We have covered quite a bit of ground in this series so far. In Part 1, we talked about being born — incorporating the company, splitting equity fairly among founders, and raising those first few dollars from family and friends using CARE. In Part 2, we talked about growing up — hiring your first employees properly, working with external contractors, and signing up your first customers. In Part 3, your start-up grew into adulthood and started thinking about “marriage” — we went through the various forms that a business marriage can take: acquisitions, mergers, joint ventures, and a few other arrangements besides.
We ended Part 3 with a promise: in this part, we would talk about the processes involved in an acquisition. So here it is.
Getting to “I Do”
Let’s say another company has come knocking, wanting to acquire your start-up. Or perhaps you are the one doing the knocking, eyeing a smaller competitor or a company with a piece of technology you need. Either way, an acquisition — like a marriage — does not happen the moment two parties shake hands and agree “let’s do this”. There is a courtship first, and then a fairly long engagement, before the wedding itself.
The courtship usually starts informally. Somebody makes an approach, over coffee or through a mutual contact, to gauge interest. If both sides like what they hear, the next step is usually a Letter of Intent (sometimes called a term sheet, or a memorandum of understanding). This is a short document, usually not legally binding (except for certain clauses, more on that later), setting out the broad commercial terms both sides have agreed on in principle: the price, or the basis on which price will be worked out; the structure of the deal; and a rough timeline.
I emphasise “usually not legally binding” because founders sometimes get the wrong idea. Signing a Letter of Intent does not mean the deal is done. It means both parties are serious enough to spend the next few months, and a fair bit of money on lawyers and accountants, finding out whether the deal actually makes sense.
Two clauses in the Letter of Intent, however, usually are meant to bind you: confidentiality, and exclusivity (also called a “no-shop” clause). Confidentiality is self-explanatory — you are about to open your books to a stranger, so you want their promise not to go around telling the world, or your competitors. Exclusivity means that for an agreed period, you promise not to go shopping for a better offer elsewhere while this suitor is doing his due diligence. Read these clauses carefully. An exclusivity period that is too long, with no way out, can leave you stuck if the deal eventually falls through.
The Engagement: Due Diligence
Once the Letter of Intent is signed, the buyer’s lawyers, accountants, and sometimes technical consultants descend on your start-up to do what is called due diligence. Think of this as the buyer getting to know your family before the wedding — except instead of meeting your parents, they are going through your cap table, your contracts, your employment records, your intellectual property, and sometimes your litigation history (if any).
This is where all that advice from Parts 1 to 3 about keeping your paperwork organised finally pays off, or comes back to haunt you. Buyers will typically ask for:
- Your cap table, going all the way back — every share issued, every option granted, every convertible instrument (remember CARE from Part 1?) that might one day turn into shares;
- Your founders’ agreement, shareholders’ agreement, and company constitution;
- Confirmation that all your intellectual property actually belongs to the company, and not to some freelance developer who wrote your original code and never signed an assignment (a very common, and very expensive, problem to discover at this stage);
- Copies of your material contracts — with customers, suppliers, landlords, and lenders — particularly to check for “change of control” clauses that may be triggered by the very transaction you are trying to complete;
- Your employment records, to confirm that KETs (from Part 2) were properly issued, CPF contributions properly made, and that nobody is quietly owed money; and
- Any past or pending disputes or claims.
If due diligence turns up something messy — an IP assignment that was never signed, an option pool that was never properly documented, a shareholder dispute nobody mentioned — it does not necessarily kill the deal. But it will very likely mean a lower price, a longer timeline, or extra warranties and indemnities demanded from you later. Best advice? Do your own “pre-due diligence” clean-up before a buyer ever comes knocking. Do not wait to be caught unprepared.
The Wedding: Documentation
Assuming due diligence does not turn up anything fatal, the next step is documenting the deal itself. The main document is the Sale and Purchase Agreement, or SPA. This sets out, among other things:
- The purchase price, and how and when it is to be paid (sometimes all upfront, sometimes with a portion held back as an “earn-out” tied to future performance, or placed in escrow against future claims);
- Conditions precedent — things that must happen before completion, such as obtaining a third party’s consent, or restructuring the company;
- Representations and warranties — promises made by the seller (that’s you, if you’re being acquired) about the state of the company, from “we own our IP” to “we have no undisclosed liabilities”; and
- Indemnities — an agreement to compensate the buyer if certain warranties turn out to be false, or certain risks materialise.
Warranties and indemnities deserve their own future article, because this is usually where the most intense negotiation happens. For now, just know this: the more thorough your own housekeeping has been, the fewer warranties you will need to give, and the less exposure you carry after the deal closes.
Getting Consents, and Finally, Closing
Before the marriage can be solemnised, sometimes you need other people’s blessing. This could mean regulatory clearance (competition law issues do arise, though less often for start-ups than for larger players), a landlord’s consent if your lease has a change-of-control clause, or a lender’s consent if you have borrowed money.
Signing and closing are not always the same day. Sometimes the SPA is signed first, with closing to follow once all the conditions precedent are satisfied — much like signing the marriage papers before the actual wedding banquet. On the closing date itself, the purchase price is paid, shares are transferred, and the new owner formally takes control.
That, however, is not quite the end of the story. Many SPAs include obligations that survive closing — an earn-out to be calculated over the following one or two years, a warranty claim period during which the buyer can come back if something turns out to be wrong, or integration obligations if key founders are required to stay on for a transition period.
Happily Ever After?
Not every acquisition ends happily. But a start-up that has kept its house in order — clean cap table, properly assigned IP, well-documented contracts, compliant employment records — will always find this process faster, cheaper, and considerably less stressful than one that has not.
We have basic templates that can help start-ups navigate this process, including Letters of Intent and Sale and Purchase Agreements. Contact Us.
Of course, not every start-up gets to walk down this particular aisle. Some, for one reason or another, do not make it. In the next part of this series, we will talk about the other ending to a start-up’s story — what happens, legally, when a start-up winds up.
