Terms to Negotiate in an M&A Transaction – 1984 Ventures - Founders Handbook

Acquisition Agreements in M&A Transactions

Acquisition agreements in M&A transactions are often long, complex documents. Although each deal has different issues and the treatment of those issues will depend on factors like the nature and structure of the particular transaction and the relative bargaining position of the parties, there are certain key provisions that are commonly negotiated in almost all acquisition agreements.

Although these key provisions all involve some combination of commercial and legal considerations, certain of them—such as Consideration, Earnouts, Escrow and Governance/Social Issues—tend to be more commercial in nature, whereas others—such as Purchase Price Adjustments, Representations and Warranties, Closing Conditions and Indemnification—tend to be more legal in nature.

Founder Tip: While your M&A counsel will help you navigate the legal terms, negotiating the commercial terms is often primarily the job of the founder.

Provision	Commentary
Consideration	The most common forms of consideration consist of (i) cash, (ii) promissory note(s) (i.e. debt), (iii) stock, or (iv) any combination of the foregoing. The type of consideration paid often has tax consequences for both the buyer and the seller, and thus tax advisors should be consulted. Generally speaking, sellers prefer the certainty of cash as opposed to the potential upside of stock consideration. However, in certain situations, sellers might prefer receiving stock in the buyer for tax-related reasons. This approach can help defer capital gains realization and potentially qualify the stock for QSBS (Qualified Small Business Stock) treatment provided that certain conditions are met.
Purchase Price Adjustments and Earnouts	The purchase price is either fixed at the closing or subject to adjustment thereafter once the value of the target company as of the closing is confirmed. The most common purchase price adjustment is based on the working capital of the target business, but it can be based on other metrics, such as the valuation of specific assets or the level of cash and debt. Earnouts—a mechanism in which at least part of the purchase price is payable after the closing if the target business achieves one or more certain financial or operational targets within a specified period of time—are often used when the parties cannot agree on the value of the target business. Sellers generally prefer the certainty of a fixed purchase price paid entirely at closing, but purchase price adjustments are quite common.

Provision

Commentary

Consideration

The most common forms of consideration consist of (i) cash, (ii) promissory note(s) (i.e. debt), (iii) stock, or (iv) any combination of the foregoing. The type of consideration paid often has tax consequences for both the buyer and the seller, and thus tax advisors should be consulted. Generally speaking, sellers prefer the certainty of cash as opposed to the potential upside of stock consideration. However, in certain situations, sellers might prefer receiving stock in the buyer for tax-related reasons. This approach can help defer capital gains realization and potentially qualify the stock for QSBS (Qualified Small Business Stock) treatment provided that certain conditions are met.

Purchase Price Adjustments and Earnouts

The purchase price is either fixed at the closing or subject to adjustment thereafter once the value of the target company as of the closing is confirmed. The most common purchase price adjustment is based on the working capital of the target business, but it can be based on other metrics, such as the valuation of specific assets or the level of cash and debt. Earnouts—a mechanism in which at least part of the purchase price is payable after the closing if the target business achieves one or more certain financial or operational targets within a specified period of time—are often used when the parties cannot agree on the value of the target business. Sellers generally prefer the certainty of a fixed purchase price paid entirely at closing, but purchase price adjustments are quite common.

Founder Tip: Founders should consider whether and to what extent (e.g. as an employee or consultant, and for how long) they will work for a buyer post-closing. If a founder remains involved in the business following the transaction, he or she may be more willing to entertain an earnout as part of the deal consideration because he/she will still be able to exert (at least some) influence on the results of the business, and thus on the likelihood of achieving the earnout targets. If, on the other hand, a founder wants to completely separate from the business, he/she will more likely prefer not to have an earnout and instead to receive all deal proceeds at or soon after closing.

Founder Tip: Founders should make sure to spend sufficient time closely reviewing the seller's representations and warranties with legal counsel to confirm their accuracy, as these are often the source of potential liability down the road (i.e. indemnification claims by the buyer).

Founder Tip: Founders should make sure to closely review and consider the impact of all covenants to ensure that they will be abided by, especially any of those that will affect future conduct by the founders post-closing, such as non-compete and non-solicitation obligations.