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Opinion Articles
High-Tech & Technology -
DUN’S
100
|
2016/17
24
Opinion Article
O
.K, so a heavy hitter, whether a private
equity fund, a conglomerate or just
somebody’s rich uncle, has agreed to
pay a hefty price tag for purchasing your start-up.
Wait just one moment before signing the “no-
shop” agreement preventing you from accepting
competing offers. It is probably a good idea to
make sure that you understand the “fine print”
affecting the bottom line, being how much you
and your fellow founders or stockholders are
ultimately going to get to put in your pockets.
Here are my top five “fine print” pitfall items, in
a nutshell. I would recommend that you skim
this list on your way to your big meeting in the
Valley with potential buyers.
1. Currency:
How are you being paid? Obviously
there is a huge difference between payment in
cash and payment in shares (for example, you
can’t buy your groceries with shares). And if
you do get paid in shares, the distinction as to
whether the purchasing company is a private
company or is listed on a respectable stock ex-
change is no less crucial. Beyond tax consider-
ations, payment in shares assumes attributing
a certain valuation to the purchasing company,
and there is no guarantee that you will be able
to sell your shares at that price. You have prob-
ably heard of some of the famous cases where
the value of shares that sellers received in their
exit plummeted before the date on which those
shares could be on-sold by the sellers.
2. Earn Out:
If part of the consideration is de-
fined as an “Earn Out”, that means that it is
conditioned on the achievement of certain tech-
nological or commercial milestones following
closing of the transaction. So, for example, a
$50M price tag might include a $15M payment
at signing and a $35M payment that is condi-
tioned on achieving a certain pre-agreed sales
target. Obviously, if the sales target is not met,
the $35M (or part of it) will not become payable,
so the price ends up being $15M instead of
$50M. It is wise to keep in mind that sometimes
a bird in the hand is worth two in the bush.
3. Escrow:
This means that, at Closing, a certain
portion of the sale price is not paid to the sellers,
but is instead transferred to an escrow agent.
This sumwill remain in escrow, often for several
years, as a security for the buyer guaranteeing
the sellers’ obligation to compensate the buyer
for any breach of contractual undertakings or
inaccurate representations made to the buyer
in the transaction. Typically, this sum will be
around 10% to 15% of the sale price. So, taking
a $100M transaction as an example, a sum of
$15Mmight not be paid to the sellers at Closing.
Sellers will instead need to wait several years
after Closing to receive the sum, or rather what-
ever remains of it if claims for compensation
were brought by buyer during the intervening
period.
4. Holdback:
A holdback means that a portion
of the consideration that the founders were
supposed to receive for their shares will not be
paid at the Closing. Instead, it will be paid a few
years after closing, on condition that they have
continued to work for the company during that
period. If founders had committed to working
for the company but ended up leaving before
the relevant date, the holdback sum won’t be
paid to them and their total consideration in
the transaction will diminish accordingly.
5. Taxes, Taxes, Taxes:
You need to remember
that the tax authorities are a silent partner to any
transaction. The structure of the transaction will
play a critical role in determining the tax rate that
will ultimately apply to the sellers. For example,
if an acquisition is structured as an “Asset Pur-
chase”, this may result in the sellers paying
nearly twice as much tax as they would have to
pay were it instead structured as a “Share Pur-
chase”. Similarly, a transaction which includes
a holdback (described in 4 above) might result
in the founders being subject to a much higher
tax rate if the holdback arrangement is not care-
fully constructed to meet certain conditions. A
transaction where the consideration is paid in
the form of buyer shares might also lead to un-
necessarily high taxes for the sellers, unless
they make sure to get the necessary approvals
from the tax authorities.
The above is really just the tip of the iceberg for
each of the points. There are creative solutions
that can be considered and many complex fac-
tors that may be involved. I recommend that you
consult professionals with expertise in the field
in order to try and negotiate and formulate an in-
formed position concerning the “real” value of a
proposed transaction. The bottom line is, before
rushing to sign with the buyer who quoted the
highest price, first make sure you understand
the “fine print”.
Though the other deal may make racier news-
paper headlines, less $$$ in cash often beats
more $$$ in shares, especially if the higher
price comes with a significant indemnification
escrow or holdback, and a less efficient tax
structure which may impose a higher tax rate
on sellers.
Exit strategies – Top 5 tips to look out for in the
fine print
By Adv. Jacob (Kobi) Ben Chitrit, High-Tech Partner
Adv. Jacob (Kobi) Ben Chitrit, High-Tech Partner, Yigal Arnon & Co. Law Firm
Adv. Jacob (Kobi) Ben Chitrit,
High-Tech Partner