Startup Acquisition — Negotiating the Legal Documents
The most stressful part of any acquisition process is negotiating the main deal documents. Some of this stress can be alleviated with a better understanding of what is happening and the motivations of all involved. Some of it is inescapable and just needs to be worked through.
This is the legal stage of the deal and the time when opposing interests in the negotiations ultimately need to be reconciled.
The startup founder’s comfort in navigating this process depends almost completely on how much they trust their legal counsel and how familiar that counsel is with the acquisition process.
So, it is imperative for founders to find a good lawyer — ideally someone who has recent experience doing similar acquisitions. They are going to be expensive, but this is a necessary cost in the acquisition process. This is not the place to try to pinch pennies.
Any lawyer can look at any legal document and propose different ways of phrasing the language. The challenge is for us laypeople is that it is hard to understand if this change is important or just legal “wordsmithing.”
Unfortunately, this makes it relatively easy during this stage to get spun up over matters that just aren’t, from a practical perspective, really all that important.
The second key piece of advice I have for startup founders is to actively manage their lawyer. Remember, you are in charge of this process, and the lawyer works for you, not the other way around.
When it comes to the specifics, there is a general range of terms that are considered acceptable by the market. I mention this because it is common during this process that at some point, one of the lawyers will claim that the other side is seeking a provision that is “out of market.”
Of course, the very nature of market conditions is that they are changeable, so this is, at best, a subjective opinion. In reality, at least one of the parties will be either exaggerating or wrong.
It is important not to get bound up by these disputes. Founders should make it clear that their lawyer’s key mandate is to get the deal done. Every issue needs to be met with the questions “Is this something that we can live with?” and “How can we move forward?”
What is at stake here for the startup is the ability to get the deal actually completed. Deals do get bogged down, and progress can stall. In fact, there is an expression for it: “deal fatigue.”
If there are two ways of doing things, the reality is that the startup is going to end up doing things the way the larger company would prefer. They will have an established way of doing things, and they will want to have a level of continuity across all their deals.
That is a lot of inertia to push back against. Excessive arguing, especially over non-critical points, becomes exhausting for all parties and can bring the process to a standstill. One of the most important things is to keep the momentum going and for both sides to continue to see progress.
Once the startup has a good lawyer identified, one who clearly understands their mandate, the founders still have to deal with the issue of directly opposing interests.
The language the company lawyers will propose will appear alarmingly intractable, especially to the uninitiated.
The feeling of much of the process up to this point will have been collaborative. Compromise should abound. The startup wants price A. The company wants price B. Both parties will likely agree on price C, which is somewhere in between.
However, the legal documents will surface in black and white those situations where the startup wants one thing, and the company wants another. For some issues, there is simply no way to “meet in the middle.” A simple example could be that the startup’s team wants to remain in New York, but the company has a policy that all employees work out of the main office in San Francisco. Suggesting Chicago as a compromise is probably not an effective solution.
So how should the startup deal with these situations? Well, for a start, all the issues need to be identified and put on the table. Then the startup founders need to be sure they understand what these issues actually mean.
By this, I mean what the implications are for the team, and importantly, what the probability is that they’ll actually occur. An acquisition is not a zero-risk proposition, so understanding the relative likelihood of events occurring is key.
Then, armed with this knowledge, the founders can determine whether a given issue is something they can live with or if they need to propose an alternative. This is the point in the process where founders need to pick their battles carefully.
The company will produce the first draft of the main deal documents. These are then reviewed, and the startup’s lawyer will “redline” these documents. That is, they will propose changes or reword the clauses deemed problematic.
In turn, the company will accept, reject, or propose alternative wording for these issues and send the document back. This updating and exchange of documents will happen a number of times.
The process is set up this way to give both sides a holistic view of the requests and concessions being asked for and provide the time for both to think through and propose solutions.
Some lawyers will want to argue the points one by one. This is not an effective approach and should be resisted. Ultimately, both sides should want to progress a single negotiation, not be working on ten separate negotiations.
It is also hard to isolate some of these issues. The company will be unwilling to concede on any one point if it doesn’t know what the requests are on the others.
When it appears that you are stuck in the weeds, it is good to periodically remind both sides why they’re doing this deal and why the shared goal matters. Then, efforts can be re-focused on what is important and getting this stage of the deal completed.
Negotiating the main deal documents can be a grind, remember but it is just one transient step in a much larger process. If you find yourself getting worn down, remember the old Churchill axiom — if you find yourself going through hell — keep going!
Click here to see the previous blog in this series, intended to bring some much-needed transparency to the M&A process for startup founders.
If an acquisition is a potential exit for your company, you should check out my book — “How to stick the landing: The M&A handbook for startups.”