Posts from Letter of intent

M&A Issues: Breakup Fees

Continuing our discussion of M&A Issues, we are going to talk about breakup fees today.

A breakup fee is a payment made by the buyer to the seller if the M&A transaction doesn't close.

Many M&A transactions do not include breakup fees, particularly smaller transactions. But as the value of the transaction rises and the potential disruption to the seller's business increases, it is more likely that the transaction will include a breakup fee. The negotiation of the breakup fee can be an important part of the letter of intent (LOI) negotiation and there are cases where merger deals have not happened because both parties could not agree on a breakup fee.

As a buyer, you want to avoid and/or limit the size of breakup fees as much as you can. And you want to be very specific about the circumstances in which you would pay them. You can and should carve out as many reasons for a deal falling apart from the breakup fee as you can.

As a seller, you want to include a breakup fee in the LOI for a bunch of reasons. First and foremost, it is a good way to make sure the buyer is serious about the transaction. It is a lot like a down payment in a contract to purchase a home. It forces the buyer to signal the seriousness of their interest.

In addition, the merger transaction can be very distracting for the seller and the seller's management team. If the selling company goes through a prolonged M&A transaction and then the deal does not close, there can be significant negative impact to the business and the breakup fee is a way to get protected from that negative impact. However, a one time cash payment is rarely the solution to the problems that result from such a situation.

When you are selling your company, ask your lawyer right up front about the appropriateness of a breakup fee. He or she will tell you whether it is typical in your kind of transaction. The smaller and quicker the transaction, the less appropriate it is.

But don't just listen to your lawyer. Decide in your gut whether the seller is serious about the deal or not. And try to anticipate how disruptive the transaction will be to your business. If you have any qualms about the seller's intentions or the disruption that will ensue, ask for a breakup fee. And if the buyer is unwilling to include one, think hard about whether you want to do the transaction.

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M&A Case Studies: WhatCounts Sale Process

Last week we got a primer on the WhatCounts story and events leading up to the decision to sell the company. This week we are going to hear what a sale process looks like.

There are a bunch of great lessons that come out of this story but my two favorites are doing your diligence on the buyer and only doing a deal with someone you have shared values with and getting the deal worked out in the LOI stage. I see so many people make mistakes in these two areas.

As we did last week David Geller and I will be in the comments responding to questions and comments.


Last week I shared with you some of the history of WhatCounts, the company I started almost ten years ago that was recently acquired. The focus was that Brian Ratzliff, my cofounder, and I had self-funded the business. We didn’t refuse VC funding. We simply didn’t pursue it with vigor at any time during our tenure running the company.

Today’s post isn’t about the merits of self-funding or when it’s appropriate or wise to seek VC. Instead, it’s to share the experience we went through in selling the company. It’s a story I would have enjoyed reading myself had it been written just six months ago.

Just to set expectations properly, I’m not going to share financial details about the transaction. I’m bound by an agreement that prevents me from disclosing specific details. My company was engaged in a very competitive market with strong, well-financed players. It would be foolish for me to give our competitors additional ammunition.

Negotiating our deal started in June and ended in December. It took a month to negotiate the letter of intent (LOI) with the rest of the time devoted to performing due diligence and, eventually, negotiating the stock purchase agreement (SPA). The total cost of carrying out the deal was many hundreds of thousands of dollars. Some of that went to pay legal bills, some of it went to fees associated with our M&A firm, some went to paying bonuses tied to the deal.

Let’s roll the clock back to June. That’s when we received a call from a company named The Mansell Group asking if we would be interested in selling our business. It turns out that we were actually already considering selling our company. The economy appeared to be recovering and the M&A market was rebounding.

We had developed a relationship with The Corum Group, a Seattle M&A firm, and were planning to pursue all the steps necessary to sell WhatCounts. The process can take anywhere from a few months (rare) to as many as 8-12 months or even longer depending upon the size and complexity of the deal.

We were preparing for a long and complex process of attracting buyers for our company when one of them, The Mansell Group of Atlanta, initiated a call to us. At first our position was one of pragmatism. We would continue working toward finding one or more potential acquirers while, at the same time, continuing to nurture the opportunity that had turned up from Mansell.

After our initial call with The Mansell Group we gave a status report to Corum. This was a little strange because, certainly in the beginning of an acquisition process, the M&A firm generally provides updates to the seller. Here we were, essentially, driving the process with one particular, potential buyer.

The rest of June was spent running the business in a normal manner. It included preparing for an important customer summit planned for August and working with our M&A firm.

It is not uncommon for a company being acquired to go through a full financial audit. While these can certainly be conducted by one of the big accounting firms, we thought a regional accounting firm might serve our needs just as well and be less expensive. A full financial audit for a small company might run $35-50K using a mid-size regional firm. Expect to pay more with a big name firm. To a great degree, though, the timing of the audit, whether it is done before or after you begin looking for an acquirer, or even done at all, depends on your circumstances.

As I noted in last week’s article, our company was tightly controlled and profitable. The beauty of running a business in this manner is that when it comes time to have discussions with a potential buyer it is very easy to answer their financial questions quickly and precisely. Additionally, when it comes times to consider whether you actually need an audit you can conduct frank conversations with your M&A firm and potential acquirer and seek their opinion. If your business is like ours everyone might agree that the expense and time required for an audit isn’t necessary.

In mid-June we received a follow-up to that first phone call. The investment committee from Riverside Capital, the PE firm working closely with The Mansell Group, had approved plans to buy our company. New meetings were arranged and our first in-person event would take place when they agreed to visit our office the beginning of July.

Of course we were still working with our M&A firm to ferret out other, potential acquirers. We had not yet received a letter of intent (LOI) from Mansell. There was interest, but nothing concrete. So, logic dictated that we keep on with our original plan. Run the business but continue seeking other acquirers. The challenge we were facing in reaching out to other potential buyers was that things tend to slow down in the M&A space during the summer. Vacation schedules impeded efficiency of communications.

Conversations with Mansell and Riverside, though, continued. Plans were set so that principals from both firms were to visit Seattle in early July. We met in our main conference room and then again for dinner, inviting some of the executive staff to meet our guests.

At this point our plans to have the business acquired were known to only five  people in the company and our attorneys. It is almost certainly advantageous to maintain the utmost secrecy about acquisition deliberations for as long as possible, no matter the size of your company. Discussions of a merger or acquisition, while exciting, can be disruptive to both employees and customers. That situation benefits only your competitors. So, keep it simple by keeping it completely secret.

We already knew that our potential acquirers had previously reached out to some of our customers, trying to find out as much about our company and our management team as possible. Similarly, a few days before our first in-person meeting, I initiated a small due-diligence exercise myself. It was important for Brian and me to know who might one day be running the company and taking over relationships with our employees and customers. I contacted one of Mansell’s largest customers with the cover that we were considering entering into a business relationship with them (which we were). I was able to get what I believed was an honest, candid overview of the company and how they treated their customers. I liked what I had heard.

Had I heard horror stories would I have attempted to shut down discussions with them? Yes, without question. What if a formal offer had been made – one that matched our financial expectations? Same answer. We had invested considerable time and effort in developing our reputation with both employees and customers and were unwilling to risk diminishing that. It was paramount that we find an acquirer that held similar values of professionalism and dedicated service toward our customers.

The beginning of August brought the official letter of intent (LOI) for our company to be acquired. We had just a few days to respond. At this point we engaged the law firm that would end up representing our interests through the rest of the process.

Of course we already had several corporate attorneys. But, this was something new. Something different. We had been given a recommendation to work with a firm well known for helping technology companies. Besides a sterling reputation, the firm’s offices were in our building. We already knew there would be lots of meetings, both telephone and in-person, that would require privacy. Convenience and reputation were only two of the factors that convinced us to use the new firm.

It was also important that we fully understood all the potential costs to be faced in selling the business. Our new attorney understood our expectations and their prior M&A experience (from a cost and time perspective) allowed them to estimate costs for completing the deal. For a relatively small company to be acquired it’s safe to estimate something between $50-$100K in legal fees. The buyer will have their own attorneys and, depending upon their size, might end upon spending a great deal more money to complete the deal.

We eventually agreed upon a hybrid, fixed-fee structure with our attorney. We also set up some simple ground rules related to what work would require review and approval by us before being pursued.

Keep in mind that you can ask your attorney almost anything related to the deal. It could be about taxes, deferred revenue, non-compete agreements, the closing process – literally anything. Be aware, though, that he or she will do their very professional best to answer your question. That might require extensive research. It might require consultation with their colleagues or other expert attorneys. Something you may casually ask on a Friday afternoon might deliver a beautiful, succinct answer the following Monday. But it may have required ten or more hours of work over the weekend. If you’re not careful and willing to control the process tightly legal expenses can become alarmingly large.

Discussing these things with your attorney at the very beginning of the relationship is critical to determine expectations and understand and agree upon limitations. You don’t want to start working only to be surprised by an outrageously large bill the first month.

One of benefits of engaging The Corum Group for our M&A work was that they had extensive experience selling high-tech companies and had successfully completed several deals with Seattle firms with which we were familiar. Two of their deals had been done with Google and some of that work had shaped a philosophy to do as much detailed work in the initial LOI as possible. Once we had received the LOI it was up to us to review it and suggest and request changes. Our initial response was due quickly, but the overall process of negotiating and finalizing the LOI took nearly a month. There was lots of back and forth and this is where the Corum’s deal prowess proved particularly valuable.

At the very end of August the LOI was signed and delivered back to Mansell/Riverside. From this point forward things would begin to operate in a more structured manner. Deliverables would be assigned. Dates would be set. We suspended all efforts to find other acquirers. Our course was set and our goal of selling our business to Mansell had been cemented.

Another in-person meeting was scheduled for September. This time Mansell would learn even more about the inner workings of our company. Source code would be shared (in a controlled setting); our data center would be toured; and we would begin the formal due diligence process where pretty much everything about our business would be exposed – in detail.

What does due diligence look like? How is it performed? For our transaction it began with a shared data vault that everyone could access electronically. Mansell and Riverside delivered a document detailing requests for information relating to our finances, our agreements and contracts (with employees and customers), leases and examples of marketing materials.

Almost all of our contracts and agreements were not only archived in paper but copied and saved as PDF documents. This proved to be a huge time saver. We literally completed our early document delivery tasks within a couple of days thanks to our having kept electronic versions of our materials.

Everything wasn’t perfect, though. One of the things we neglected to do over the years was centrally organize notes about all our electronic documents. While all of them were organized within specific folders, there was no quick and easy way to, for example, determine which customers had which versions of our sales agreement (we had three over the years). Or, in the case of employee documentation, which employees had signed invention assignment documents? Which had executed NDAs? We literally had to go through and read our documentation, whether on paper or electronically, to answer some of the questions we had been asked.

As the end of September approached everyone seemed to realize and agree that an October close, even on the very last day, was unlikely. We were concerned because we were trying hard to complete the transaction in 2010 before any changes to the long term capital gains tax could be made. Similar to Summer where M&A activity seems to temporarily slow down while everyone vacations, late Fall events can be hampered by weather and Thanksgiving Holiday plans.

At the end of the first week in October the stock purchase agreement (SPA) was delivered.  The first few days of the next week were spent reviewing the document with our attorneys and M&A firm. Early efforts to detail issues in the LOI proved valuable as the SPA contained very few new issues of great concern.

We continued to review and discuss the SPA while documents continued to be prepared and delivered into the data vault. As November approached we were literally weeks away from a closing event. It was both thrilling and exciting.

Once the SPA had been agreed to by both sides the mechanics of the close event started to be discussed in detail. How would the funding take place? What would happen to the cash in the business? How and when would the attorneys and M&A firm be paid?

On December the 2nd previously signed signature pages were released by both sets of attorneys. Stock certificates that had been held in escrow were sent by Fedex to the new owners. All that remained was to complete the funding event by initiating a series of well-orchestrated wire transfers. These would occur the next morning on the third, which was a Friday.

The new buyers had flown out over the weekend and were present when news of the event was revealed for the very first time to our staff Monday morning. Approximately the same time our meeting was concluding a previously scheduled email was instantly delivered to every WhatCounts customer using our own platform. At 10am that same morning a story appeared in TechFlash, a regional Technology Blog run by John Cook and Todd Bishop, describing the event publicly. Congratulatory calls and emails from friends, former colleagues, vendors and competitors started to arrive moments later.

Two exciting additional items were revealed that morning. The first was that instead of WhatCounts operating as a Mansell Group Company, Mansell would be rebranding and adopting the WhatCounts name. Second, Brian Ratzliff was invited to join the new Board of Directors.

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