COVID-19 has wreaked havoc on all economies and businesses across the globe. While some of the businesses will sail through to see better times in the future, some will not. Specifically, smaller companies and startups at nascent stages may be handicapped with no funds or hope to recover. The rise in number of troubled companies may result in a lot of distress sale transactions soon.
A distress sale can be structured in different ways – asset sale, share sale, slump sale, mergers or acquihire transactions. Some of the sectors have been positively affected by the prevalence of COVID-19; particularly, the ones driven by technology. The market leaders in tech sectors are in constant need for qualified and senior employees to expand their teams and launch varied products/services. So, it may be safe to say that the acquihire trend may well be back again and provide some respite to troubled companies.
An acquihire is where a company is being acquired for the excellent team it has assembled and not particularly for its product/service. This is preferred since it is a saving grace for the failing company and is easier than a winding up process. For most tech companies, the real value lies with their employees and intellectual property. These are acquired by the acquirer in an acquihire transaction. In certain instances, an acquihire transaction is coupled with an asset sale; whereas in others, the assets are left behind. The cash paid by the acquirer and the residual assets are then distributed to shareholders in the liquidation of the startup.
From the acquirer’s perspective, employment agreements rolled out to the employees are quite critical. An important aspect is the non-compete obligation. While the target company waives off any subsisting non-compete obligations, the acquihired employees always demand lenient non-compete restrictions from the acquirer. It may be useful for the acquirer to have an amicable discussion with the employees and curate their employment agreements, compensation packages and build in restrictions based on the level of seniority. It makes the employee feel valued and not just a mere asset being transferred from one organisation to the other.
The acquirers also need to analyse and build in mutually agreeable lock-in restrictions. The acquihired employees are generally locked-in for a comparatively longer period. The incentives, stock options, increment in salary may be made dependent on the employees serving the entire tenure of lock-in. More so, in certain rare instances where it is necessary to preserve the entire team, the acquirer may consider proposing structured lock-in restrictions on the entire acquihired team. That is, the incentives, perks, stock options etc. may vary subject to the entire team sticking around for the lock-in period and achieving the goals set by the acquirer.
From the target company and selling founders’ perspective, being acquihired may sound like an easy way out for most troubled companies – but that is easier said than done. The selling founder / target company needs to assess the most profitable way of structuring the acquisition cost. In most instances, the consideration is bifurcated into cash and stock (i.e., of the acquirer). The selling founders may also be a part of the team being acquihired and hence it becomes even more important for them to understand how their consideration is being structured. Having said that, it is always better for the selling founders to convert an acquihire into a full acquisition to ensure that they do not have to go through the long-drawn process of winding up and recovering the value of the remaining assets, if any.
The selling founders also need to take care of certain other things such as tax planning, payments being made to their existing shareholders etc. In certain instances, the shareholders of the target company may want a curated consideration package, i.e., in cash and stock. The selling founders should discuss this with their shareholders. The selling founders also need to consider paying off their creditors in priority as per applicable laws and contractual undertakings.
There are various other related matters that the parties need to discuss and navigate through – which of course vary on a case-to-case basis. However, if you look at an acquihire deal objectively, the failing company gets its saving grace; the acquihired employees get a deserving pay cheque and certain stability; and the acquirer gets an experienced team. While it may not be easy to appease all parties concerned, a well-structured and amicably negotiated deal could be a win-win situation for everyone involved.
Arun Mohanty | Principal Associate, Veyrah Law; Ajay Joseph | Partner, Veyrah Law
Views expressed above are for information purposes only and should not be considered as a formal legal opinion or advice on any subject matter therein.