The booming public markets, rising valuations and increasingly active Private Equity firms helpedg drive an increase in more complex tech M&A deals--stock, earnouts, debt and other structural methods are being used to bridge gaps and get deals done. But more complexity can mean more risk if you aren't properly prepared. Corum's global team of senior dealmakers shared 12 deal structure tips to help you achieve an optimal outcome when you sell your technology company. Plus a special report - Trump and M&A: What does this mean for you?
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Good day and welcome to Tech M&A Monthly for November 2016. I’m Bruce Milne, CEO of the Corum Group, and your host for today’s event.
We have a jam-packed agenda. We will be featuring a presentation on Trump and Tech M&A: What Now? Our 2016 research report, and then 12 deal structure tips to maximize value, and we’re actually going to add a 13th.
Trump and Tech M&A: What Now?
Let’s get right to it with the impact of the election. What do we see?
First off, we’re not that concerned. I was listening, like many of you, to late night broadcasts, and I saw Carl Icahn up there and one of the reporters said, “Your man is going to win, what do you think? Futures are down 800 points.” And he said, “Really? I didn’t know that. That’s silly. Time to trade it.”
And that is exactly what he did, overnight he put a billion dollars in the market, and it recovered. It hit new highs yesterday and again today. We don’t see much impact, it’s a little like Brexit. What we see in our industry is that disruptive technology is driving M&A, you have to have strategic imperative to acquire. There is an urgent need for growth and unlimited access to capital, historic low cost of debt, and record cash out there.
Speaking of cash, let’s take a look at this. One of the problems that we have mentioned before is that a lot of the cash of American companies is offshore. When Obama came in, he immediately stopped allowing them to have any kind of a tax holiday or even pay dividends, which would have generated a lot of income to the government. Instead they went and put it in debt. So there is somewhere between 2.5 and 3 trillion dollars in all companies. Tech companies, as we see here, have about one trillion of that. Apple alone, as we see here, has about $230 billion. Microsoft has $113 billion and over 70% of that is offshore. If they go back to what we were doing during the Clinton and Bush administrations and allow them to repatriate that money at dividend rate of perhaps 15% the government wins and we pump hundreds of billions of dollars into the American system. Investments in jobs, buying stocks and real estate, and more importantly, we think, acquisitions. With funds like that they aren’t just going to be able to issue dividends or buy back stock, they will want to grow and make acquisitions. We think there could be some record activity on the domestic front.
What markets do you think are going to benefit, Elon?
Well, Bruce, a quick sector survey among Vertical markets, AEC and tech company sellers stand to see relative gains, as do government productivity tech providers. While another round of churn in healthcare systems and the ACA will undermine existing compliance tech value, but create new opportunities.
In biomed, the prospect of reduced regulation has already popped many public market values with deal values likely to follow suit.
Turning to Horizontal, we see HR compliance waning while demand for training companies increases, along with BI, SCM and ERP, where it will help with change in international supply chains and dispersed manufacturing.
Internet sector uncertainties will produce downside risk to values of ecommerce and travel-related sellers, while the social-network related sellers that are positioned to share in accelerated revenue capture from old media will see that reflected in their M&A value as well.
Finally, in IT services our call at this term is for the closing of the gap between the emerging and developed market multiples to proceed even faster than its current trend line. We will dig further into these and other implications in a subsequent special report, but that’s our first take. Back to you, Bruce.
Thanks, Elon. We’ll have more on that next month.
Corum Research Report
Now let’s go to our Corum research report with Amber Stoner, Amanda Tallman, and Thomas Wright.
Firstly, congratulations to Amber for her promotion to Director of Research and Amanda for her promotion to Senior Analyst.
Thank you, Bruce.
We start with the public markets, where all 3 indices we track returned to July levels as part of a pull-back amid the uncertainties of US elections and other incipient changes, giving the Bull reason to pause before charging forward this week erasing last month’s losses after the election, with the Dow hitting a record yesterday.
Our advice remains that tech execs should take advantage of this window of opportunity to at least calibrate the value of their assets, since our Corum Index still shows a relatively strong market in spite of a slow-down on last month’s total volume of transactions after the mid-year boom in spending. There was a significant increase in PE activity as we tracked a swing back toward smaller deals and saw a record number of new clients here at Corum along with increased buyer interest. Megadeals held steady with the largest being the $39B acquisition of NXP by chipmaker Qualcomm which we’ll be addressing in more detail next month.
Speaking of megadeals, another chipmaker Broadcom spent $5.5B for Brocade to diversify beyond its core storage networking business. Broadcom plans to divest Brocade’s IP Networking business, which includes the recent $1.5B acquisition of Ruckus, to focus on Broadcom’s ability to address the growing needs of its OEM customers.
In the travel booking world, China’s Qunar was taken private by a consortium led by investor Ctrip for $4.4B. We’ll unpack more M&A deals in the travel subsector a little later.
Another consortium, made up of UK-based private equity firms, paid $3.2B to get e-commerce company Allegro from Naspers in one of the largest ever takeovers of a Polish tech company.
And while not counted among the tech deals, AT&T’s $85B purchase of media conglomerate Time Warner could lead to AT&T using M&A to bolster its recent megadeal with technology allowing it to compete with rivals Comcast and Verizon. Comcast and Verizon have also made billion dollar media content acquisitions in the last few years, followed by smaller tech deals to fill in gaps. It is likely that AT&T will likewise complement its record media purchase with similar advertising and content services tuck-ins going forward. However, the deal must still overcome regulator hurdles, and the president-elect has asserted that his administration will not approve the deal, so we’ll have to keep watching to see how this plays out.
In the meantime, let’s go to our market sectors, starting with Consumer, Amanda.
Consumer Software Market Valuations
Sales multiples in the Consumer sector dipped down a bit towards May levels, but EBITDA metrics kept the upward trend they exhibited through the third quarter.
Canadian YouTube partner any.TV was wrapped up by Hong Kong-based private equity firm AID Partners for a reported $60M, with an eye towards rolling out its product in Asian markets, with possible alliances with the Chinese video streaming platforms like Tudou and Youku. For AID, the deal might foster further acquisitive moves going forward.
Down in California, Influencer Marketing Platform FameBit was picked up by Google to tighten connections between YouTube creators and brands and to boost its marketing capabilities.
In the gaming space, Russian video game developer Pixonic was bagged by Mail.ru for $20M in cash and a $10M KPI-based earnout to break into the worldwide free-to-play audience. In the American Midwest, gaming studio PerBlue, maker of the DragonSoul RPG franchise, was acquired by Japan’s GREE for a reported $28 million in cash and a $7 million debt payout, another example of Asian demand for successful gaming companies with original IP.
Finally, following its acquisition of DEQ Systems, Scientific Games nabbed its second Canadian gambling company, purchasing Karma Gaming. The addition of its interactive games suite will allow Scientific Games clients to move seamlessly between the retail and mobile/online lottery entertainment experience.
Moving on to the Internet sector, Amber?
Internet Software Market Valuations
Sales and EBITDA multiples in the Internet sector dipped last month, with the travel sector remaining active in M&A.
Just a day after being taken private Qunar sold its homestay business to China-based online vacation rentals company, Tujia, which also purchased the homestay business of Ctrip, playing on China’s growing appetite for travel and pumping up its global accommodation offerings after its purchase of the short-term rental platform Mayi.com in June.
Сtrip itself did a deal in China’s online-to-offline travel market by acquiring rival booking platform Traveling Bestone.
India’s travel market has been consolidating with no less enthusiasm as ibibo Group, a travel and ticketing operator, was snapped up by its major competitor MakeMyTrip for $720M in stock to complement each other’s platforms and potentially create one of the leading travel groups in India. And Directground, an online directory for finding sports and recreation in India, teamed up with Play Your Sport.
In Europe, consolidation in the travel segment is happening on a somewhat smaller scale. Italy’s Agriturismo, a vacation rental property website, was scooped up by Feries to create a local non-hotel hub for travelers worldwide.
And the German AirBnB rival Wimdu was picked up by Singapore’s 9flats to try to mitigate the risks caused by European regulations on accommodation platforms by adding scale and reaching into more geographic regions.
And that brings us to the IT Services sector, Thomas?
IT Services Software Market Valuations
IT Services valuations sagged slightly this month, with EBITDA multiples dipping and sales multiples holding constant. While the sector experienced several consolidation waves, starting with System integrators.
Australian Salesforce and marketing systems integrator Cinder Group was grabbed by Deloitte Digital to strengthen The Big Four firm’s regional presence and add marketing optimization to its Salesforce implementation offerings.
In Virginia, non-profit and higher ed salesforce systems integrator ACF Solutions was bought by traditional IT provider Attain, to expand its services from the public sector into the adjacent semi-public markets – illustrating a recent M&A trend: using acquisitions to gain admission into markets with high barriers of entry such as nuclear power, defense, or government.
Indianapolis-based Appirio, a SaaS integrator focused on Salesforce and Workday, was snapped up for $500M by India’s Wipro, in an attractive, all-cash deal structure. As one of the last high profile, independent SaaS integrators, the sale of Appirio signals a new phase of SaaS integration consolidation of mid-market deals.
Consolidation has also dominated the value-added ecosystems around other major product lines such as SAP, Oracle, Microsoft, and others. Utah-based Asset Management Engineering was purchased by IBM partner ValuD, which wants to expand its footprint in the IBM ecosystem.
Private equity firms continued their buying spree as Texas-based Masergy-traded PE owners, with Berkshire Partners purchasing the cloud expert for $900M from our top acquirer ABRY. Deal flow continues to be up among Private Equity firms, as financial buyers still have access to record cash deposits and low interest rates – for now.
Finally, as we have mentioned several times recently, non-traditional buyers are populating the M&A landscape. Maryland-based Integrity Consulting Solutions was acquired by non-tech financial services provider WeiserMazars, which is looking to utilize Integrity’s broad IT expertise to diversify its service offerings with a division with lower overhead and higher margins.
And just last week, Intel moved further into the realm of sports following its acquisition of Replay and the formation of new business unit Intel Sports by picking up live virtual reality software provider VOKE in order to deliver an immersive sports experience for athletes, fans and content providers.
A timely deal following the Cubs’ historic World Series win, right Bruce?
Cubbies! Yeah, like that. Thank you very much, guys.
Special Report: M&A Deal Structures Today
In our conferences we talk about all the elements of doing a merger, preparation, research, contact, etc, and we explain that we think structure is more important than price. We have a role-playing exercise we do where we take three people in the audience and tell them that we’re going to give them $50 million, and they get very excited. We tell them that the press release is that night.
However, we tell them that one of them is going to get unregistered stock, one of them is going to get all earnout, and one of them is going to get cash. Which one do you think they should take? I hope you all say cash immediately.
The point is that structure is absolutely critical. Let’s talk about the various components of structure, beginning with before you even do the deal, going to Steve Jones in Salt Lake City.
We at Corum are committed to generating the optimal outcome for you and your shareholders.
But you shouldn’t wait until the day of the transaction to put in place the right vehicle to shelter your new wealth.
It is imperative that you begin now with the end in mind.
You should consider the benefits of structuring your personal ownership of the company into a trust that can provide significant tax protection to your estate.
The earlier you do this, the lower the valuation of your company which will reduce the taxes owed versus being exposed at valuation levels that will be their highest at time of exit. In addition to a lower tax rate, there are ways to gift a portion of your holdings to your estate that will eliminate taxes altogether.
Tax liability, gifting opportunities, personal protection and control are all critical elements of estate planning for company owners to safeguard their investment.
You’ve worked your tail off... so protect yourself now to enjoy the maximum benefits down the road.
Very important topic, Steve. I’m not sure if a lot of you are aware of it, but you can gift a total of up to $5.5M, so if you want to do a valuation of your company, the non-voting shares will be a much lower price, so think about setting up gifting through a trust. There’s a lot more that we’re going to be talking about in an upcoming Estate Planning and Tax Tips conference.
Now let’s go to Rob Griggs in the Midwest to talk about Asset versus Stock.
Deciding whether to structure a business sale as an asset sale or a stock sale is complicated because the parties involved benefit from opposing structures.
An asset sale is the purchase of individual assets and liabilities, whereas a stock sale is the purchase of the owner's shares of a corporation.
An asset sale of a C-Corp is particularly burdensome as the gain will be taxable to the Company when they sell the asset, then taxed again to the shareholder when the funds are distributed. Asset sales can not only involve tedious valuation of each asset class, but may well require sign off from customers whose contracts are considered an asset. Getting these sign-offs will at least delay closing, maybe kill the deal.
Sellers often favor stock sales because all the proceeds are taxed at a lower capital gains rate, and in C-corporations the corporate level taxes are bypassed.
These are very complicated elements, having strong advisors can smooth your path to your optimal outcome!
Complicated indeed. One thing to remember is that when you are negotiating, you are basically diametrically opposed with the buyer. What they want in terms of price, structure, liabilities and ongoing warranties, employment agreements, non-competes, etc, is very different from what you want. What is good for them is not necessarily good for you. Therefore, what you need to do is make sure that as you go along you are not serially negotiating and set basic structures. For example, we just saw a structure where no one said anything and then the buyer said, “Okay, I assumed you assumed this asset sale.” The company went ahead and let that happen and now they’re trying to claw that back. It should never be an asset sale, and we’ll expand on that in a minute.
Now to expand on our present idea, let’s hear from Dave on Cash versus Stock.
Agreeing to the form of consideration when you sell your company is one of the most important choices you will need to make.
Choosing whether to accept cash, stock or stock options or even debt will each have their own benefits and risks.
Depending on the buyer, they may test the waters to see if you’d be open to taking their stock as part of the transaction.
Cash is generally the best option, however, if you are dealing with a company whose stock is expected to perform well, this may be a serious consideration.
Even if the buyer is public, will you have registration rights and is there enough float and daily volume to handle stock sales if you want to sell? It becomes more complicated if the shares that are being used to purchase your company are from a private company. If so, is there a Put provision in the agreement?
Can you sell with founding shareholders when they go public? With private companies, valuation will be a key element and don’t overlook the need to include anti-dilution provisions as well.
In addition, evaluate the tax impact of taking each of these forms with your tax attorney and accountant as each of them will have different tax treatment.
Great stuff. Again, I want you to take the lead in setting the tone for what you will accept in structure.
Speaking of taxes, let’s hear from Steve.
Rob talked about asset versus stock sales and the typical buyer preference for asset acquisition.
But be warned that the IRS becomes a third party to the transaction and their take can be dramatically different based on structure.
This is the first tax trap.
The structure of your company makes a huge difference.
An asset sale in a C-Corp can result in double taxation since any gain will be taxable to the company, then gains are taxed again as individual income when funds are distributed to shareholders. In a stock sale, the proceeds are only taxed once as a capital gain which usually results in lower total taxes paid.
Sellers will also often try to push purchase consideration into employment agreements.
This is the second tax trap. This is advantageous to them, since it can be deducted for taxes in the year of the expense.
The problem is that it becomes highly taxed ordinary income to you.
Taxes are complicated.
You need a profession advisory team to ensure you get an optimal deal.
Thanks, Steve. Let’s take a look at this a little closer. I have pulled a slide out of our Selling Up Selling Out seminar. Just take a look at this. Here’s a stock versus asset sale, in other words, you’re going to sell your stock and your ownership in your C-Corp versus selling the assets. You started with $100 and look at the bottom here. You’re only getting $47 versus $77. The reason is the double taxation. It went into the company and then to get to you it gets taxed again. Which one do you want?
This is why it is so important to look at whether you are selling your stock or your assets. Asset sales seldom work, also because of liability issues.
Now let’s move on to related earnouts and hear from Dan.
Earnouts: The most litigated portion of any M&A transaction – this should say it all.
When properly structured, they can work well, but, determining the right amount of integration, full, partial, or none, into your acquirer, having solid and demonstrable goals and reporting, will yield a higher chance of success.
Regardless, we see earnouts as “icing on the cake” where the cake is the initial consideration and earnouts are often structured to bridge the “valuation gap” between what a seller really wants and what a buyer is willing to pay.
Now let’s go from Dan, who has been in Singapore doing a conference to Jim who has just completed a transaction in China with what to avoid in earnouts. Jim?
Deals today, particularly larger ones, are typically structured with a large portion of cash up front and some sort of earn out scheduled for post deal closing lasting from 1 to 3 years. These can be based on EBITDA, sales performance, retention, and other measures.
Earn-outs can be quite rewarding for the seller if structured properly.
There is potential to outperform and therefore earn more for the seller than the anticipated enterprise value at closing.
We've seen 20 to 30% upside as a result.
However, when structuring an earn-out, here are factors to avoid.
Ambiguity - the earn-out must be clearly measurable with as few interfering external or buyer factors involved as possible.
Even the simplest earn out can prove to be difficult to measure when the time comes to pay that to the seller - keep it simple.
Define roles and responsibilities of the buyer and seller post sale, prior to closing the deal.
This is important in any deal, but with earn outs, it's crucial. If the buyer can negatively influence your earn out performance, what the point of the earn out.
Have a tight integration plan documented before closing the deal.
And post-sale, during integration, constantly monitor the performance of the earnout with buyer and seller involved, so that when it comes time to pay that earn out, there are no unanswered questions.
Great. We have on our website a video of 10 CEOs who sold their companies, we took them fishing. One of them is Eva Costiok, who said, “I thought it would be all about price and structure. We spent most of our time on liabilities.”
Let’s hear from Jon Scott in Amsterdam to talk about that.
A client once told me that the most important part of the sale of their company didn't turn out to be the valuation or deal structure, rather it was the liability the seller was responsible for after the deal.
What if your biggest customer walks away after the transaction or someone claims ownership to some of your IP?
In the agreement these are things like representations you make about your company and warranties you have to provide if something goes wrong.
Some of these are covered by an escrow of an amount of the sale price at closing but, if not managed properly in the agreement, you might be responsible for paying back the entire purchase price, or more.
It is true, liabilities can kill you!
Now let’s talk about escrows and holdbacks and hear from Rob at HQ.
To satisfy potential future indemnity claims, a portion of the purchase price is withheld in the form of an escrow or holdback - the difference being whether the funds are held by a third party or the buyer.
Escrow terms describe the percentage of the consideration withheld, the survival period, how and by whom the escrow is to be funded, and so forth.
A basket provision may be included, detailing the minimum amount of damage the buyer must sustain before the seller is required to pay for losses. A cap provision places a limit on the aggregate of claims drawn against the escrow but some liabilities, like IRS audits, taxation, intentional fraud, remain uncapped.
Generally, we see escrow amounts in the range of 10-15% and a survival period of 12-24 months. The exact numbers depend on the inherent risk and the likelihood of liability. One of the advantages of having multiple buyer candidates in an orchestrated engagement, is that escrow, like all structural elements of the agreement, can be negotiated - and we’ve seen escrow completely taken off the table to sweeten a buyer’s LOI and win the deal.
Now let’s go to Peri in Portland to hear about who stays with the deal.
Certainly one of the important elements of deal structure is identifying who stays on post transaction.
From the buyer’s perspective, they’d like retain all the key people who built the business; this specifically applies to the subject matter experts and technical people. Buyers are much less interested in retaining stakeholders who were primarily investors but not direct contributors. This can create conflict between the active and passive investors on the seller’s side.
In times past, relocation was often an issue, but today we’re seeing fewer and fewer companies require it.
Bottom line, as a founder do your best to express flexibility and interest in the future entity as this will ultimately result in a better outcome for you and other key stakeholders.
Now let’s hear from Allan Wilson in Texas on employment agreements.
You are negotiating your employment agreement because the business you have built is about to be sold. You are negotiating with someone whose primary motivation is to make the acquisition successful. The reason this negotiation is taking place at all is that they see you as being important in the transition and its sustained success. It is therefore important that you make it clear that you want to contribute to that success.
This is no longer your company, you are about to be part of a team, offering ideas to contribute will help you achieve the best personal agreement. This is no time to grandstand. Offering ideas and demonstrating a willingness to help make the integration of your business into theirs is by far the best approach.
Sage advice, Allan. Now we’ll hear from Peter in England on non-competes.
By a broad definition a non-compete is an agreement by which the buyer protects its investment by restricting the movement of an ex-shareholder. In short, it prevents the seller either working for a competitor or starting a new business in a competitive situation.
These aren’t always involved, but we do see them particularly in larger deals, and in deals involving more complex technology. Imagine if someone just paid you a billion dollars for your company, they don’t want to see you showing up as a competitor ever. However, there are restrictions in certain jurisdictions, so the average we see is about three years; typically lasting longer than the employment agreement. Generally they cover using your domain expertise, knowledge of code, clients, and other proprietary information.
Good stuff. Thank you. Now we’ll hear from Ivan on integration.
When one company acquires another, it invests a great deal of effort and treasure to quite literally buy a piece of its future. Yet, in over 50% of cases, the transaction is a failure. There are lots of reasons why deals don’t work, but an important one is the lack of a well-considered, well-communicated and well executed integration plan.
The plan should always start with the specification of a “go forward” operating model. Remember to pay special attention to risk mitigation, how you’re going to manage cultural differences and development of appropriate staff retention packages.
Before closing, both sides should contribute to an integration task force led by a dedicated executive to guide the process.
The first 100 days after closing will be vital, so ensure you have a good communication and feedback mechanism in place, and that the integration team is empowered to ensure a smooth transition.
Having been acquired twice, I can personally testify to the fact that good integration doesn’t “just happen.”
Good stuff, thank you, Ivan.
Lastly a couple of closing comments related to integration.
If you want to be successful, you’re going to have to be considering other types of folks that aren’t being taken care of. You may want to keep them or perhaps in your ownership structure you didn’t allow for some folks that should have gotten more. There are a couple of ways to take care of that.
One is through sharing who pays the cost of closing. Staying bonuses that can be taken out of cash. Completion bonuses if there is a product to be completed. Stock options or notes, profit sharing, no cut contracts where they are paid money if they are cut. There are a lot of ways we can manage both integration to keep the people and also to handle if there is any disparity with ownership in terms of getting benefits.
We’re right at the end of our time here.
If you’re wondering about this market place and want a no-cost assessment, we can have an analyst talk to you. I can tell you right now that every company in every market out there is getting a lot of interested, we’re seeing record levels of that.
We have a few questions that we don’t have time to address, so we’ll respond to those offline. Thank you very much for attending today.