Mergers and Acquisitions are Back – The Impact on Emerging Companies

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Recent statistics have confirmed what many executives, lawyers and advisors have sensed for the past few quarters: mergers and acquisitions of emerging technology companies, especially those in mobile, social, analytics and security, are hot. In 2013, cumulative technology deal value closed at $99.8B, down just three percent from 2012. And while it started off as a slow year, 2013 ended strong, paving the way for what is expected to be a robust 2014.

It has long been true that a merger or acquisition is the most common path to liquidity for investors and employees of privately-held companies, but often considered second choice to the more glamorous initial public offering (IPO). But times are changing. Exiting through a merger or acquisition is a common and attractive choice for many emerging companies in the current environment for several reasons, including:

  • Many mature technology companies have been hoarding cash and are willing to pay top dollar for the right technology and/or team. For example, FaceBook has been on a buying spree with the $2B acquisition of Oculus and whopping $19B purchase of What’s App. Average deal size last year was $489M, up from $415M in 2012.
  • The venture financing market continues to be choppy, and can be especially challenging for companies that do not have institutional equity investors. As a result, remaining independent can be difficult. The Series A squeeze is still on, making it hard for companies to raise funding right at the point when many are ready to scale. These companies are excellent targets, often with well-developed products and/or teams.
  • While the IPO market has been very hot, with a substantial increase from 39 offerings in 2012 to 51 offerings in 2013, the public market for technology companies has dropped recently and is often volatile. As a result, a public offering is attractive only for a very small group of companies.

With these developments in mind, what steps should you take from day one? In general, staying focused and having a long term exit strategy in place will help you have a successful exit, and will help you grow a solid business along the way. Here are some specific issues to consider if a merger or acquisition for your company may be interesting to you, even if not your current choice:

  • Impact of Dilutive Financings. The Company should consider how the size of any additional equity financing will affect the allocation of the proceeds of a merger or acquisition. A larger financing round will give the company freedom to invest in its growth and development. However, investors in a larger financing round will receive a larger portion of the proceeds of a merger or acquisition than investors in a smaller round would. If your company is relatively confident that an exit through a merger or acquisition will soon occur, it may be in the best interests of existing investors and management to keep the next round small and minimize the dilution of existing investors and other owners. This will also simplify your fundraising efforts, saving valuable time.
  • Prepare for Due Diligence. Acquirers are only becoming more thorough and inquisitive in their due diligence investigations as time passes. If a merger or acquisition may take place in the near term, you should start working with your advisors – especially your accountants and lawyers – now so that you are well prepared for those seemingly endless rounds of inquiries. Questions answered quickly and accurately are a good thing: they will move a transaction to a conclusion quickly. Questions that are answered slowly or inaccurately, or in a way that leads to follow-up questions, are a bad thing: they will slow down a transaction, and the old adage that “time kills deals” is as true today as it ever was.
  • Intellectual Property Ownership. While it’s a part of any due diligence effort, Intellectual Property (IP) ownership is so critical to emerging companies that it deserves to be separately considered. Be sure that your company has appropriate agreements with each member of its founding team – including consultants, no matter how trivial their efforts may be or have been. The absence of the right agreements can slow down and even stop a transaction because it can prevent the company from proving that it has sole ownership of its intellectual property.
  • The Right Team. Whether your company has unique technology that’s creating a big buzz in your industry or you just have a terrific group of technical or creative people (and potentially are a target of a so-called acqui-hire), having the right team is critical. If there are any weak spots or gaps in the team that will concern potential acquirers, consider filling them before the M&A process starts.
  • Compensating the Team. Think about what the key members of the executive team will receive if there is an M&A exit. Will the vesting of their options or restricted stock accelerate in whole or in part? How much of the proceeds will go to investors in past equity financings, and how much will go to the executives and other employees? If investors will receive most or all of the proceeds from a merger or acquisition, can the company nevertheless adopt a so-called “carve-out” compensation plan so that management shares in the proceeds of the transaction? It is critical to think about these issues early, to avoid frantic and often ill-conceived plans and adjustments during the heat of an acquisition.

The return of an active merger and acquisition market is a healthy sign for everyone. If you take some time to consider and act on the suggestions outlined above, you’ll maximize your opportunity to take advantage of it.

Topics:  Emerging Growth Companies, IPO, Startups

Published In: Mergers & Acquisitions Updates, Science, Computers & Technology Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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