Software Executive Magazine

August/September 2017

Software Executive magazine helps software executives grow their businesses by showcasing the business best practices of our readers, executives from established and innovative software companies.

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Tips For An Optimal M&A Deal Structure J E F F R I L E Y VP, Corum Group 8 If three buyers offered $50 million for your company — one in unregis- tered stock, another via earnout, another in cash — which would you take? I hope you'd say "cash" immediately. Structure, ultimately, is more im- portant than price. Below are tips to achieve an optimal structural outcome when selling your software company. AIM FOR A STOCK SALE Companies can be purchased as assets—preferred by buyers—or via company shares—preferred by sellers. In an asset sale of a C-corp, the gain will be taxable to the company at time of sale, then taxed again to the share- holder at distribution. In a stock sale, proceeds are taxed at a lower capital gains rate, and in C-corporations, corpo- rate taxes are bypassed. Be sure to clarify expected deal type early in the process to avoid being surprised later. 1 AIM FOR A CASH DEAL Cash is the best option—literally, money in the bank. If buyer stock is expected to perform well, taking some may be reasonable—but with a public buyer, will you have registration rights? Is there enough float and volume to handle sales? Private stock is more compli- cated. Is there a put provision? Can you sell with found- ing shareholders if going public? Is the valuation realis- tic? Don't overlook antidilution provisions either. 2 EARNOUTS ARE ICING, NOT CAKE Earnouts, based on EBITDA, sales, retention, or other measures, are the most litigated portion of M&A transactions, but can be rewarding if structured proper- ly. Before agreeing to an earnout, ensure unambiguous goals and reporting methods. Consider earnouts "icing on the cake," a way to bridge the gap between what a seller really wants and what a buyer is willing to pay. 3 STRUCTURE EARNOUTS FOR SUCCESS Build structure into the deal that gives you the control you need to achieve them. Prior to closing, de- fine postsale roles and responsibilities. This is always important, but crucial with earnouts. If the buyer can negatively influence your performance, what is the point? During integration, monitor performance close- ly, so there are no surprises on payday. 4 BEWARE OF LIABILITIES What if your biggest customer walks away? Or someone claims ownership to your IP? In M&A, you provide representations about your company and war- ranties if something goes wrong. If not managed prop- erly, you can be responsible for paying back the entire purchase price, or more. Get experienced counsel, and watch liability language carefully. 5 BE CAREFUL ABOUT ESCROWS AND HOLDBACKS To satisfy potential liabilities, part of the pur- chase price is withheld. The percentage withheld, sur- vival period, how the escrow is funded, etc., are all part of deal structure. Expect escrow amounts of 10 to 15 percent and survival periods of 12 to 24 months. Spe- cifics depend on inherent risk and likelihood of liability. Escrow, like all structural elements of the agreement, can be negotiated—and we've seen it completely taken off the table to sweeten an offer and win the deal. 6 BE POSITIVE ON EMPLOYMENT AGREEMENTS Signing new employment agreements with the acquiring company is a necessary reality for every current employee. To minimize transition risk, review these agreements up front and negotiate terms that result in neutral to favorable reactions amongst your employees. Oftentimes these agreements incorporate incentive pay for key people. Steer clear of shareholder conflicts by reviewing with counsel. 7 KEEP NONCOMPETES REASONABLE A noncompete is one way buyers protect their investment, restricting sellers from working for or starting a competitive business. They aren't always in- volved, but are often included in larger deals and those involving complex technology. There are restrictions in certain jurisdictions, so the average is about three years—longer than the employment agreement. Gener- ally they cover proprietary information: domain exper- tise, knowledge of code, clients, etc. They are part of the package, but keep them limited in length and scope. S 8 THE LIST Index By J. Riley 8 TIPS FOR AN OPTIMAL M&A DEAL STRUCTURE SOFTWAREEXECUTIVEMAG.COM AUGUST/SEPTEMBER 2017 10

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