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Selling Your Company? Don’t Make These Five Common Mistakes

Opinion

Xconomy Boston — 

You always believed your startup would be a success. Now others are realizing it, too, and you’re fielding offers for an acquisition of your company. Before you ink any agreements, protect your company, your employees, and yourself by avoiding these five common mistakes.

Rushing to sell. Take the case of a biotech startup CEO, who found himself literally holding an offer he never expected. “I want to buy your company,” the prospective acquirer told him, thrusting acquisition documents into the founder’s hands. There hadn’t been any negotiation of the terms, and the prospective buyer had a take-it-or-leave-it mindset. So my client—wisely—left it.

Granted, this is an extreme case—but pressure is a common tactic in an acquisition. Don’t ever feel pressured by buyers to sell a business you spent years building. Some buyers will lean hard on you, insisting their offer is good for only 24 hours. Like a marriage proposal, a solid, reasonable offer doesn’t include a tight expiration date. A serious prospective buyer will deliver a term sheet or letter of intent that spells out the key deal terms. This concise document describes the structure of the proposed deal so you can evaluate the offer. It’s a starting point—never an end point—for discussions and negotiations.

When you get a term sheet, ask a lot of open-ended questions. Are they proposing a merger or something else? Will all employees be kept on following the deal? Is the purchase price paid upfront or over time? Speaking of purchase price, scrutinize this number carefully. How did they arrive at it? And is it close enough to your valuation to consider moving forward? In short, make sure you understand what the proposed deal is before you spend too much time on it.

Dropping your guard. Early in the exploration process, insist that every prospective buyer sign a confidentiality or non-disclosure agreement (NDA) restricting them from disclosing or using your company’s confidential information and from poaching your employees.

This safeguard is even more important if you’re targeted by a competitor or potential competitor. They may be on the prowl for your top-notch scientists, programmers, or managers. Be especially wary if the prospective buyer is a company you don’t know well. Do your diligence on the buyer—talk to executives at companies the buyer has acquired in the past and ask how they were treated. That alone may help you decide how to proceed.

Figuring you’ll DIY. A Boston-area founder I know worked out a straightforward $100,000 deal with a buyer. No need to pull a lawyer or other expert into such a trifling transaction, right? Fortunately, he had second thoughts. A careful review of the proposed sale agreement revealed terms that could have exposed him to massive personal liability or potentially bankrupted him—language that was easily retooled to eliminate his personal liability. Remember that the dollar amount of a transaction has absolutely no relation to the amount of potential liability or personal obligations in the agreement. The buyer cares about closing the deal, not your potential exposure to risk.

Ignoring tax implications. A sale isn’t “just a sale.” The deal’s structure affects your company’s tax liability and your own as a stockholder when it’s time to pay Uncle Sam. A merger or stock sale can provide you with the most tax efficient result, because as a stockholder you’ll pay long-term capital gains—for most people, that’s 15 percent—if you’ve held the stock for at least a year.

If your business is a C-corporation, you want to avoid an asset sale because its structure can trigger two layers of taxation. The corporation must pay taxes on any gains from the sale of the assets, and then its stockholders have to do the same when the corporation distributes the proceeds from the sale to stockholders. [Note that this doesn’t apply for LLCs (limited liability companies) selling their assets because the LLC generally doesn’t pay income taxes.]

Buyers often push hard for an asset sale because it’s best for their bottom line. They get a stepped-up tax basis in the assets they buy and higher depreciation deductions on those assets for tax purposes, which is a non-cash charge that can reduce their taxable income. They can also pick and choose which assets they want, purchasing only gems like intellectual property and inventory and leaving behind liabilities such as accounts payable and general loans. Who wouldn’t want such a sweet arrangement? I know several founders who questioned buyers about proposed asset sales and were told, “Oh, we structure deals like this all the time.” That may be true, but yours doesn’t have to be one of them.

Not thinking past the closing. The thrill of selling a startup is undeniable, especially when there’s a significant upside for the founders and employees. It’s a heady moment indeed when you can buy a home or take a long-overdue vacation. But what happens after the sale?

Not all buyers will want or need all of your employees. An acquisition may leave some, or maybe even most, of your hard-working crew jobless. You can make a point to hammer out terms that provide a safety net for departing workers and incentivize your core folks to stay on through the transition. Those incentives might look and smell a lot like a traditional severance package, so you can call it a “transition services agreement” if that’s easier for the buyer to swallow.

Give the same attention to the future of your product. Buyers who want to squelch competition might shelve your product after acquiring it. I’ve seen founders become very emotional about this, and rightly so. They’ve struggled, scrimped, and toiled to get a product to market, and now that effort feels wasted. If your product fulfills a vision, its fate may be more important to you than you suspect. Find out what the buyer’s plans are and make sure you can be comfortable with them.

And beyond your product, what’s your next step? A non-compete agreement can take you out of circulation for up to five years, even in California, which permits narrowly tailored non-competes in connection with a business sale. Buyers will insist on them, so you need to think through your post sale plans before you sign. You were clever enough to launch and grow a company into a roaring success. Now you need to make sure you can continue to do the kind of work that keeps you energized and happy.