How to Overcome M&A Hurdles

23:23Would it continue? Would there need to be authorization? to continue to contract? Would they have to strike a new contract? Whatever it might be. Or whether it could just be assigned. Can we just assign it without any type of change of control? So immediately it goes to the acquirer. So those are the types of things we look for because if there is a change of control mechanism, A, it might also mean that we might not have that key contract if we need to renegotiate it. And B, we might not get the same terms either, especially when a third-party vendor might see a larger company is acquiring a smaller company, I can ask for more money.

23:56And that often becomes problematic because at the end of the day, no one wants to pay more for the same service. But oftentimes we have to get into a process of renegotiating those relationships. And that becomes really time consuming and painful as part of the deal process. So assignments are a type of change of control. You can have a provision specific to assignments. And then broadly speaking, around the change of control is the definition of any event that would change control. That's right. It's a really key aspect to contracts and even other vendor agreements. It might be even employment agreements.

24:27There's specific contracts that really matter when it comes to change of control. And you want to make sure you account for all of those things. There might be things in employment agreements as well that in a change of control, you might get accelerated vesting. And it's painful if that's the case, because sometimes that means that key executives might get accelerated vesting and no longer be incentivized to continue to work. You really need to look and understand contracts on both the people front or any of the more critical contracts that the company has in terms of how they operate their business to make sure you can continue the business as is going forward.

24:59Let's talk about how to mitigate these issues. It's interesting. There's a lot of different ways to think about mitigating it. For a startup, the best thing they can do is just hire good lawyers. Having good advisors and lawyers are really, really important. Have someone managing your taxes and, if possible, your HR. Oftentimes, the CEO of the company or the founder wears many different hats, but they're not an expert of HR or taxes or payroll or accounting. They're kind of wearing all these different hats to just make buy. And often that's when there's errors that occur. So for a startup, the best thing they can do is just hire good lawyers and advisors.

25:33For the acquirer, it's focusing on these key areas earlier on on the deal process. So you can make sure you have a flag early on so you can deal with them. And so you have time to deal with them and understand them and come up with a solution. It also helps that if you understand these flags earlier on in the deal process, then you can start planning for that in the integration process as well. The other thing that really helps me has been to make sure you understand your non-negotiables. Having a set of principles you agree to at the beginning of the deal and refer to them when you need them helps with negotiations.

26:03It helps you also understand whether something is a deal breaker or whether it's perceived as a deal breaker because you're in the middle of a process. or it might be a deal breaker for one cross-functional team, but it might not be a deal breaker for the deal sponsor who wants to find a solution that these still hold for the company and the target and for the deal. But there's a flag for which we need to navigate and figure out a solution or we might be willing to take on the risk for. So those are some tactics that I've seen have been helpful to try to mitigate these. There's always a solution.

26:31It's just a matter of who bears the risk. So you can always increase indemnity. You can increase timeline for indemnity. You can haircut the purchase price. There's always a solution. It's just who's willing to bear the risk and who's willing to get the deal done with those new terms. Get a good lawyer, plan your integration, and list your non-negotiables. What's a good approach for a startup to find a good lawyer? Because I feel like you go on Google and it doesn't necessarily take you to the great lawyers. Referrals. There's a lot of referrals you can get. I would always work for a referral for a really good lawyer or an advisor.

27:02Oftentimes, a startup might have board members who they should discuss with and figure out who would they recommend. I would go with recommendations rather than just a blanket Google search. You do want someone that has experience working with startups that have seen these type of contracts or have dealt with cap tables and things of that nature. So someone that has experience with more startup formation, extremely important. What's the one or two questions you'd ask to make sure you got the right lawyer? I would always want to deal flow, understand your deal sheet and who they worked with and the outcomes of those deals.

27:31Just to see a company they represented and whether those companies have gotten into any issues or whether they've been successful exits, etc. I would also look at just their caliber of their talent, which law firms they come from. There's a lot of more independent advisors and law firms that have come from larger law companies and have then created their own separate business. Those are often good advisors who are probably more cost-effective than some of the larger law firms that are out there. And then also to kind of just understand their current customer set. Who are they advising? Are they a lawyer for a similar company in your space?

28:03It just gives you a little more comfort that they understand your space, they understand how legal terms are being negotiated within your space. And so it gives you a little more guidance in terms of what you should be looking for, especially when you're negotiating cap tables or terms for your deal or fundraising. Someone that has experience within your key segment is extremely important. And then on integration, what's the approach there? You mentioned you want to plan integration early, but how do you actually do that? I think integration is probably one of the most underrated functions within CorpDev is sometimes gets overlooked because it's the hard part, frankly.

28:38It takes a lot of effort to integrate a business, but it's a very crucial part of M &A. At Toast, at Square, at Yahoo, integration sat within our CorpDev team and it played a pretty integral part of our deal process very early on. So we would bring integration from the very beginning. Even before we signed a term sheet, we would inform integration about deal, what aspects of the deal are important to us, why are we doing this deal, and then have them start joining us and shadowing us as we get into the deal process. And then once we actually do start diligence, we would have integration join all of our cross-functional diligence sessions so they can hear and understand where we might have potential issues in terms of integration or areas where we will have to figure out a integration plan.

29:19But I think it's very important to have this person or this team dedicated to post-closed integration rather than just having someone doing at the side of their desk, but having dedicated individuals doing this can either make or break the deal. A lot of people talk about this. integration and I'm trying to get a sense of how do you know when you're hitting the right level of detail? Because I feel like you can start a deal process and say, okay, here's how we're going to integrate our companies. We're going to move our sales team here and the product's going to go here. But then when you really look at all these things, there's so many things that could be assumptions that are totally wrong.

29:54How do you really know the level of detail for integration planning to know that's actual integration planning versus just hypothesizing? A lot of integration planning is done in collaboration with the cross-functional teams. We do something called blueprinting, where we have a view of the current state, and we lay it out. What's the current state of the target for each one of these functions? What would be the 30-day, post-30-day close status? Where do we want to be? Where do we need to be? How do we know what needs to get done by day one readiness? And then what's the long-term plan? Eventually, do we want to migrate ERP systems?

30:27Do we want to migrate them into workday? Do we want to move our Salesforce instance together? All of those things cannot be done on day one, but we'll have a viewpoint on where the company is today, what is feasible in the 30 days post-close and what needs to get done day one, and then where we want to have the end state. We work pretty closely with those cross-functional teams post-close to hold them accountable for at least the first 30-day plan. And then post-30 days, we start planning out when we can complete the rest of integration. It is a moving process. It doesn't all get done day one because as you acquire the business, you uncover new things and priorities change, viewpoints change.

31:05We might be doing something within the company that might no longer make sense from that integration process. You have to kind of be willing to change things as they come up. But I would say at least the current state and the first 30 days, you can have a pretty good viewpoint with the cross-functional teams prior to close. It's really the 1690 and then the 180-day plan that takes some time and usually gets moved around quite a bit. The fact you refer to it as blueprinting gives me a good sense of the details to get into and how you referred to this before and after state. And it sounds like it's a pretty broad initiative that goes far beyond just corporate development in terms of who's involved to do all that planning.

31:42Yes, absolutely. We're lucky enough when we're at a bigger company where you can have cross-functional teams who are experienced to come in and help out with diligence, but they are very much involved throughout the deal process as well as post-integration. They're the ones that make the integration happen. It's not just the prop dev team. That's when all the hard work happens, to be honest, for a lot of teams. And it requires a lot of thinking and a lot of different approaches to get there and make sure the deal is successfully integrated. But it's very much collaborative. And it continues for many different quarters post-acquisition as well.

32:14So it's not something that just happens first 30 days and it's over. We track acquisitions for many quarters post-close and we're accountable until the deal is integrated. What if you're a smaller 2-300 person company? Maybe you have a half a corporate person there. there is no real dedicated integration resource. How would you approach it then? Would you simply bring in functional leads and give them that similar exercise for integration planning? So usually when we do acquisitions, we would have the acquirer side take the lead in terms of integration. And we would find a party within each cross-functional role.

32:51So there might be someone that's wearing a hat for accounting and tax. That person will be the liaison with our accounting and tax individuals. Same thing on the HR side, whoever is holding that hat today. They might be involved going forward as we get into 30, 60, 90 day planning. So we usually find that individual that's spending the time at the company to help us make that decision. Sometimes you might not have anyone, frankly. And so they're fully reliant on you to figure out what do you think the best plan is. At that point, we usually work with the founder to determine what's the best approach.

33:20But we would take more of the heavy hand in terms of determining what's the best end state. Okay. So pretty dynamic in the approach based on the situation and company sizes and structures. But ultimately, you want to get to the details and have a good plan in place. You have to get into the details. A really good integration leader is someone that can get into details, has seen these integrations happen before and where they failed, but also help keep the teams motivated and accountable. We say we will do something post-close. And then if we get busy and we don't prioritize it, that integration doesn't happen.

33:54And oftentimes that can hinder the business and the deal pieces. So we spend a lot of time making sure we are meeting on the regular with our cost-functional leads. And then also doing things like scorecards where we measure the success of the deal. We have clear KPIs that we're tracking and report that upwards. So when there is something that's falling into the cracks, we quickly address it and make sure we try to keep things on the same track going forward. How early do you define those key KPIs? Oh, before deal close. So you have a set of KPIs for which you will be accountable for the deal pre-close.

34:24And by the time you close the deal, we start tracking that. You have some principles on doing deals. Can we talk through them? There are different principles we use. There's key areas where if one of these principles no longer is true, we will reconsider the deal. One is the deal thesis. The deal thesis and why you're doing the acquisition. If during diligence, something changes and that deal thesis no longer holds true, then we reassess whether it makes sense to continue the deal. The other is a financial profile of the business or the health of the business. If we uncover that the business is not as healthy as we had expected, they're losing customers or churn is higher than we expected, or we don't think we can cross sell, or there might not be synergies, then we reassess whether it makes sense to do the deal, or maybe it makes sense to do the deal, but at a lower valuation.

35:09And then the team. Without the team, you cannot do this deal. At the end of the day, you need continuity post-close, at least for a period of time. If you acquire a business and majority of the team leaves, you're going to have a really unsuccessful deal. Ensuring the founders are on board or the CEO, and then a good portion of the team is willing to sign offer letters and join the company post-close is really important. And so getting ahead of that is something that we like to ensure as well. If for whatever reason, we cannot get the team on board, we probably wouldn't proceed with the deal because it will basically mean that we're going to have to inherit a company, the infrastructure and rehire and retrain folks to start working and inheriting that business and P &L, which is often hard and impossible to do.

35:51These are three good pillars that make a lot of sense. You got to have your your deal thesis concrete, can't compromise on that. The financial health of the business, that QAV comes back with some surprises, that's not going to be a good thing. And the team, you don't want some key folks that aren't going to be around to drive close-close success. We skipped over listing the non-negotiable. Can we talk through your approach? Does it fit into this with the deal thesis and some of these other elements? I guess, how do you go about what are examples of listing your non-negotiables and sticking to it?

36:20The deal thesis, financial profile, the team, we have those that are kind of our non-negotiables or our principles that we end up using for the deal thesis. So things that for sure we don't want to bend on. Writing it down earlier on in the process is really helpful and healthy because oftentimes if the deal prolongs, you forget about the non-negotiables. You're just trying to get the deal done at some point and willing to kind of knock down an issue and then move things forward. But when you actually look back at the things that we said we would not negotiate, yet we're at the table negotiating that, you need to reassess whether we should be doing that or not.

36:52So having it written down and having clarity with the deal sponsor, what is really important and what we can bend on really helps bring a little light into the negotiations and helps you figure out a path forward. Sometimes there's no path forward and you just decide this deal is not worth doing. Sometimes you're willing to bend, even though it's a non-negotiable, because at the end of the day, you still think the business is a great business to acquire. And we might have to find a different way to just remediate the risk. But it helps us at least alleviate some of the concerns and also enables us to be a little accountable when we're thinking about acquisitions.

37:24What are examples of non-negotiables you would list out? One negotiable is like whether it would harm the current business. If we inherit this business, would it put us in harm's way from a regulatory aspect? Would it ruin the way we think about our accounting structure? or would it impact the way that the rest of the company operates? Things that kind of have to be really detailed and something that could be really impactful to our current business is something that we would consider non-negotiable. It's often probably the larger deal where you might have things that can be really impactful to your current business.

37:55Or maybe it's like a principle, right? Something where the company did something and we think it's fraudulent and we don't want to associate ourselves with a company that's done fraud. And we don't want to obviously associate with companies that have done anything that's been fraudulent or neglected or things of that nature. And so those are things that are non-negotiables on the legal side. From the people's side, if we feel like someone is just ethically not behaving the way we would have expected them to behave as an employee, that's a non-negotiable for us too. Whether they lied about something in the diligence process and we uncovered it, that's something that I would say is a non-negotiable, that we would likely cancel the deal or at least address it with the founder or the CEO.

38:30And then if we're not able to reach resolution, then we would actually not do the deal. But things that are really impactful and can really hinder the company post-close. How do you incorporate that into your process? Is it something you do as a team activity? We list this out and discuss what our non-negotiables are? Or is it just something that is generally known deal-to-deal? I would say it's something we do deal-to-deal. Depends on the size of the deal, right? If it's a small deal and it's more straightforward, it's a lot easier to think about your non-negotiables. If it's something where it's a larger deal for which we got comfortable, then we would align with it with the deal sponsor and make sure we're in agreement because it enables us to then be in a position where we can negotiate where it matters.

39:09If we know we're willing to bend on XYZ, it enables us to then when we go into the negotiating table to have something to trade versus other areas that we know are non-negotiable that we're not willing to trade on. I wanted to talk through real life examples. I'm hoping to learn how do you overcome the hurdles and work with the target company specifically? And I'm sure you got some fun surprise stories because we didn't talk so much about the surprises that come up. It's honestly more of an art than a science on how you deal with these issues. You have to remember at the end of the day, the founder, the CEO, they have been building this company for many, many different years.

39:46This is their life's work. If you find issues and you need to address it, you need to be empathetic. You can't just go in and list out a bunch of issues and then leave them. Think about it for days on end. You need to really be tactical and go in and be direct and often rip the bandaid at the very beginning, but be transparent about it. Like we found an issue. We think the exposure is XYZ. We need to think about a solution here, but we have a couple of options and go with more of that collaborative approach versus just laying down all the issues and then letting the CEO or the founder just dwell on it is often a recipe for disaster.

40:17Oftentimes also, we want to make sure we're fully bulletproof when we actually present an issue to the target company. Sometimes it might be our understanding. Sometimes it might just be a mistake in kind of how we comprehended something. When we do discuss issues with the company, we want to make sure we really have bulletproof evidence that was the case and then present it in a way that we can make sure that they understand there are options. It just means that we're going to have to think about the risk a little more and potentially think about ways to kind of mitigate that, whether it be an indemnity, whether it be a purchase price reduction or whether it be something else altogether.

40:50It'd be pretty collaborative in working with the target to overcome the hurdles. We obviously spend time internally before we kind of talk to the target about it. We'll talk about it with our sponsors. We'll talk about it with our executives to make sure we're all on the same page. We often do find a solution. It's really about kind of risk balancing. Who bears the risk? How much are you paying for this company? Are you paying top dollar? And if you're paying top dollar and a really high premium, then your expectation is that you want a very clean company. And if the company ends up being very messy and there's a lot of exposure, then you're not willing to pay that same price.

41:22You have to have those type of conversations, but be collaborative about it. Explain why, get them over the hump to understand it, and then help them figure out a solution. Interesting enough, usually when you're through the deal process, a company is usually pretty invested in a deal at that point and are willing to work with you to figure it out. What are examples of surprises you've come across? I found a bunch of issues in relation to IP assignments where the IP is not owned by the company. Understanding that and then working with the company to help untangle that was something that I dealt with in a deal a couple of years back.

41:52In one acquisition I was working on, the company had publicly stated something about their platform, which was very key to their platform on their website. And it was kind of the way they marketed their platform all across. And after we did diligence, we realized that it was absolutely false. and what they were claiming was actually not true at all. And when we approached the CEO about it, they actually turned what we said into their favor. They just twisted the language and turned it into their favor and tried to pull it under the rug. And that became very clear to us that it wasn't just comprehension or a difference of opinion.

42:24It was really the ethics of the company and kind of how they try to find ways to kind of navigate a messy segment that they were a part of. At that instance, we actually decided to walk away from the deal due to many reasons, but one of them was just the ethics of the company. They just weren't very straight shooters. And we were looking at paying a really top premium for the acquisition. There's other deals that I worked on where we found so much tax exposure. It was about 50 % of the purchase price, which is never great when you have so much exposure. So negotiating indemnity where 50 % of the purchase price is in the form of tax exposure is pretty wild.

42:59That's just when you see taxes just go really wrong. I've also worked on a deal where the company had their top three vendors, which were very important to how they continue their business. When we actually dug into it, we realized that they actually didn't have any signed contracts. They had everything was done through handshakes, which is pretty scary because once you've acquired the business, those handshakes no longer work. And so we actually needed to go and renegotiate all of their key contracts prior to the deal closing. And so that was a beast to do. We ended up doing it on a deal, but it was also very messy and very interesting to see.

43:30Again, it was a new business segment, one that we weren't as comfortable with before. And so new players that we haven't dealt with. It was an interesting way to navigate. But that often happens when you have a company that's been growing really fast. They might have signed up vendors and contracts. And it's just very messy paperwork. Unfortunately, that messy paperwork gets inherited for the acquirer. And so you really need to do a good part of trying to remedy some of that post-close or even pre-close. Wow, those are some great stories. But it's fun. Honestly, those are what keep me in M &A.

44:00I've been in M &A for almost two decades now. And that's what keeps it interesting. So Ritika, what's the craziest thing you've seen in M &A? Diligence really, really matters. And I think there's a lot of scary stories out there, even more recently about companies who didn't do their diligence and they ended up investing or acquiring a business that ended up being just a sham. Luckily, I've never been in that position. But I have done diligence on companies where what they claim to be presenting publicly was totally false. And so for me, that's always been a red flag. That to me is like a Ponzi scheme.

44:32It's just a house of cards ready to kind of collapse. Sometimes happens, sometimes doesn't happen. But when I do see that, and I'm often running the other way because you know that there's going to be issues and it's just another kind of story to be heard in the next TechCrunch. So I try to stay away from those. But that's probably the craziest story that I've seen is when a company just blatantly is lying about what they've built and then publicly stating that they've built it and then not being truthful, even when it comes across that they haven't built it. It's interesting that you don't cite one example.

45:03You've seen it more than once. I've seen it more than once. You can't say where. You see it a lot. That's why diligence is really important. You want to try to do as much diligence as possible. Make sure you have the right experts to help you think through and look at diligence throughout the process. There's no shortcut to good diligence. Jika, thank you so much for your time today. This has been a great conversation and you're helping me become a better M &A scientist. You're welcome. I enjoyed myself. Thanks for having me. Until next time, here's to the deal.

45:43Thank you for taking the time to explore the world of M &A with our podcast. We love hearing feedback. Tag us on a LinkedIn post, add a review on Apple Podcasts. We'd love to hear from you. If you need help standing up an M &A function or optimizing one that you already have, we're here to help. And if we can't help you, we probably know someone that can. You can reach out to me by email, Kisan, K-I-S-O-N, at mascience.com. Or you can text me directly at 312-857-3711. If you just want to keep learning at your own pace, visit mascience.com for a lot more content and resources. That's where you can also subscribe to our newsletter.

46:28Again, that's mascience.com. Here's to the deal.

46:42views and opinions expressed on mna science reflect only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual this podcast is purely educational and is not intended