- 1. Pending Litigation Outcome
- 2. Pending Contract Renewal
- 3. Pending New Contract or Client
- 4. Pending Asset Transfer
- 5. Entering New Market
- 6. Clients Must Work With You
- 7. Employees Must Work With You
- 8. Incoming Legislation
- 10. Technical Debt
- 11. Growth Forecast
- 12. Outstanding Debt
- 13. Transition Services
- 14. Partnerships
- 15. Vendors and Suppliers
- 16. Tax
- 17. Intellectual Property (IP)
- 18. Ownership Issues
- 19. Outstanding Employment Law Liability
- 20. Financing Uncertainties
- 21. Board or Stockholder Approval
- How to Apply These Tips to Your Next Acquisition
You can’t eliminate every risk when buying a business. But that doesn’t mean you should run for the hills at every sign of trouble. With the right deal structure or acquisition strategy, you can minimize risk and earn a return on companies you might never have dared to acquire.
Your risk appetite will render some risks non-negotiable – your dealbreakers. It’s not our intention to sway your opinion on these high-risk startups. Rather, we want to help you manage certain risks so they become tolerable under the right conditions.
Below, we’ve compiled a list of 21 common acquisition scenarios and how you might approach acquisition dealmaking to minimize risk and encourage a return.
Disclaimer: The measures outlined below do not guarantee to minimize or eliminate risk. Always consult with an attorney or other expert if you’re unsure.
1. Pending Litigation Outcome
The startup is involved in a legal case that has yet to be resolved. For example, a former employee or contractor is disputing IP ownership or suing for wrongful termination.
Best Case
The business wins or settles the legal case with little to no impact on its performance or reputation.
Worst Case
The business loses, resulting in one or all of the following:
- Business losses
- Remedial costs
- Activity restrictions
- Reputational damage
How to Manage the Risk
Stall the deal until litigation is resolved. Or, request indemnity for litigation-related losses in your asset purchase agreement (APA), and hold back a portion of the purchase price to draw from if such a loss occurs.
2. Pending Contract Renewal
One of the startup’s largest clients is due to renew their contract around the time of acquisition or shortly afterward. This could be an enterprise customer behind a large chunk of revenue.
Best Case
The client renews and you retain the revenue post-acquisition.
Worst Case
The high-value client lapses, resulting in a loss of revenue and the cost to replace it.
How to Manage the Risk
Make renewing the client’s contract a closing condition. Or, hold back a portion of the purchase price until the client renews or you replace the revenue. If neither is possible, you might consider negotiating a lower asking price given the lack of revenue diversification.
3. Pending New Contract or Client
The startup expects to sign a new client or sale contract before the acquisition closes. Maybe it’s a new enterprise client or partnership that promises to boost revenue.
Best Case
The founder signs the new client or inks the partnership deal.
Worst Case
The client or partner goes elsewhere and you never realize the additional revenue.
How to Manage the Risk
Make landing the new client or partnership a condition to close. Or, hold back a portion of the purchase price until the business signs the client or partnership agreement.
4. Pending Asset Transfer
One or more of the startup’s assets are difficult to transfer. An example is a social media account – transferring things like Twitter handles can be tricky.
Best Case
You receive the assets as expected and on time.
Worst Case
You don’t receive the asset or do so much later than you expected.
How to Manage the Risk
Make transferring all assets by a certain date a condition to closing. Use our escrow builder to ensure you only release funds once you’ve received and approved acquisition assets.
5. Entering New Market
The startup’s valuation accounts for a recent or pending launch in a new market or territory (a UK firm expanding in the US, for example).
Best Case
The business hits its projections.
Worst Case
The market underperforms, or the product doesn’t fit, delivering little to no return on investment.
How to Manage the Risk
Split the purchase price gap between actual and forecasted performance with an earnout provision. The seller only receives the difference if entering the new market succeeds.
6. Clients Must Work With You
The startup’s clients have a close relationship with the founder. They might even be friends or old colleagues. The success of your acquisition hinges on retaining these clients.
Best Case
All clients agree to work with you after acquisition.
Worst Case
Some or all high-value clients lapse to competitors.
How to Manage the Risk
Determine the assignability of client contracts (can they be transferred?) by consulting with an attorney and/or reviewing the assignment provision in each. Assign where possible, renegotiate where necessary, and make certain assigning high-level contracts a condition to closing.
7. Employees Must Work With You
The startup’s employees are critical to its long-term success, or you want to acquire talent over other acquisition assets. For example, you need the engineering team to continue developing the software because you lack technical skills.
Best Case
You retain critical employees for as long as you need them.
Worst Case
Critical employees leave, the business’s performance suffers, and you spend a fortune recruiting new staff.
How to Manage the Risk
Make certain employees entering into post-closing employment agreements with you a condition to closing. If they’re hesitant to join as a full-time employee, consider asking them to provide services as independent contractors for a set amount of hours per week or month.
8. Incoming Legislation
The startup falls under proposed (but not yet ratified) legislation that could restrict business activities or increase responsibilities. For example, you want to acquire a real estate agency that’s soon to fall under stricter anti money-laundering legislation.
Best Case
- The legislation is never ratified.
- The legislation is ratified, but the founder takes steps to minimize the business impact and stay compliant.
Worst Case
The legislation is ratified, imposes restrictions on business activities, and requires you to take remedial action to stay compliant.
How to Manage the Risk
Involve counsel to analyze the business impact before you send an LOI. Either determine it’s not worth the risk or reduce your offer accordingly.
10. Technical Debt
The startup has racked up technical debt in the form of soon-to-be-obsolete technologies, libraries, or other dependencies. For example, the tech stack depends on a retiring third-party library or can’t handle demand as the business scales.
Best Case
The founder completes all upgrades and updates before you close.
Worst Case
You inherit vast technical debt that will cost you time, effort, and resources to resolve. Your product may fail, causing outages and hurting your brand and bottom line.
How to Manage the Risk
Delay closing until you’re satisfied that all technical debt has been addressed. Or, use technical debt to justify a reduction in the purchase price equivalent to the cost of addressing it yourself.
11. Growth Forecast
The startup’s growth rate must accelerate or at least maintain momentum to earn a return on investment. Otherwise, your returns could widely miss targets.
Best Case
The startup meets or exceeds your growth expectations.
Worst Case
The startup misses its growth projections and revenue contracts, forcing you to rethink how you acquire and retain customers or invest more capital into growing the business.
How to Manage the Risk
Make some of the purchase price conditional on meeting growth targets in an earnout provision. For example, if your valuation model factors in a 30 percent growth rate, revalue the business using a baseline growth rate and only pay the difference when the business meets the target.
12. Outstanding Debt
The startup has accrued debt that you don’t want to inherit. Maybe the founder took a loan out against the business and has yet to repay it, for example.
Best Case
The business repays all its debts before closing day.
Worst Case
The business can’t pay its debts, its credit score suffers, and you inherit repayments, interest, and potentially onerous terms.
How to Manage the Risk
Identify outstanding business debts during due diligence and any liens attached to the purchased assets. Require the seller to satisfy debts with purchase proceeds in a drafted funds flow memorandum.
13. Transition Services
You need the seller to provide transition services while you familiarize yourself with the business and how it’s run. For example, you might require the founder of an agency to introduce you to its clients so you can build rapport with them.
Best Case
The founder agrees to provide transition services for as long as you need them.
Worst Case
The founder wants to leave and does so after the deal closes.
How to Manage the Risk
Make post-closing services a condition to closing. If the founder fails to perform, seek remedies from them under that condition of your APA and under the terms of the post-closing services agreement you enter into with the founder.
14. Partnerships
The startup relies on one or more partnerships for some or all of its revenue. For example, the business has negotiated several strategic partnerships where it cross-promotes its services. You need these partnerships to continue with you as the new owner.
Best Case
All partnerships continue after your acquisition closes.
Worst Case
Some or all partnerships discontinue, resulting in a loss of revenue and the cost to replace it.
How to Manage the Risk
Determine the assignability of partnership agreements by consulting with an attorney and/or reviewing the assignment provision in each contract. Assign where possible, re-negotiate where necessary, and make assigning certain high-level contracts a condition to closing.
15. Vendors and Suppliers
You expect the startup’s vendors and suppliers to continue working with you as the new owner. Say you acquire a dropshipping business and need its manufacturers to continue existing contracts or arrangements with you as they had with the founder.
Best Case
All vendors and supplies continue on the same agreements as before.
Worst Case
Some or all vendors or suppliers cease doing business with you. Or, they want to renegotiate contracts and arrangements, resulting in potentially higher costs and more onerous terms.
How to Manage the Risk
Determine assignability of contracts by consulting with an attorney and/or reviewing the assignment provision in each contract. Assign where possible, re-negotiate where necessary, and make assigning certain high-level contracts a condition to closing.
16. Tax
The startup has yet to file, pay, or administer tax obligations at the time of closing.
Best Case
The business pays all its taxes on time and has kept accurate tax records throughout its history.
Worst Case
The business hasn’t paid its taxes or has misfiled or misadministered records (or kept no records at all). You then inherit a big tax bill and an even bigger task of tidying up tax records.
How to Manage the Risk
During due diligence, review the seller’s tax records and returns to ensure they’ve paid all tax obligations in full and on time. At the APA stage:
- Require the seller to represent and warrant that they’ve paid all outstanding tax obligations.
- Draft your APA so that this is a fundamental representation and warranty with no shortened survival period and actionable until the expiration of the statute of limitations.
- Finally, require indemnification from the seller if they breach any of the representations or warranties in the APA.
17. Intellectual Property (IP)
The startup owns valuable IP that you want to acquire. You want reassurance the seller can legally sell it to you and that no other party will claim ownership.
Best Case
The founder verifies they own all IP and can legally sell it.
Worst Case
Someone makes a claim to the IP – an employee, contractor, or even a competitor. You are pulled into a protracted legal battle to defend ownership or must relinquish the IP to the legal owner. In either case, you suffer considerable losses.
How to Manage the Risk
In due diligence, have your attorney review all service-provider agreements to ensure that each service provider assigned all “on the job” intellectual property to the company.
At the APA stage:
- Require the seller to represent and warrant that it owns all IP outright and there are no current disputes.
- Draft your APA so that such a representation and warranty has a sufficiently long survival period.
- Finally, require indemnification from the seller if they breach any of the representations or warranties in the APA.
18. Ownership Issues
You must identify all stockholders and determine whether the seller has the legal right to sell the business.
Best Case
The founder confirms with absolute certainty every stockholder and that they have the legal right to sell the business.
Worst Case
Equity grants are inconclusive and a previously unidentified stockholder appears post-closing wanting a payout or makes a recission of transaction claim.
How to Manage the Risk
In due diligence, have your attorney match each purported stockholder to a documented, perfected stock grant or purchase.
At the APA stage:
- Require the seller to represent and warrant that it has obtained all necessary authority to sell the company and there are no current or potential ownership disputes.
- Draft your APA so that this is a fundamental representation and warranty with no shortened survival period and actionable until the expiration of the statute of limitations.
- Finally, require indemnification from the seller if they breach any of the representations or warranties in the APA.
You might also hold back some of the purchase price for some time to account for this risk.
19. Outstanding Employment Law Liability
You’re concerned that a disgruntled employee might file an employment law claim after closing.
Best Case
No employees file claims.
Worst Case
Employee files a claim post-closing and successor liability creates exposure for you. Defending such claims isn’t cheap, and if the employee wins, you could have substantial compensation claims to make.
How to Manage the Risk
- Make the employee settling with the company a condition to closing.
- Alternatively:
- have the seller represent and warrant that there are no outstanding employment law-related claims; and
- Include special indemnity related to the specific claim and hold back an amount of the purchase price over time to account for such exposure.
20. Financing Uncertainties
You want to finance the acquisition with a loan, investor funds, or other financing vehicle. You need reassurance you won’t be legally obliged to acquire the company if your financing falls through.
Best Case
Your financing is approved.
Worst Case
Your financing is rejected or you can’t raise sufficient capital, but you’re still legally obligated to close.
How to Manage the Risk
Make securing financing a condition to closing.
21. Board or Stockholder Approval
The founder requires board or stockholder approval to sell the business to you.
Best Case
The founder obtains the necessary approval from the board and stockholders.
Worst Case
The founder can’t obtain board or stockholder approval and yet is legally obliged to close. You lose the time and resources spent in acquiring the company and/or incur the cost of legal action to force the founder to sell.
How to Manage the Risk
Make securing board and stockholder approval a condition to closing.
How to Apply These Tips to Your Next Acquisition
When talks with a founder get serious, raise any concerns early. Maybe around the time of sending an LOI. You don’t need all your risk boxes ticked to make an offer, but you want to know enough to make moving forwards a good use of your time.
The founder is likely aware of the risks inherent in their business and might’ve figured out how to minimize or even eliminate them. Failing that, consider which of the above deal structures and acquisition tips might make you feel better about the risk in question.
Your attorney is the best person to speak to about risk. They can help you understand how it affects you and the different scenarios that might play out. They’re also best placed to advise how to manage these and many more acquisition risks.
In the meantime, the tips above give you a starting point for negotiations with sellers. It’s in their interest to help you de-risk the acquisition. Be honest about what you want, explain your rationale, and I’m sure you’ll find a deal structure that makes both of you happy.
The content on this site is not intended to provide legal, financial, or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional before entering into any M&A transaction. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any M&A professional.
