How Does the Acquisition Process Work?
/Few founders really understand the acquisition process the first time around.
And why would you? You’ve been building a business, not working in a private equity firm.
The problem is that lack of knowledge can put you at a disadvantage in what may be the most important negotiation of your life.
In our recent acquisition series, we’ve shared the knowledge our team has gained from participating in more than half a billion dollars in M&A transactions. We’ve talked about the difference between building your business for growth or for sale, how to find the right buyer, and now we’re sharing the ins and outs of the acquisition process so you’ll be prepared.
Meeting with potential acquirers
Let’s start by acknowledging that the time spent in the acquisition process can be overwhelming. “It’s like having two full-time jobs,” says Max Rice, the founder of SkyVerge. “You’re trying to keep the business running and growing during the day. And then you’re doing all this other stuff at night. I don’t think there’s any way around it being a lot of work.”
When you’re meeting with potential acquirers, you’ve already done research on each other. They’ve probably looked into your competitors. They may have already talked to some of your customers. They’re building an investment profile.
And as we talked about in recent articles, you’ve been researching acquirers to determine who’s a good fit for your company.
During the courting process, they’ll explain their investment philosophy. You might talk to founders who’ve worked with them before, who’ve been acquired by them, and maybe some that didn’t go through with a deal. You’ll be asking them questions about what it’s like to be a part of their organization or their portfolio.
It’s not uncommon to sign an NDA as discussions become a little more focused.
Typically you’ll share a little about your strategy, your financials, your team, and your market position. You may provide an organizational chart (without names) or a product roadmap.
In terms of money talk, it’s appropriate for the acquirer to make the first move. Like in any negotiation, we expect the party with the power to make the first move. So either of you may have given a general expectation (“I’m not talking to anyone for less than $50 million” or “We don’t do deals for more than $100 million”), but they’ll set their price.
Joe Spinelli, Trajectify coach and Senior Vice President of AccessDx Holdings, says, “The goal is to let the market speak, and you don’t ever want to negotiate against yourself. Your objective is to articulate why your business has value, and then see what someone arrives at as an arbiter of that value. Then you get to determine whether or not you feel that number and structure accurately compensates you.”
Spinelli acknowledges that it can be difficult to not answer if a potential acquirer asks the purchase price question outright. That’s why it can be helpful to have a trusted advisor in your corner to help work through those potentially challenging scenarios.
“It’s important for founders to realize that they’re playing a game that the person on the other side plays all day everyday,” says Spinelli. “Most founders only play it once, maybe twice, in their career. Buyers have an enormous amount of leverage and comfort that you don’t have, and especially by managing the process in ways that maximize the economic pressure on the founder. We look for opportunities to help create a more level playing field.”
The letter of intent
Acquirers that are interested in purchasing your company will send you either a term sheet or a letter of intent (LOI), which is essentially a term sheet that includes legal language.
If you’re lucky and you’ve had a successful meet and greet process with multiple acquirers, you’ll get several LOIs. That way you can compare general terms because once you get an LOI you like, you’ll want to sign it.
Typically, an LOI includes a “no-shop” clause that locks you out of discussions with anyone else during the process of due diligence.
What’s included in an LOI?
High-level terms like the enterprise value, the structure of payments, and what happens to your organization after the sale.
There are four potential financial components of any acquisition — the way payments could be structured.
The money you get upfront for doing the deal.
An earn-out. Additional value you could get if the company meets certain milestones over a specified period of time.
A roll-over. Some percentage of what the buyer is offering rolls over into shares of the acquiring company, often instead of an earn-out.
Management incentives, if you’re going to work for the acquirer.
LOIs may include other specifics, like your role in the new company, the structure for due diligence, or conditions to close the deal.
Some acquirers prefer a detailed LOI with detailed legal parameters of the deal. Others keep it very brief and include the details in the final agreement after a due diligence process. The style of the LOI is typically up to the acquirer.
These letters of intent are non-binding. You’re essentially agreeing to go through a due diligence process with the acquirer, aka if everything we’ve communicated to one another thus far turns out to be the case, we will sign a deal which reflects those terms.
That doesn’t mean there isn’t a risk or commitment when signing them. Both parties will spend money on lawyers and accountants and carve out a lot of time to go through a very intensive period of due diligence.
This is probably your last chance to negotiate what you want. The deal rarely gets richer after due diligence — they buyers may uncover risks that warrant a reduced price, so ask for all your terms now.
The due diligence process
Due diligence could last anywhere from six weeks to several months, and a good due diligence process will be invasive — perhaps slightly less so if you’re doing a corporate acquisition.
The acquirer is looking for any sort of “gotcha.” They want to know where any risks are, so they can decide if they’re getting a fair value, or if any money needs to be held back to protect them from these risks coming to fruition.
Here’s how the process works:
The acquirer will put together their team. If they’re corporate or a big private equity firm, they may have a bunch of people internally who work on these types of deals all the time. There’s a good chance they’ll pull in outside people as well.
They’ll hire one of the big accounting firms to do a quality of earnings (QOE) or a quality of revenue. The accounting firm will ingest all of your financial data and look for risks in your business model or income stream. They’ll verify that the numbers are what you say they are and give a qualitative report on what they think the major risks are.
The acquirer will provide you a due diligence checklist of anywhere from 80 to 100 items that need to be dealt with through the course of those six to twelve weeks.
They’ll set up a data room — a cloud-based system where you put all the files as you collect them. There will be multiple sections for all the areas you’d expect a deep dive: technical, product, human resources, administrative, legal, marketing, and sales.
You’ll definitely want to level up your support once you start due diligence. You’ll build a due diligence team.
Legal: If you have a corporate lawyer that’s more scrappy or a startup operation, you need to upgrade your law firm to someone with experience in M&A transactions.
Accounting: You might need to bring on a new accountant who can do something more akin to an audit or a review, as opposed to the one who’s your tax returns.
Consultation: You might use a bank or a broker or a consultant or a coach who can bring an outside-in and unemotional perspective.
Ownership: Determine who will represent the company — just you as the owner, you and a partner, you and a board member?
While you are putting a significant amount of money and resources into the process, you’re not necessarily looking for risks in the same way the buyer is. Your main concern is the solvency of the acquirer and the certainty of the funding. If the money is largely in an earn-out or rollover, will they have the ability to pay you in the future?
Deals often fall through during the due diligence process — the acquirer doesn’t want to take a certain risk, the parties can’t agree on particular terms, they decide during the process that they’re not actually a good fit for each other. You’ve spent dozens (or hundreds) of hours and perhaps $75K in professional services.
Finalizing the deal
During the due diligence process, you’re negotiating a definitive purchase agreement. That document will be anywhere from 20 to 120 pages, and it’s totally normal to iterate on the agreement a dozen times. Sometimes there are sticking points between the buyer and the seller. More often, the back and forth is between the law firms about protections — agreeing on the words that yield the best protections for both parties.
Components of the final agreement can include the purchase price and terms, representations and warranties that both parties might be making, indemnifications and other legal protections, any working capital and escrow requirements.
In addition to the purchase agreement, there may be employment agreements for executive leadership, and corporate documents for any business entity created or modified in the process.
In most cases, once the agreement is signed, the deal is done. The signing and closing are simultaneous.
Occasionally, the closing is separated from the signing if there are conditions that can’t be met until the agreement is signed. For instance, the deal might rely on a third-party partner agreeing to do business with the new entity. They can’t talk freely with that partner until the agreement is signed, so they wait to close until that condition is met.
For Adam Stokar, the founder of ClubOS, there was a 60-day closing period. “It was the longest 60 days of my life — hoping the deal wouldn't fall apart,” says Stokar. “We were worried about rocking the boat with some of our biggest customers who were required to sign off, which was concerning. But in the end, those customers said okay and my fears were unfounded.”
Once the deal is closed, the buyer and seller can announce in whatever manner they’ve decided, assuming they’re both privately held entities. Publicly-held companies are subject to certain reporting requirements.
When Rice sold to GoDaddy, they developed a detailed plan for communicating the news to their employees. “We had an all-hands meeting over Zoom the day the deal was announced and shared why we were doing this, what was going to happen, what we would do in the future together,” says Rice. “We tried to anticipate what questions people were going to have and answer them upfront. Then we had a series of one-on-one conversations with the entire team over the next two days.”
After the sale
If selling your business is the ultimate goal, it can also be the beginning of a period of challenging or unanticipated changes.
Someone described those early days to Rice as a change curve, “where you go in and there’s a lot of change happening, and it’s exciting,” he says. “And then there’s a bit of a lull and you start thinking, ‘Oh this is different. This is not what I expected.’ And then things start to get better.”
The loss of control also takes some adjustment. “You have to be okay with some of the things you can no longer change,” says Rice. “As a founder before, you had that magic wand where you could make anything different. And then once you join, you don’t have quite the same power anymore. So that’s part of the trade. And you try to go into it with that mindset.”
After Stokar sold ClubOS, he had to let go of his CFO and the head of his legal team — the people who’d helped him get to that point. The private equity firm had their own finance and legal departments. “That was tough because they didn’t really see it coming. Luckily they’re both really smart and found new things very quickly.”
Stokar saw other members of his team leave after the sale. “When you sell your company, there are going to be people that start second guessing things. As a business owner, you have to be okay with people coming and going,” he says.
In our work with sellers, we also find more often than not that the acquirer behaves slightly differently after the acquisition is done. The buyers have been selling themselves to the sellers throughout the process, and they may reveal some other intentions once the deal has been finalized.
It’s typically not an issue. At times, the change can create conflict for the founder of a recently acquired organization. Even though you might have gone in with one set of expectations, there are lots of little things that could happen that ultimately force you to make decisions contrary to what you envisioned when you first went into this.
Here’s an example from my own experience.
When CDNOW was bought, the acquirer knew we were losing money. We were a public company now being taken private. They said they were going to give us a certain period of time and the assistance of their resources to help us break even.
They gave us an aggressive target to hit, and we put together a plan. That seemed manageable except that they made the target more aggressive about six weeks down the line. And they did the same thing again six weeks later. And again.
The acquiring company had also promised corporate synergies to help with the process. One small problem — they didn’t tell that to the other business units in their corporation. I was expected to get synergies from my peer companies, but those peers didn’t have the same goals or incentives.
I got a dose of reality. I couldn’t grow the business quickly enough because I couldn’t spend more money. I couldn’t get the benefit of working with my peer companies. So I had to start cutting expenses and, ultimately, do a workforce reduction.
That wasn’t the intention when we did the deal. But that was the hand we were dealt, and I was under contract with them. I had an employment agreement, and I needed to do what the new bosses said.
Final thoughts
2,500 words into this article and we’ve only scratched the surface. There are details and variations that are too long to capture here. It’s a process that can go in many directions.
For most entrepreneurs who experience it, the acquisition process is one of the most stressful and exciting things they’ve been through. And few are fully prepared for it — not through any fault of their own.
You can’t really understand it until you’ve experienced it. That’s why our team works with entrepreneurs to provide that inside knowledge. Talk to our team about coaching you through positioning your business for sale, the search for buyers, or navigating the acquisition process.
