Today’s post of the day is from my partner Seth Levine (Foundry Group) and is titled Trends in M&A Deal Terms. Seth has been involved in several significant acquisitions recently, including Google’s acquisition of AdMeld and Federated Media’s acquisition of Lijit, so he’s been deep in the contemporary negotiating dynamics. He also includes a great link to an M&A deal terms report from Shareholder Representative Services.
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.
Roger Ehrenberg from IA Ventures has today’s VC post of the day titled Financing your start-up. He covers some very relevant ground talking about what he thinks are the key variables an entrepreneur should consider with regard to her financing strategy: (1) Founder objectives and mind-set; (2) Business potential; (3) and Interpersonal dynamics. As with many things in life, Roger states something that we strongly believe: “But at the end of the day, interpersonal dynamics plan a vital role in any financing plan for a business of any size.”