22.3.11

Between Rocks & Hard Places: Managing Low M&A Bids

One of the toughest situations for founder/CEOs and venture capital investors is a “good but not great” M&A offer: A bona fide proposal, but one that is below seller price expectations.

These are difficult for several reasons. The buyer is usually a strategic acquiror, who knows the target’s markets and customers quite well. They may not know the target’s full value, but think they know what it is worth, and what it will take to acquire it. Typically these are one-on-one negotiations, not multi-bidder sale processes. Information imbalances create conservative M&A bids. Conservative bids in turn can create problematic "agency conflicts."

Agency Conflict is a financial economics term for a conflict of interest between parties with different interests in the same asset (for example, different % shares in sale proceeds at different deal prices). Individual circumstances and incentives can put one party at odds with their partners. And below-expectations pricing exposes agency conflicts like nothing else.

In a typical venture-backed capital structure, management is at the bottom of the deal proceeds water-fall: That is to say, VCs usually get paid first. Depending on the terms of options imbedded in different classes of stock (preferred dividends, participation rights, vesting rights, etc.), there can be significant differences in net proceeds to the junior parties in a deal.

The graph below shows a sample transaction, illustrating how increasing (decreasing) deal proceeds get divided up between common, participating preferred and non-participating preferred.



Lower-priced deals can be very difficult negotiations. VCs have a fiduciary duty to maximize portfolio returns to their investors. Management however, has all their economic interests in the company’s common stock and options. If management proceeds are less than hoped for, the deal could be at risk. The deal may make sense overall, but not for key employee decision-makers.

Counter-Strategies for Targets: There a number of steps VC-backed companies can take. Here are two general pieces of advice.

First, before acquisition interest turns into a written bid, have appropriate management/VC discussions about key employees, market compensation and retention packages, unallocated stock/options and other issues with economic ramifications. Have some level of internal agreement (or at least shared awareness), and be in a position to manage these views early in any M&A discussions.

Second, get a 2nd bid. Work quickly to evaluate other actionable options, whether staying independent, or trying to stimulate additional buyer interest. Nothing changes negotiating leverage (and pricing) like multiple bidders.