The Anatomy of a Deal Newsletter July 24, 2020
Each month, Eric Duffee looks at a different piece of The Anatomy of a Deal – a series of easy-to-digest articles that break down complicated aspects of business transactions – helping you better understand terms + processes that can shape the direction of your business.
- Alternative motivations, such as acqui-hiring, deal settlement, and business restructuring, are lesser-considered drivers that can be the impetus for M+A transactions.
- An acqui-hire can be an attractive way to acquire talent from another business, but it can be fraught with complexity and there are often more effective ways to accomplish the same goal.
- When in litigation, the most practical and financially attractive resolution can sometimes be for one business to simply acquire the other.
- Removing problem-investors and avoiding creditors can often be triggers for using M+A as a tool to restructure the entire company, but will often create major legal or tax consequences.
In many cases, it’s fairly obvious why the parties to an M+A transaction are doing a deal. The seller may simply be ready to cash out. The buyer may see the transaction as an opportunity to add to its product or service offerings or expand its customer base. Pretty simple.
But sometimes M+A may be a means to achieve a different end. This month, we take a look at a few of the more common alternative motivations behind M+A transactions.
Simply put, “acqui-hire” refers to a transaction in which the buyer decides to buy the seller company solely (or at least primarily) as a way to acquire its talent. The buyer may not care much—or at all—about the seller’s business or products, but the buyer sees value in the seller’s team. The buyer simply uses the M+A transaction as a vehicle to hire the seller’s team.
While acqui-hiring was all the rage throughout the 2010s, in reality, there are only a few circumstances where an acqui-hire really makes sense:
- First, acqui-hire may not be needed at all if the buyer can successfully attract the talent on its own. If the buyer can simply hire the desired team members without violating non-competition agreements or other restrictions, then that’s probably a better and cheaper way to achieve the goal.
- Second, in a true acqui-hire situation, the buyer is saying that it doesn’t care about the seller’s business, just its talent. Yet, the buyer will be paying something for the business in an acqui-hire transaction. A buyer may be willing to pay something just for the convenience of hiring the seller’s team in one easy swoop, but it’s probably not going to be willing to pay much for this privilege. As such, an acqui-hire really works only when the seller company doesn’t have much value. Oftentimes, the seller company is going under anyway, and acqui-hire is a last-ditch effort to salvage something for the business and provide a landing spot for the team.
- Third, an acqui-hire strategy is risky for the buyer. Employees don’t consider their employer to be fungible. The team may like working for a smaller start-up and may not stick around if the buyer is a big corporation. While employment agreements and long-term incentives (remember we talked about those previously) may help encourage retention, you really don’t know how successful you’re going to be at keeping the team around. And entrepreneurs often experience severe culture shock when they transition from owner to employee. For this reason, there are many examples of attempted acqui-hire strategies that have failed miserably. Don’t believe me? Just Google it!
An acqui-hire may seem like a simple solution to a simple problem, but it adds a bunch of complexity. While buyer and seller may be focused only on the team, both need to be aware of what’s happening with the business and what unintended consequences come along with the deal. Buyers may find that they’ve unwittingly stepped in a pile of the seller’s historical liabilities. On the other hand, sellers who aren’t careful may have creditor and wind-down issues to deal with post-transaction. Just because the buyer and seller decide that the seller’s business doesn’t really matter, that doesn’t mean that it magically goes away.
Acqui-hire is something both buyers and sellers should keep in mind. It can provide a good opportunity for both sides in the right circumstances…though those circumstances are not as common as one might think. While there are risks for both sides, buyers especially need to understand what they are really buying when pursuing this strategy.
We usually think of M+A deals as the product of negotiations between the apocryphal “willing buyer” and “willing seller.” But sometimes deals are borne instead out of the ugliness of litigation.
There are endless reasons why companies end up embroiled in a dispute. In some cases, the amount in dispute can be huge. For example, a patent infringement claim could involve millions of dollars. Sometimes estate litigation focuses on the deceased person’s business, which may be the only significant estate asset.
I’ve made my entire career out of letting others handle the litigation. But resolving disputes is part of what we do every day. And in some cases, the best result for everyone is to turn the dispute into an acquisition.
Take the patent infringement claim I alluded to above. Let’s say Mega Corp, Inc. gets sued by Start-Up, LLC for millions of dollars based on Start-Up’s claim that its patents cover one of Mega Corp’s major products. Start-Up will invariably claim that it is entitled to everything under the sun. Mega Corp will “lawyer up” and tell Start-Up to go fly a kite. Months of subpoenas, depositions, and nasty-grams ensue. Then, as trial comes closer and both sides see that hardening their positions produces significant risk, they start considering settlement.
Start-Up wants to be properly compensated for what it believes to be a legitimate infringement claim, but Start-Up is drowning in legal fees. Mega Corp doesn’t want to pay big dollars and potentially get nothing in return. Both sides are afraid of what happens when they lose control over the situation and hand things over to a judge or jury.
A solution! Mega Corp “hasn’t done anything wrong,” but suddenly has a totally unrelated interest in acquiring Start-Up for…millions of dollars. Start-Up gets the money it wants and Mega Corp not only makes the problem go away, but it also acquires Start-Up’s intellectual property, business, customers, team, etc. Win-win, right?
Sometimes this type of solution is actually a true win-win. And for some businesses, the “settlement by acquisition” strategy may be the only way to actually resolve the dispute. But in some cases, the transaction may not have actually been the best result. For example, if Start-Up litigated the case to conclusion, it may still have recovered millions of dollars and kept the business.
So “settlement by acquisition” is really like any other settlement negotiation—just a different method for accomplishing the same end result. And the old adage about settlements remains true: a good compromise is one in which both sides walk away unhappy.
Finally, sometimes M+A is used as a means to achieve a restructuring or recapitalization of the business. This can often be part of an attempted reset of the company’s capital structure. Other times, it’s the implementation of a succession plan.
There are many, many different transaction types that fit this bill. And the motivations may be very different in each case. Sometimes the goal is to sidestep “problem” investors or creditors. Or maybe the goal is simply to give the owner an exit by handing the reins to family members or key employees.
Each of these transactions brings its own unique issues. Owners hoping to use M+A to involuntarily push out investors or creditors need to be extremely careful. These transactions are very risky, and you may simply be buying a lawsuit. On the other hand, sometimes a business owner has no choice but to force the issue. In any event, owners should tread very carefully.
Transitions to family members or key employees raise unique tax issues. Failure to understand the tax issues and how to navigate them will produce unpleasant surprises at tax time. I’ve yet to meet the client who doesn’t care about taxes (spoiler alert: that’s why we’ll talk taxes next month).
M+A is a versatile tool that can achieve many different business goals. It’s a great tool in some cases, and not so great in others. Knowing how and when to wield that tool can be a powerful advantage for your business, regardless of where you are in the business life-cycle.
Next Month: M+A Tax 101
Read last month’s piece: Strategic Buyer vs. Financial Buyer