I get asked this question many times in many different ways. Sometimes people are coy about it (“someone is expressing strategic interest – what should I do?”) other times people are clear and direct (“someone wants to acquire my company – help!”).
David Cohen, the CEO of TechStars, has encountered this many times. Before starting TechStars, he was an entrepreneur who sold his company to a public company after running it with a partner for a decade. He then started a few more companies, including one that failed and one that was acquired. Finally, he started TechStars and of the 28 companies from the first three programs (there have now been 126 companies that have gone through the program to date) 8 have been acquired. He’s also invested in a number of companies as an angel investor and I know of at least a half dozen that have been acquired.
He’s got awesome advice in a blog post titled You have acquisition interest – now what? His 10 step process is:
- Assess the acquirer
- Notify the board
- Set your number
- Engage the acquirer
- Ask for the ballpark offer
- Identify mentors
- Assess the ballpark offer
- Get to know them and answer their questions.
- Push for a term sheet
Go read the post now. It’s excellent and I plan to refer people to it often whenever this question comes up.
In today’s installment of our convertible debt series, we cover a specific case where the company is acquired before the debt converts into equity. There are a few different scenarios.
The lender gets its money back plus interest. If there is no specific language addressing this situation, this is what usually ends up happening. In this case, the convertible debt document doesn’t allow the debt to convert into anything, but at the same time mandates that upon a sale the debt must be paid off. So the lenders don’t see any of the upside on the acquisition. The potential bad news is that if the merger is an all stock deal, the company will need to find a way to find cash to pay back the loan or negotiate a way for the acquiring company to deal with the debt.
The lender gets its money back, plus interest plus a multiple of the original principle amount. In this case, the documents dictate that the company will pay back outstanding principle plus interest and then a multiple on the original investment. Usually we see 2-3x, but in later stage companies, this multiple can be even higher. Typical language follows.
Sale of the Company: If a Qualified Financing has not occurred and the Company elects to consummate a sale of the Company prior to the Maturity Date, then notwithstanding any provision of the Notes to the contrary (i) the Company will give the Investors at least five days prior written notice of the anticipated closing date of such sale of the Company and (ii) the Company will pay the holder of each Note an aggregate amount equal to _____ times the aggregate amount of principal and interest then outstanding under such Note in full satisfaction of the Company’s obligations under such Note.
Some sort of conversion does occur. In the case of an early-stage startup that hasn’t issued preferred stock yet, the debt converts into stock of the acquiring company (if it’s a stock deal) at a valuation subject to a cap. If it’s not a stock deal, then one normally sees one of the above scenarios.
With later stage companies, the investors usually structure the convertible notes to have the most flexibility. They either get a multiple payout on the debt, or get the equity upside based on the previous preferred round price. Note that if the acquisition price is low, the holders of the debt may usually opt out of conversion and demand cash payment on the notes.
While in many cases issuing convertible debt is often easier to deal with than issuing equity, the one situation where this often becomes complex is an acquisition while the debt is outstanding. Our strong advice is to address how the debt will be handled in an acquisition in the documents.