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Hi, I’m Brad Feld, a managing director at the Foundry Group who lives in Boulder, Colorado. I invest in software and Internet companies around the US, run marathons and read a lot.

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The Joy of Registration Rights

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As Jason and I close out our Letter of Intent series, we thought we’d cover one last item that has screwed many a seller – the case where a public company acquires a private company for unregistered stock.  Some buyers will try to ignore this – a good seller should work hard up front to get agreement on what type of stock and what kind of registration rights they will be receiving. Expectation setting is key in this situation.

One thing to consider here is the non-binding nature of a “promise” to register shares. The buyer will argue that they can’t guarantee to register the shares because they don’t control the SEC. The past history of the buyer with the SEC is crucial, including knowing the current status of SEC filings, any outstanding registration statements, and any promises that the buyer has made to shareholders of other companies it has acquired.

We’ve had several unfortunate situations where we’ve been “promised” a quick registration from a buyer, only to have them drag their feet on the filing after the deal, or get the filing hung up in the SEC. In today’s SOX environment, we’ve been amazed by the poor behavior of several of the big four accounting firms who “don’t have time” to work on merger accounting questioned by the SEC, especially in situations where the accounting firm is not going to be the merged company’s auditor going forward. Be very careful here as stock isn’t tradeable until it’s registered and the 12 month automatic waiting period for unregistered stock to become registered (in the absence of a registration statement filed with the SEC) can be a long time (and a lot of volatility) to have to wait for.

While I much prefer sex (as in “The Joy of …”), sometimes I have to settle for registration rights.  With this post, Jason and I end our Letter of Intent series.  We hope you’ve enjoyed it – feel free to comment and email me additional questions to address.

Fees, Fees, and More Fees

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While watching the Sopranos tonight, I saw the magic manilla envelope stuffed with cash get passed to Tony and thought “what would a good deal be without some fees?”  Remember – it is important to make sure that the lawyers and bankers can afford their fancy sports cars. 

A letter of intent will usually be explicit about who pays for which costs and what limits exist for the seller to run up transaction costs in the merger. The transaction cost associated with an agent or banker, the legal bill, and any other seller-side costs are typically included in the transaction fee section. While it’s conceivable that the buyer will punt on worrying about who covers transaction fees, in today’s M&A world most savvy buyers are very focused on making sure the seller ends up eating these, especially if they are meaningful amounts.

Occasionally the concept of a break up fee if the deal doesn’t close, or the seller executes a deal with another buyer, comes up. This is rare in the context of private company VC-backed M&A but prevalent in the context of public company M&A deals (where one public company is acquiring another public company.) We generally fight any request of an buyer to institute a break up fee and tell the potential buyer to rely on the no shop clause instead. Most buyers of VC-backed companies are much larger and more resource rich than the seller it seeks to acquire, so it strikes us as odd why the buyer would receive a cash windfall if the deal does not close, especially since both parties will have costs incurred in the process.

No matter how you structure things, most fees end up coming out of the seller’s proceeds, so tread carefully.

The No Shop Clause

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Since it’s a Saturday morning, I thought I’d cover a topic in our Letter of Intent series that my wife Amy would never agree to. Signing a letter of intent starts a serious and expensive process – for both the buyer and seller – as you both work to consumate a deal.  As a result, you should expect that a buyer will insist on a no shop provision similar to the one that we discussed in our term sheet series.  In the case of an acquisition, no shop provisions are almost always unilateral, especially if you are dealing with an acquisitive buyer. 

As the seller you should be able to negotiate the length of time into a reasonable zone (45 to 60 days). If the buyer is asking for more than 60 days, you should push back hard as it’s never in a seller’s interest to be locked up, especially for an extended period of time.  In addition, most deals should be able to be closed within 60 days from signing of the LOI, so having a reasonable deadline forces everyone to be focused on the actual goal (e.g. closing the deal.)

Since most no shops will be unilateral – the buyer has the right but not the obligation to cancel the no shop if they decide to go forward with the deal – this time window is particularly important since the seller is likely to be tied up for the length of the no shop even if the deal doesn’t proceed. Rather than fight the no shop, we’ve found it more effective to carve out specific events – most notably financings (at the minimum financings done by the existing syndicate) to keep some pressure on the buyer.

Letter of Intent: Conditions to Close

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When you are asked “Hi – it’s been fun to date. Will you marry me?” you usually don’t expect the person asking the question to say “Oh – and it’ll only happen if my mother says it is ok.” (although I expect this happens occasionally, especially if the person asking hasn’t had enough therapy.)

Buyers are like this and will normally include certain conditions to closing in the LOI. These can be generic phrases such as “Subject to Board approval by Acquirer,” “Subject to the Company not having a material adverse change,” or “Subject to due diligence and agreement on definitive documents.” They can also be phrases that are specific to the situation of the seller such as “Subject to the Company settling outstanding copyright litigation,” or “Subject to Company liquidating its foreign subsidiaries.” We generally don’t get too concerned about this provision, because any of these “outs” are very easy to trigger should the buyer decide that they don’t want to do the deal.

Instead of worrying about whether or not the provision is part of the LOI, we tend to focus on the details of the conditions to close, as this is another data point about the attitude of the buyer. If the list of conditions is long and complex, you likely have a suitor with very particular tastes. In this case, it’s worth pushing back early on a few of these conditions to close, especially the more constraining ones, to learn about what your negotiation process is going to be like.

As the seller, you should expect that once you’ve agreed to specific conditions to close, you’ll be held to them. It’s worth aggressively addressing them early in the due diligence process so you don’t get hung up by something unexpected when you try to “liquidate a foreign subsidiary”, especially if you’ve never done this before.

Letter of Intent: Employee Matters

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As my body recovers from my recent marathon, my brain turns back to Letters of Intent. Jason and I left you hanging for a while in our Letter of Intent series – we plan to tromp to the finish line in the next few weeks.

In an effort to mix metaphors, while Jack Bauer tries to always look out for other people at CTU (except for say – in Ryan Chappelle’s case), it’s not always true that management is playing the same role in an acquisition.  In public company acquisitions, you often hear about egregious cases of senior management looking out for themselves (and their board members helping them line their pockets) at the expense of shareholders. This can also happen in acquisitions of private companies, where the buyer knows he needs the senior executives to stick around and is willing to pay something extra for it.  Of course, the opposite can happen as well, where the consideration in an acquisition is slim and the investors try to grab all the nickels for themselves, leaving management with little to nothing.

Since management’s (and the board’s) responsibility is to all shareholders, it’s important for management (and the board) to have the proper perspective on their individual circumstances in the context of the specific deal that is occurring.  Whenever I’m on the board of a company that is a seller, I prefer to defer the detailed discussion about individual compensation until after the LOI is signed and the management of the buyer and the seller have time to do diligence on each other, build a working relationship, and understand logical roles. Spending too much time up front negotiating management packages often results in a lot of very early deal fatigue, typically makes buyers uncomfortable with the motivation of the management team for the seller, and can often create a huge wedge between management and the other shareholders on the sellers side. We aren’t suggesting that management and employees “should not be taken care of appropriately” in a transaction – rather – there won’t be an opportunity to take care of folks appropriately if you don’t actually get to the transaction, and this is an area that often causes a lot of unnecessary stress if addressed too early in the negotiation.

While we don’t recommend negotiating the employment agreements too early in the process, we also don’t recommend leaving them to the very end of the process.  Many buyers do this so they can exert as much pressure as possible on the key employees of the seller – i.e. – everyone is ready to get the deal done, the only thing hanging it up is the employment agreements.  Ironically, many sellers view the situation exactly the opposite way – i.e. now that the deal is basically done, we can ask for a bunch of extra stuff from the buyer.  Neither of these positions is very effective – both usually result in unnecessary tension at the end of the deal process and occasionally create a real rift between buyer and seller post transaction.

As with most things in a negotiation (and in life), balance is important.  When it comes to employee matters, there’s nothing wrong with a solid negotiation – just make sure that it happens in the context of a deal, or you’ll likely never actually get the deal done.

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