What happens when a company receives an acquisition offer? What does due diligence require? Should you go with an asset deal or a stock deal?
In their book Venture Deals, Brad Feld and Jason Mendelson break down the complex process of company acquisitions. From letters of intent to due diligence requirements, they guide entrepreneurs through the essential steps and decisions involved when selling their business.
Let’s explore the key elements you need to know before signing that acquisition offer on the dotted line.
Managing an Acquisition Offer
Feld and Mendelson explain that receiving an attractive acquisition offer is often the end goal for many startups and their investors once the company has achieved a certain level of financial success. However, they warn that acquisition is a complex process involving multiple parties—from the acquiring company to shareholders, board members, lawyers, and other stakeholders. We’ll cover two concepts you should understand when going through an acquisition: how letters of intent work and the differences between asset deals and stock deals.
Letter of Intent (LOI)
A letter of intent (LOI) signifies a potential buyer’s serious interest in acquiring your company, indicating that they’re ready to discuss terms more formally. It outlines the basic terms of an agreement before the actual deal is finalized, laying out key elements like purchase price, structure of the deal, due diligence process, and timeline. While it’s typically nonbinding, the LOI does set the stage for deeper discussions by clarifying initial expectations and priorities between you and the buyer.
Exclusivity Clauses
The authors advise you to be aware of exclusivity clauses in LOIs—terms that prevent you from engaging with other potential buyers for a certain period. Exclusivity clauses can limit your options and hinder your ability to negotiate with other potential investors for a specified period of time after presenting your pitch. This might leave you in a vulnerable position if the initial VC decides not to invest or delays the process.
The Due Diligence Process
If you’re OK with the terms of the LOI, you can sign it to keep things moving forward. After signing, expect the buyer to conduct a thorough due diligence process, in which they verify the information you’ve provided and assess the financial and legal health of your business. The LOI should outline what this process looks like, including its scope and expected duration.
The authors explain that due diligence can be an intensive process. To uncover any potential risks or liabilities, buyers will want to scrutinize everything from your financial records and customer contracts to intellectual property rights.
For instance, the buyer may discover that your company is involved in a legal dispute. This could be a lawsuit from a former employee claiming wrongful termination or a patent infringement claim from a competitor. These kinds of legal issues represent potential financial and reputational risks that may discourage the buyer from proceeding with the acquisition. Similarly, if the buyer discovers that major customer contracts are about to expire without any guarantee of renewal, that would impact future revenue projections and, as such, may make them think twice about the deal.
Feld and Mendelson advise you to prepare for the due diligence process well in advance by keeping detailed records of all business activities. They also suggest working closely with your legal team during this phase to ensure all requests are handled properly. Most importantly, they caution against hiding or withholding information during due diligence, since any discrepancies found could lead to renegotiation or even termination of the deal.
Asset Deals vs. Stock Deals
Feld and Mendelson outline two main types of acquisitions: asset deals and stock deals. Below, we’ll explain the differences between the two, as well as their respective implications for both buyers and sellers.
Asset Deals
The authors note that, in an asset deal, the buyer purchases specific assets and liabilities from the target company rather than acquiring the company itself. This method allows the buyer to choose precisely which components of the business they want to take on, such as equipment, intellectual property, or customer contracts, along with any associated debts or obligations. Buyers often prefer this structure when they want to select only those assets and liabilities that align with their business objectives, effectively “cherry-picking” the components that offer them the most value. This approach helps a buyer avoid liabilities or non-essential assets that might come with a full company acquisition.
The authors warn that asset deals may not be such a great deal for you as the seller. This is mainly because in an asset deal, the buyer acquires only the assets of the company—not its liabilities, which you could still be responsible for. (Shortform note: On the other hand, the “cherry-picking” principle can also be an advantage for the seller in an asset deal. For example, you might opt to keep assets that provide more tax incentives or retain assets that allow you to keep running your core business.)
Stock Deals
In contrast, write the authors, the buyer acquires all outstanding shares of the target company’s stock—so a stock deal gives the buyer ownership of the entire company, including all assets, liabilities, contracts, and obligations. As the seller, you relinquish your shares in exchange for the agreed purchase amount, resulting in a complete transfer of ownership and operational control. In this scenario, you exit the company entirely. This tends to be more favorable for you as the seller, since you get to transfer all your company’s liabilities along with its assets, leaving you free from any obligations after the sale.
