Payments behemoth Square recently announced its intention to acquire buy-now-pay-later player Afterpay
in a USD30million deal. In the ultimate buy-now-pay-later
acquisition, the terms of the all-share deal mean shareholders in Afterpay will need to wait a little longer to cash out. Square of course is publicly listed so its shares are liquid. Investors can therefore cash out in due course, subject to applicable lock in periods. But what about if a private or non-listed tech company offers to acquire your company? And instead of cash, they fully or partially offer shares as consideration? This scenario is increasingly common as even well-backed startups do not typically have large cash resources to fund acquisitions. What should sellers in these circumstances be thinking about? In this guide we unpack some key factors to consider.
who’s the buyer?
Before getting into negotiation of the key commercial and legal terms of the deal, the first question is – who is the buyer? And what are its plans? Is it already listed or looking to IPO, or even seeking a listing of the enlarged group via a SPAC process? If the answer is none of the above, then the buyer is likely to remain a private company up to an exit. Therefore your shareholders are in effect exchanging illiquid shares in the target for a smaller shareholding in a larger buyer entity, whilst losing control of the business at the same time. This means that the prospects and plans of the buyer should be key to your decision to sell. The ability to cash out via a successful exit will be dependent on the prospects of the larger combined business. And all the key strategic decisions, including whether and when to sell, will of course be made by others going forwards.
part cash / share consideration
One factor to consider is how the consideration (the purchase price) will be split between cash and shares, and whether all shareholders in the target company will receive the same deal. Your investors may prefer to cash out as part of sale of the company rather than receive shares in another private company. Part of their decision making will be based on how well they consider the prospects of the buyer. Further, if the buyer is based in a foreign jurisdiction, investors sometimes can have issues with receiving consideration shares if the buyer’s place of domicile is outside of the scope of their fund mandate.
A key aspect you need to agree at the term sheet stage is of course the valuation of the consideration shares to be issued to the sellers. This, along with the valuation of the target company being sold, determines what percentage of equity sellers will own in the buyer. If your potential buyer is a private company, this might be based on the valuation of their most recent financing, or any more recent valuation they have obtained independently. Or it might just the view of the board of the buyer. Either way, you should undertake financial due diligence and challenge this valuation where necessary. Between the timing of signing the non-binding term sheet and closing of the transaction there should be scope for the valuation to be adjusted subject to material due diligence findings. Finally, unlike with an all-cash sale, shareholders of the acquired target will be partners in the post-acquisition business and will therefore have as much interest in ensuring that there are synergies between the two businesses as the current shareholders of the buyer.
class of shares
Valuation is one thing. The class of shares that sellers receive as consideration is just as important. If the buyer has raised several rounds of venture financing, it will inevitably have a liquidation preference stack. This is important for sellers to understand early in their diligence process. The class of shares is often a key negotiation point. If you receive ordinary shares in the buyer as consideration for the sale proceeds, those ordinary shares will sit behind any preferred shares that are in issue. This is particularly relevant for your investors who may be reluctant to in effect exchange their existing preference shares for ordinary shares in the buyer.
On any M&A deal, a buyer will carry out financial, legal and commercial due diligence on the target company. In the same way, sellers will want to do the same thing on the buyer in circumstances where shares are offered as consideration. As mentioned above, this would cover the financial due diligence (to validate the buyer’s valuation). We also recommend legal due diligence on key aspects such as the buyer share structure, its governance arrangements, whether there is any debt or key liabilities, and any material contractual matters, amongst other things. For example, if there are any convertible securities which would further dilute shareholders in the buyer.
warranties from the buyer
To support any due diligence on the buyer, sellers should also insist on the buyer providing certain warranties. If the buyer fails to disclose an issue which represent a breach of warranty, sellers will want to be compensated in the same way as a buyer would be if they were in breach. Ideally these buyer warranties would be equivalent to the warranties being provided by the sellers. However sometimes buyers will only offer basic warranties around the shares to be issued as consideration. Ultimately, this is an issue for negotiation in the sale and purchase agreement.
warranties, liability and price adjustment
As with any M&A deal, your investors may be reluctant to stand behind business warranties and liability for breach of such warranties. With all-cash deals, often the liability gap between buyer expectation and sellers wanting to minimise their potential liability is resolved by way of an escrow account, from which claims can be met pro-rata from all sellers. With all-share deals, sellers are unlikely to want to reimburse a buyer for breaches in cash. To deal with this, typically some consideration shares will be held back (or escrowed
) by the buyer for a period to meet any claims, or alternatively the buyer may have an ability to claw back shares from sellers if there is determined claim (or a combination of both of these).
approval rights in the buyer
In all-share deals, sellers transition from full owners who exercise control over their business to minority owners of the combined business. In these types of acquisitions, shareholders in the selling company might end up with around 15-20% of the equity in the buyer once all the consideration shares are issued. This means that realistically, investors cannot expect to retain the kind of control in the buyer as they might have had previously in the target company. Founders of the target are the same. They might get a single board seat but will not be making material decisions. In terms of approval rights, most likely the sellers will simply be able be vote alongside all other shareholders in the buyer, but nothing much more than this.
restrictions on shares transfers
Your investors may have limited or even no restrictions on their ability to sell shares in your company. That may not be the case in respect of their shares in the buyer. Again, this requires some due diligence on the governance documents of the buyer. Practically, it is unlikely that material changes will be made to the buyer’s governance documents as this will require agreement from all its shareholders. In addition, as part of any warranty period, there may be a restriction on selling shares for some time. Selling shares to a listed buyer is very different as lock-ins period are typically required by law or under the applicable stock exchange rules. Even for private company buyers, there may be contractual restrictions on selling shares for a period.
If you are selling your company to a listed company like Square and being issued shares as consideration, it is fair to say that things are somewhat easier. As a listed company, the buyer will have a fixed valuation at any time. Financial information is publicly available which is likely to require less due diligence. Consideration shares issued by a listed buyer should be the same class as the listed shares and they will be capable of being sold easily in the market subject to any lock-in periods. For a sale to a private company, all-shares deals bring more issues to think about, and due diligence on the buyer is essential. Otherwise, it will not simply be a case of buy-now-pay-later
— the expected pay day may not come at all.