Early-Stage Acquisitions – Common Elements

With an increasing search for talent and ideas, some early-stage start-ups are faced with a happy problem – acquisition interest from large companies. In our first segment we previewed some considerations for founders before embarking on the road to a sale process. We will now review some of the common elements in early stage acquisitions.

The Process. Similar to many financing deals, early negotiations in a sale context will lead to a “term sheet”, a statement of key economic and other deal terms such as price, timing of payments, indemnification, escrow, the percentage of stockholders that will need to approve the sale, and non-competition provisions. Most provisions of a term sheet (with the typical exceptions of exclusivity and confidentiality provisions) are non-binding. The final, definitive agreements will include additional terms and refinements of the core understandings, but as a general matter, the parties will adhere to the terms in the term sheet where applicable.

After a term sheet has been signed, the attorneys will prepare and negotiate the deal documents: the acquisition agreement, offer letters and non-competition agreements (if any) and other related ancillary agreements. The parties will sign the agreements after finalization and obtaining the appropriate corporate approvals from their board of directors and shareholders, as applicable. There may be a period of time between signing and closing to obtain shareholder or other required consents (including antitrust or other governmental approvals). At or shortly following closing, the startup shareholders will be paid at least a portion of their consideration.

The Consideration. Many deals at this early stage are talent acquisitions and the consideration is paid accordingly. A certain portion of the total proceeds will be paid for acquiring the assets or stock of the startup and another portion will be paid to key persons for joining the buyer as employees or consultants. The former payments may be held in escrow or subject to a holdback for a period of time for any indemnity claims that the buyer may have, and they may also be subject to earnout milestones. The latter payments may be subject to vesting or performance-based metrics.

The Key Documents

The Acquisition Agreement. The acquisition may take one of many structures such as a direct stock sale, merger or asset sale.  The acquisition or merger agreement is comprehensive and will include, among others, payment provisions, representations and warranties of the startup and other deal parties, additional agreements and actions to be taken both pre and post-closing, indemnity provisions, filings and closing conditions. The acquisition or merger agreement will include disclosure schedules, where the startup will disclose certain matters relating to, for example, its structure, agreements, operations, business and compliance with laws.

Offer Letters. The buyer typically identifies key persons at the startup and will ask that they join the buyer as a condition to and as part of the transaction. The terms of employment will be set forth in employment agreements or offer letters, and may include signing bonuses, performance bonuses, new equity grants in the buyer, and other compensation terms. In some deals, a specified number (or all) of the key persons will have to remain employed by the buyer for a certain period of time before some or all additional consideration is paid.

Non-Competition Agreements. Buyers may require certain key persons, and in an asset sale also the startup itself, to enter into non-competition agreements for certain periods as a condition to the acquisition of the startup. Non-competition agreements entered into in connection with the sale of the goodwill of a business by someone owning a substantial ownership interest are generally enforceable in California (and in states like Massachusetts, New York and Virginia, where such agreements also may be enforceable in other contexts). This is one of the limited statutory exceptions to the general rule that non-competition agreements are not enforceable in California.  In light of the unusual nuances and restrictions in this area (particularly under California law), it is advisable to contact an employment law specialist in connection with drafting or reviewing such non-competition agreements.

Dan Green participated in writing this post.

This post on M & A was authored by Maya Blumenfeld.

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