October 20, 2005

"Top Ten Commandments of Venture M&A"

Bill Burnham of Celsius Capital has a great post. While it is a VC's angle, it has relevance to entrepreneurs as well.

Given the importance of M&A to both VCs and start-ups, it’s important to realize that the seeds for M&A success or failure can actually be sown quite early in a start-up’s life and well before any potential deal materializes.

With this in mind, I offer the following Top Ten M&A Commandments with the idea being that if a start-up follows these commandments it will be able to avoid some of the most common structural and financial issues that have the potential to blow-up a deal or dramatically reduce its value. These commandments include:

# Thou Shall Not Give a Strategic Investor a Right of First Refusal, Right of First Offer or a Protective Provision that Enables Them to Block a Sale.
If you must have a strategic investor in your company (and in general I recommend against it) by all means do not give them a Right of First Refusal, a Right of First Offer, or an ability to block a sale in the event of M&A....

# Thou Shall Require “Drag Along” Agreements In All Series of Stock....


# Thou Shall Not Enter Into Contracts That Create Liabilities More than 2 Years In Duration.
When big companies buy small companies they want as few complications as possible. Long term liabilities, such as 10 year leases or long term supplier contracts (which will no longer be needed if the acquisition goes through), usually won’t kill the deal, but they will lead to direct reductions in the price that the acquirer is willing to pay. With this in mind it makes sense for start-ups to keep most of their agreements to as short a term as possible. Even if a vendor or landlord is offering a significant discount for a 5 year deal as opposed to a 1 year deal, it actually makes more sense to take the 1 year deal, not only from an M&A perspective but also because start-ups are so dynamic that you never know what you will need 5 years from now.

# Thou Shall Write All Customer Contracts And Partnerships Such That They Can Be Transferred to An Acquirer And/Or That Such Contracts Can Be Terminated With Reasonable Notice.

# Thou Shall Not Enter A No-Shop Without Hammering Out All of the Key Terms and Conditions of a Sale First.

# Thou Shall Not Allow A Buyer to Interview Employees Until At Least An LOI is Signed.


# Thou Shall Discuss Exit Expectations With Management and Board Members Prior to Funding and At Least Twice a Year After That.

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.