What to Know Before Acquihiring a Team

Growing companies will often use acquihires to bring in a team of new employees. This can be more efficient and effective than hiring one by one, especially if the team being brought aboard works well together and has expertise that is complementary to the buyer’s existing business. We discuss acquihires, and the points that sellers should consider, in this Cooley GO article, which we recommend to buyers as well – both to understand these transactions generally and to get a sense of what the sellers may be thinking about. Below are additional points that buyers should consider when contemplating an acquihire.

Retaining and incentivizing your new team members

Since you are buying the company primarily (or even exclusively) for the team, you will need to consider how to retain your new hires after closing. One tool acquihire buyers often use to incentivize the sellers to stay on is to include buyer stock as part of the purchase price for the transaction, and to ask key incoming personnel to revest some or all of their shares so that a significant portion of their consideration is contingent on them remaining with the buyer.

Bringing in a new group of people to your company of course involves more than just incentives, so you also will want to think carefully about factors like integration, culture fit and career growth opportunities for your new hires.

No matter how intelligently you structure the incentives and prepare for integration, there’s no guarantee any specific employees will stay for the long term. This means buyers also need to consider what the deal will look like if the acquired team leaves sooner than expected. Will you be able to take back unvested stock? Are there other assets in the seller’s business, such as IP, that will provide value even if the sellers leave? These factors will influence how you will want to structure and price the deal.

If you are using your company’s stock as part of the deal consideration, you also will need to pay attention to what this implies about the stock’s value. In particular, if the company grants options in the US, you should be aware of whether the deal places a value on your common stock that is higher than your last 409A valuation.

Be sure to speak with your legal and tax advisors – including advisors in the jurisdiction where the incoming team is based – before offering stock as part of the consideration for an acquihire.

Understanding the seller’s cap table and why it matters

If the selling company never received outside funding, then all of the equity is likely owned by the founders and other employees. In that case, you can price the deal based on whatever amount will motivate the team to sell. If the selling company has raised venture financing, there is an additional level of complexity, since the investors on the cap table will likely need to approve the deal. Investors typically see an acquihire as a disappointing outcome and may prefer to keep the company independent so it can build more value before an exit.

While you as a buyer may not be directly involved in internal seller discussions, you should be aware of these dynamics, since they will affect how much you may need to pay in order for the seller’s stakeholders to find the deal attractive. Keep in mind that the amount necessary to secure investor approval might be more or less than their investment amount. Understanding the tax treatment of the deal also is critical here, since it affects the amount of proceeds that the selling stockholders will actually receive, and it will be most critical for the selling founders themselves, who generally have paid very little for their shares and want to avoid a large tax bill, especially if their consideration in the deal is principally in stock. Again, it is important to discuss with the tax advisors in the jurisdiction where the incoming team is located to ensure you understand the tax treatment of their deal consideration.

Preparing for diligence

Because the targets of acquihires are usually small, early-stage companies, buyers may expect that the diligence will be simple and straightforward. In reality, it’s often the opposite. If the selling company never went through standard legal diligence or was operating in a distressed state for an extended period of time – fairly common in acquihires – it may have issues and liabilities that you’re less likely to encounter in an acquisition of a larger, more mature company. These may include uncertain ownership records, unusual side deals, tax exposure and agreements that were not formally documented. These kinds of issues can result in an unexpectedly costly and involved diligence process and may affect how you price and structure the deal.

Structuring the deal
Like other acquisitions, acquihires can be structured as stock sales, asset sales or (less frequently) mergers. The pros and cons of each structure are discussed (from the seller’s perspective) in this Cooley GO article. The considerations discussed above, such as the complexity of the seller’s cap table, tax efficiencies and the degree of concern about seller liabilities, as well as local labor and other laws in the jurisdictions where the service providers of the target are based, are among the factors that influence how a deal is structured.

The time to start thinking about these issues is before you send a term sheet to the seller. We suggest talking to legal and tax advisors early – including, as noted above, advisors in the jurisdiction where the incoming team is located – so you can get the benefit of their guidance as you move forward with bringing a talented team into your company.