those have little upside from the sale but are still critical to the integration. You and your cofounders simply need to align on who those employees are and make the recommendation to the buyer.
The conversation with your cofounders gets very difficult when the headline price does not clear or barely clears the preference stack, meaning that the common stock holders are wiped out completely, and even the investors take a loss after the lawyers and bankers get paid. The only source of any compensation from this transaction for the founders now comes from the buyer retention pool and potentially a carve-out (which I will cover in the next section) from your board if they are nice.
The cap table at this point plays virtually no role in the determination of how the retention pool is divided among founders and employees. In the eyes of the buyer, it is simply a function of the criticality of the domain knowledge of the retained employee and replacement cost. So even though a cofounder historically may have owned an outsized number of shares, if she does not serve a critical role to the integration, the buyer would not sign off on her getting the lionshare of the retention bonus. Understand that the retention allocation needs to be approved by the acquirer almost all the time. In such a case, and I am well aware that each founder may feel that her contribution is more significant than the rest, I recommend proposing an even split among the founders for the retention pool to the acquirer, where the founders receive anywhere between 50% to 80% of the total retention, and the rest of the team receives the rest 50% to 20% depending on the size of the team. Bigger the team, bigger the allocation, and vice versa, smaller the team, smaller the retention. An even split between the founders spells out an united front when negotiating with the buyers as long as the alignment is that every founder is staying for the entire duration of the retention period. This leaves nobody’s ego bruised and also indicates that every founder pulls her own weight in the acquisition.
Again, in this negotiation, understand that your biggest allies for this entire transaction are going to be your cofounders. In the same token, if anybody could destroy the deal, it would also be your cofounders. As difficult as it may be, put the needs of your cofounders as high as your own needs, compromise and come up with an outcome that everybody feels good about. Chances are, this won't be your first company together, and you will call upon your cofounders in the future.
2. Board of Directors
Before signing the term sheet, it is customary for you to send over the final redlined version to your board to approve. This is not required because the term sheet is non-binding, but it is critical to have alignment with your board throughout this process. Your board of directors likely will have your lead investors, where they have a fiduciary duty where they need to act in the best interest of the company and its shareholders. During a M&A, this means overseeing a due process of discovery and finding the best possible deal, and also ensuring that all the necessary counsel and precautions are made.
There are two sources of potential conflicts at this point with your board. Firstly, it is the allocation of considerations versus retention. In the eyes of the buyer, they would much prefer a deal where not a single cent is paid out to the investors or ex-employees on the cap table, and all the cash spent is on the team that is retained to be incentivized for a successful integration. Of course, this is a conflict of the fiduciary duty, as shareholders include investors as well as those who are no longer working at the company. Again, this is less likely an area of contention if the considerations are significantly more than the preference stack, and everyone is swimming in the upside. There could still potentially be board members who expect an outsized return on investment, and have veto rights that can potentially block the deal. In such a case, the work should have been done at the beginning to set alignment on expectations so that there are no surprises at this point. In the case where the consideration barely or does not clear the preference stack, an interesting balancing act needs to be made so that a fair deal can be done so that the investors still get some returns and the team still feel motivated to complete the deal. Imagine a scenario where the upside for the team is zero and all the money is paid out to the preferred shareholders, in this case, the founders would not sign off on the deal as the opportunity cost of joining the acquirer would be greater than just seeking employment in the job market or starting a new company. Experienced board members would instead offer a management carveout, that ranges in the 5-10% of the total proceeds the investor would receive, and offer that to the founders and key employees as extra motivation to ride out the deal. How this money is divided is largely a discretion of the founders. My advice here is similar to the last section where you treat others the way you want to be treated. Moreover, if a management carve-out is offered by your board, this information needs to be disclosed to the acquirer. The additional incentives will need to be voted by the board members, and would also affect the 280G analysis. There is also the potential issue of an escrow, where some percentage of the proceeds may be put aside to cover any unforeseen lawsuits or expenses post M&A. The size of the escrow directly affects how much distribution investors get at deal close. In the ideal case, they all want everything all at once, but the buyer may insist on having an escrow to protect the buy-side from any potential risks. This would be another area to account for and align with your board on how much money to set aside.
The second biggest piece of contention, and perhaps matters a lot more to the directors, is the cap on indemnifications and reps and warranties. When a company is sold, typically the board dissolves, and the board members want to move on with their lives. The last thing they want is an unlimited cap on indemnifications that a future lawsuit wipes out any of the upside plus some. So in such cases, your board would not sign off on any deals with these types of terms and it is critical to have your lawyers flag anything that potentially puts your board members at risk in the definitive agreement. This would also mean that you and your cofounders may have to front some of the risks personally when it comes to indemnifications as well as reps and warranties. Do not be surprised if your retention bonuses are used to backstop any future lawsuits so that your investors are off the hook from these litigations.
Aside from these two areas, typically the board members are fairly empathetic of the M&A as long as you ran a clean process and they were all informed along the way. Nevertheless, you want to make sure there is unanimous board approval on the actual deal terms. While only a majority is needed to pass a resolution, having even one board member dissent could lead to litigation risks and the buyer having low confidence that the deal can get through, in fact sometimes buyers put unanimous board approval into the closing condition to limit their exposure to such risks. Having dissenting board members could also mean that critical deal information may get leaked, or they go rogue completely and try to sabotage the deal. Hence, be sure to spend the time to meet each board member individually and understand their needs. This way you will not have any surprises when it comes time for the actual vote. Be sure to start providing weekly email updates to your board at this point and keep them informed on the latest progress leading up to close. Next let's take a look at those investors who are not on the board.
3. Outside Investors
Depending on how many outside investors you onboarded throughout the lifetime of the company, if the number is large, then most of them will not get a board seat or even an observer seat and have very little visibility in the M&A process. If you have not informed them on the potential exit, now would be the time to do so. Failure to inform them any later could cause a hold up during the actual shareholder approval process, or even lead to litigations if these outside investors feel that the board did not fulfill their fiduciary duty in finding the best possible deal for the shareholders. To approve a M&A (not a share purchase), typically as there is one vote per share, only fifty percent of the shares need to vote yes in order to approve the deal. The main thing that these investors would care about is again what the waterfall looks like with the agreed upon headline considerations. In other words, what would they get at close, cash or stocks, and how much they would get.
Typically non-board member investors behave in two distinct ways when it comes to M&A. The vast majority of institutional investors in Silicon Valley vote in the same direction as the lead investors who are typically board members, and they either led the last round of financing or owned the majority of shares outside of founders. The reason is quite simple, institutional investors are friends and share a very tight network, it’s not uncommon for partners to switch firms or start their own funds, being a naysayer in a deal when the lead investor already approved the deal could signal the dissenter as difficult to work with and hurt access to future co-investment opportunities. If you took investment from institutional investors on Sand Hill Road, chances are, the work is already done as soon as the lead investors are onboard with the transaction.
However, there is the other class of non-institutional investors who could be your family offices, internet celebrities, early advisors, rich uncles, wealthy friends who do not have large ownerships of the company but still hold preferred shares. Typically these investors do not follow the unwritten customary rules of Silicon Valley, and could be a potential holdout for the deal for a number of reasons. For one, they may not be as responsive as institutional investors, so you may not even get their signatures in time if you would like to have a fast close. And if they do have an issue with the transaction, most likely it would be because they hold unrealistic expectations on what the return multiple should be. This is where having good prior investor relations can be super helpful, where even the smallest investors are in the loop with company financials and latest strategies and initiatives. In any case, if you do find yourself in a pickle where an investor of this class is not replying to your emails, dragging their feet, or flat out belligerent with the top line deal terms, first analyze if you have the necessary votes to pass the deal. If so, then be as courteous as you can and that you will try to address any concerns that they may have, but also make it clear that this deal already has the necessary votes and that unless other major shareholders are on board, do not have expectations that what they ask for will be agreed upon by the buyer or the board. In the case that you do need their votes to approve the deal, then you will need to make sure that the demands by this rogue investor are met either by renegotiating the terms with the buyer and the board. Simultaneously, reach out to your lead investors for help to provide additional context or help mend the relationship. Sometimes having the same news delivered by a fellow investor instead of a founder is easier to swallow. In any case, given that the deal is not closing imminently, you still have time to get everybody on board, and be sure to spend the time to meet, explain and align with all your investors on the upcoming transaction. You want to make sure that everyone will sign the definitive agreement a couple months when the deal is about to close.
There is also the issue of 280G analysis down the road if you and your cofounders and key executives receive compensation or incentives from the transactions that significantly exceeds the typical pay, where the compensation package would then be put under a vote by all shareholders excluding those who would be receiving such pay packages. Guess what, this means those investors who were holding out the deal in the first place could potentially block the vote once again. A failure to pass the 280G vote means an additional 20% excise tax for all the recipients. I will talk more about 280G in a later chapter, but the point again is, be sure to be on good terms with all your shareholders as dissenters could indeed do serious damage to the deal.
4. Shareholders with Significant Ownership
There is a class of shareholders who hold common stocks that account for more than 1% of the company who are neither investors nor employees. Most likely they would be your ex-cofounders or ex-employees who have left the company. While it is unlikely that their shares could sway the shareholder vote one way or another, their vote could in fact be the deciding vote when it comes to the 280G. Ideally the deal clears the preference stack and these shareholders also have some upside and it's less likely they would turn adversarial in the vote. Still, now would be the time to do a tally from the cap table and figure out if there could be a potential issue with any of the upcoming votes, and proactively reach out to those individuals and give them the lay of the land and answer any question they may have on the upcoming potential transaction.
5. Other Shareholders on the Cap Table
No communication needs to be done to folks in this category at this point. They will find out about the deal during the final approval process.
6. Employees
As much as you would like to share the news with your employees, I would again advise you to hold off this communication until the deal becomes a certainty. Your employees do not have half the context that you have on the M&A and will not be able to stomach a failed deal as well as you do, and you do not want all your subsequent interactions with them to always be on the topic of M&A. Plus, the term sheet may even forbid you from discussing the existence of the term sheet with anyone outside of your board, officers, lawyers, bankers and accountants.
If you must, any communications that involve the potential buyer should be on a need-to-know basis and only in the context that's necessary for the due diligence. For instance, if a confirmatory due diligence needs to be done in engineering that requires key engineers to be present, have them sign an NDA and then loop them in with only what's needed for the meeting. Something along the lines of company X is looking to do some deep integration with us, and would like to run a technical review on the area that you are responsible for. That's it, no need to talk about anything else. If they ask follow up questions, simply tell them that you can't tell them much at this point.
7. Bankers
If you have the luxury of being able to afford bankers, they should have done the heavy lifting of getting the term sheet, and will help you greatly with navigating the rest of the process and get the deal to a close. However, understand that the incentives are not always aligned between you and the bankers. Your objective function is to find the best place to spend the next few years at least to work on a joint venture, grow your business together, and develop your career. This would mean potentially negotiating hard on titles, areas of responsibility, or even walking away from a deal if the vision lacks alignment. Your bankers on the other hand, are mainly driven by the financial incentives of closing the deal at the best possible headline price and retention bonus with the least amount of risk. Thus, they would also be significantly more risk-averse than you are when it comes to negotiating for terms that could potentially jeopardize the deal, not work as hard as you want them to when it comes to haggling over terms outside of retentions and considerations, and would even nudge you to take a safe deal as opposed to pressing on with an ultimatum of demands to the buyer threatening walking away if it is not met.
Luckily, the bankers we hired were not these types of nonscrupulous hustlers, but many founders aren't as fortunate. So the best thing to do here is to set clear expectations with your bankers on what you are looking for in the deal. Also understand that they are working for you, and no deal is done without you agreeing. Keep a close pulse with your point of contact from the acquirer, and don't be afraid to step in to steer your bankers even though they may still be doing the negotiations on your behalf.
8. Lawyers
Whenever a company goes through a M&A, especially when representing the sell side, the lawyers get to have a field day. Given that this is likely the last invoice that your lawyers will bill you, expect their team of partners and associates to step in and bill you hours for reviewing anything and everything with respect to the lifetime of the company. Majority of the work will be done by the acquiring counsel in terms of providing the initial draft of the definitive agreement, requests for various disclosures, as well as managing the closing process. Nevertheless, your lawyers will need to step in to redline and negotiate on the company’s behalf for any draft documents, prepare the final disclosures, and manage the close process from your end like getting board and stockholder approvals, and running the 280G analysis.
The biggest potential money drain is in preparation of the disclosures, where you should align with the buyer on a tight list of items to disclose that is material to the transaction. That could include your key customer contracts, critical intellectual properties, employment contracts, legal documents, and tax filings. Things that may not be material could include vendor contracts that are below $10,000 a year, open source software usage, or existing employee health insurance plans. Reason being, all of these documents will be read through by the lawyers on both sides, and this could easily turn into an endless discovery process where the lawyers flag random items that require further clarifications or supporting documents. Don’t let them play this game with you, each email exchange along with additional disclosure schedules they draft will be billed as hours.
Another potential money drain is overly zealous lawyers being aggressive with terms in the final agreement. While it’s helpful to have a strong and knowledgeable legal presence, you have to set the expectations on materiality with respect to only negotiating on terms that matter.
Finally here are some techniques to help you stay on budget. For one, not everything needs to go through your lawyers. Reviewing of new employment contracts from the buyer, preparations of the disclosure schedules, even negotiating of the key terms can all be done by you. The lawyers sometimes are only needed to put the final language in legal terms. At the same time, set a budget and review the billable hours on a regular basis. If at any time you feel like the lawyers are spinning the wheels and not making enough progress, bring the matter directly with the buyer, and drive alignment first and have the lawyers put it on paper.
2. Final Interviews
The buyer may require a final round of interviews with some or all of your employees before deal closing. If no team interviews have been conducted yet up to this point, then please refer back to the Key Employee Interviews chapter on how to prepare your team for the interview. If interviews and technical due diligence has already been completed, then this round of interview mainly serves the purposes of cultural fit and retention assessment. This also means that you will now need to disclose to those who are being interviewed that there is a potential offer in place for the company. Of course, manage expectations to your employees and tell them that there are still a number of big ticket items to be completed, and there is no guarantee that the deal will close even if everyone aces the interview.
The acquiring executive or HR will ask whether your employee is excited to join the acquiring company, and may implicitly get this information by asking how much they already know about the company and what they think a joint strategy would look like. Your employees may also get asked what their day-to-day function looks like, and assess how critical they are for the acquisition. Certain roles may get eliminated based on redundancies, lack of impact, and cost constraints.
It is still critical to prepare your team and potentially run mock interviews. Ideally you have a great culture and everyone is super aligned. Nevertheless, you may still have disgruntled, unmotivated, or even underqualified employees who should not be part of the interview process. It is best to terminate those relationships early on as having them strung along in the process could have catastrophic damages to the deal. Imagine what your acquirer will think if your star engineer told them in the interview that she hates working for you, or has no desire to work for the acquiring company, or has not written any code for the last year. The deal could be killed from a single bad interview.
It is rather bizarre, but some employees do start to act out-of-characterly upon finding out that the company is going through an M&A. People don't really know how to react when they are faced with the potential of either making a lot of money, or being laid off because they don't get to be retained by the acquirer. That's why it is always better to communicate this to the team when the context is clear and the decision is already made. For the employees who are in the privileged circle who you had to share the news with, then you have to spend extra effort and attention to manage their day-to-days and also ensure that you provide them ample opportunities to ask questions and talk through their concerns.
3. Confirmatory Due Diligence
At this point, the acquiring lawyers will be deep in your data room, HR combing through your past performance reviews and internal docs, accountants scrutinizing over your bank statements and budget for the last three years, and senior engineers reading through your code base. You should already have done some level of due diligence, but if not, please refer back to the chapter on Initial Due Diligence.
In addition to what was discussed in the earlier chapter, if you have weekly check-ins scheduled with your main point person from the acquiring company, expect such meetings to be effectively due diligence calls where various members of the acquirer team get looped in and ask you questions on different aspects of the business. They could be as trivial as what is a line item from your credit card balance a year ago, whether an ex-employee has returned their company equipment, or why a certain software library is used over another. Other times, the questions could be a lot trickier and require much thought and deliberations. For example, they may also ask you what is the likelihood of a major customer renewing their existing contract, for such a case, it is always prudent to be conservative and provide the worst case projections. The reason you don’t want to be overly optimistic is your retention bonus could be tied directly with projections. This would be disastrous as changes in the company direction post-acquisition could result in this revenue target no longer being a priority, and thus retention bonus that you thought you would get never being paid out. At the same time, it is also not a good idea to sandbag or cast overly pessimistic projections for future earnings. Such posturing could spook the acquirer and lead to loss in confidence for the acquisition.
As frustrating as this process is, understand that all the necessary questions need to be asked by the acquirer in order for the sponsor of the deal to fulfill her duty to her direct manager. Very often the case is that the CEO is actually the sponsor of the deal and she has a fiduciary duty to her board and shareholders that requires her to demonstrate rigorous oversight, eliminate any potential blind spots, and ensure full accountability to stakeholders. Remember, she has personally championed this deal and needs to justify it meticulously, knowing her own reputation and credibility within her organization are directly at stake. Consequently, the buyer's team might seem excessively cautious, even paranoid, as they probe for red flags and hidden risks. They're attempting to uncover anything that could later cause embarrassment, financial loss, or operational disruption. While the barrage of questions may feel exhausting or overly intrusive, it's rarely personal—rather, it's a reflection of the buyer's internal pressures and the high stakes involved. Recognizing this context can help you stay patient, transparent, and constructive during what is inherently a challenging phase of the deal process.
4. Disclosure Schedules
Providing disclosure schedules to the buyer during an M&A transaction is a nuanced task with multiple areas requiring careful attention. A critical starting point is establishing clear alignment with the buyer on which types of disclosures are truly material to the transaction. Without this clarity, legal teams may unnecessarily expand the scope, leading to bloated documentation and potentially extending the due diligence timeline. It is crucial to manage lawyer input proactively to ensure disclosures remain focused, relevant, and manageable.
Precision and honesty are paramount. Each statement in the disclosure schedules should be meticulously verified and triple-checked for accuracy. Errors, omissions, or ambiguous statements can become significant liabilities down the line, potentially triggering disputes or even litigation. Be especially cautious with detailed disclosures such as consulting agreements, employee compensation agreements, vendor contracts, and software licenses, as inaccuracies in these areas can result in substantial post-transaction issues.
Watch out for subtle "gotchas" like ensuring clarity on notice periods or first right of refusal when it comes to liquidation or change of ownership. Certain enterprise contracts give customers the right to terminate unilaterally if there is a change of ownership, or the right to put an offer in place for an acquisition. Additionally, special attention must be given to contracts needing assignment or consent from third parties, as these can often introduce unforeseen complexities.
Lastly, intellectual property and data security disclosures require particular vigilance. Explicitly highlight any dependencies on third-party datasets, models, or tools, including clarifying license terms, commercial limitations, and potential replacement costs. Similarly, gaps in formal data privacy practices—such as the absence of internal security policies or regular audits—must be transparently communicated to avoid future compliance disputes or penalties.
In sum, disciplined management of disclosure schedules—with clear buyer alignment, precise communication, and thorough review—is essential to protecting the integrity of the transaction and ensuring a smoother path toward successful completion.
5. The "Oh Crap" Moment
Proactive and explicit communication is critically important when unfavorable business developments occur during the M&A closing period. Issues such as losing key customers, significant employee departures, lawsuits, or material contract terminations can significantly affect the transaction's terms or even its viability. Rather than burying such developments within dense disclosure schedules, it is always best to communicate these developments clearly and immediately to the buyer. This openness builds trust, maintains goodwill, and can often help mitigate potential adjustments or even termination of the deal.
In my own experience at Polarr, I faced this scenario firsthand during our acquisition by Pixieset. Upon signing the term sheet, there was a closing condition stipulating that no material adverse change to our business would occur. However, about a couple months thereafter, I received termination notices not from one but two of our largest enterprise customers, OPPO and Samsung, collectively responsible for nearly a quarter of our entire revenue. This news was particularly unsettling because of the potential implications for the transaction. Fortunately, this segment was not central to our future strategy, and we had been transparent from the start that this enterprise licensing business would eventually diminish, though the timing was unexpectedly bad plus the two seemingly independent catastrophic events happened simultaneously.
Delivering this news to the Pixieset founders was extremely challenging, but my cofounder Borui and I made the conscious choice to be proactive, honest, and explicit. Alongside communicating the losses clearly, we also presented mitigation strategies. This transparency reinforced the trust we'd cultivated with Pixieset and allowed them to confidently proceed without altering the original deal terms. Despite this positive outcome, the stress of potentially jeopardizing the acquisition highlighted just how pivotal transparency can be during this sensitive period.
Honesty and proactive communication are always the best choices in such situations because they significantly reduce the buyer's perception of risk and uncertainty. Buyers naturally expect some degree of turbulence during the acquisition process, and their confidence in your integrity can often carry more weight than the immediate financial impact of negative news. In contrast, discovering hidden problems independently through diligence can severely damage the buyer's trust, possibly causing them to renegotiate terms aggressively or abandon the deal altogether. Being forthcoming not only demonstrates your good faith but also positions you as a reliable partner, laying a stronger foundation for post-acquisition collaboration and integration.