Orrick Legal Ninja Snapshots
12 minute read | September.08.2025
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When start-ups dream of an exit, they picture ringing the bell at an IPO or celebrating a headline-grabbing acquisition. But what happens when the journey takes a detour through the valley of distress?
In this multi-part Orrick Legal Ninja Snapshot, we shine a light on the tough side of start-up M&A—where liquidity is tight, options are limited, and the "soft landing" is sometimes the best outcome on the table. We’ll break down the interests at stake, the mechanics of bridge financings, the unique quirks of asset deals, and the strategies for keeping key talent motivated when the liquidation preference waterfall looks more like a trickle.
Whether you’re a founder, investor, or operator, this series will arm you with practical tools, market insights, and a few hard-won lessons from the front lines of distressed deals. Because sometimes, the real test of a start-up isn’t how high it can fly—but how skillfully it can land.
In this two-part mini-series, we present key findings on:
For a comprehensive overview of start-up and scale-up M&A in Germany, we refer you to our Guide OLNS#13 – M&A in German Tech which discusses deal structures, M&A processes, practical challenges and best practices for both the buy- and sell-side in detail.
Success for start-ups is often framed as reaching a liquidity event, or exit, that provides financial returns for investors, founders, and (hopefully) the start-up’s employees. There are two main ways to achieve an exit: go public or sell the company for live-changing sums. We are not sure why we still say that there are two options but maybe IPOs will make a comeback one day.
Most venture-backed start-ups, however, never reach either of these paths; or if they do, it is in a state of more or less distress. While exact numbers are hard to come by, there is widespread consensus that most start-ups fail, i.e., go out of business or are sold for an amount that doesn’t provide a return to all shareholders. Founders and investors may not expressly call this a "failure" and indeed may work mightily to find a "soft landing" that allows them to characterize it otherwise.
Selling a start-up through an M&A deal is generally the first preference for most start-up participants in a venture that does not have a likelihood of continued lifespan as an independent VC-backed start-up.
However, such a distressed deal is the end of a journey that may pose some particular challenges to the parties involved. In this Snapshot, we will shed light on some of the most relevant issues.
Aligning the interests of all major stakeholders, including common shareholders (read founders), early-stage investors and later-stage investors, is critical. This may require extensive communication and negotiation to ensure all parties understand the financial realities and agree on the sale process. Enforcing a drag-along right provided by the start-up’s shareholders’ agreement is a legitimate option but one that should come only after the failure of negotiations to align all of the sell-side stakeholders.
In distressed exit cases, the start-up will still be loss-making and have negative cash-flows. Thus, securing sufficient liquidity until the deal can close can become an issue when heading into the exit process. However, existing investors might be reluctant to provide a bridge to an exit when the expected exit proceeds will be underwhelming.
Major investors will also be aware that smaller or earlier investors might have an incentive to look to them for writing just another cheque while themselves adopting a free-rider approach. On the other side, investors who still have the means to keep investing might realize that, while their liquidation preferences will only give them some downside protection, a bridge financing might juice up returns at least a little bit.
Against this background, major investors might be willing to provide bridge financing but only on terms others might consider onerous at the very least. The goals are twofold:
Such exit bridges can come in the form of a straight equity financing against the issuance of senior-ranking preferred shares or in the form of a convertible loan (note that the tax treatment might be different in the two scenarios). Irrespective of the form of investment, bridge investors will request special conditions for what they consider an above-average risk with a limited equity upside. This might include, among other things:
In tech exits, we need to distinguish between share deals and asset deals. We explain the two deal types in detail in OLNS#13. Suffice it to say that in a share deal, shares in the start-up are acquired by the buyer who thereby indirectly (economically) acquires all assets and liabilities of the start-up. In an asset deal, the buyer acquires some or all assets of the start-up and usually seeks to only assume selected of its liabilities (if any).
Acquiring the start-up’s business (or parts thereof) via an asset deal becomes particularly strategic when the start-up is facing impending or ongoing insolvency. In these scenarios, assets can often be snapped up at bargain prices. If the buyer swoops in before insolvency proceedings are officially opened, the debts may remain with the target company. But beware: there’s a catch.
If the target still ends up in insolvency proceedings, because the proceeds from the sale don’t cover all its creditors’ claims and the costs for an orderly liquidation process, the insolvency administrator could challenge the asset acquisition for disadvantaging creditors and seek reclaiming the assets if they haven’t been bought at their fair value. The buyer would then only get back the purchase price according to the insolvency quota – not exactly a ninja move. So, the buyer might wait until the insolvency proceedings are underway.
In this scenario, the asset deal is handled directly with the insolvency administrator. While the opening of insolvency proceedings can delay the transaction, destroy value in the start-up’s business or cause important talent to move on, it has some advantages, too: In particular that the buyer won’t be on the hook for employee claims that arose before the insolvency proceedings began and that insolvency law provides tools for simplifying personnel reductions.
Given that asset deals, especially in distressed situations differ significantly from "ordinary" M&A transactions, we want to highlight a few key differences and a few challenges of asset deal processes. We start with some general considerations that characterize many asset deal exit processes before presenting some particularities in asset deal transaction agreements.
Time Pressure: Often, distressed asset deals must happen under extreme time pressure with little time or financial possibilities to properly prepare a divestment process with respect to data room, due diligence process or draft transaction agreements. The time constraints will create a lot of pressure to move into full due diligence right away. That often leaves little room for a staged process that seeks to preserve confidentiality unless the bidder is really interested in the acquisition. The overall process can put a lot of pressure on the start-up’s organization and personnel, especially when several business units are meant to be sold to different buyers more or less in parallel.
(Rationally) Uninterested Shareholder Groups: The purchase price will often not be what parties had hoped for and chances are that most or even all the proceeds will go to the holders of the most senior preferred shares or investors who provided the latest "bridge to exit" financing, often with multiple liquidation preferences. So, if the founders have little to gain and investors will at best get their money back or make a modest return, the question arises: Who shall take the lead on the sell-side and drive the transaction to conclusion?
The problem is that, for most shareholders, doing nothing might seem like a sound strategy, a phenomenon described in organizational behavior as "rational apathy." Where ownership is highly dispersed and no meaningful exit consideration can be expected once the money flows through the waterfall, the perceived costs of involvement (i.e. outside advisors' fees and own time commitment and resulting opportunity costs) outweigh the anticipated benefits.
The small shareholders or those with shares at the bottom of the preference stack will rely on others to take on the burden of searching, organizing and negotiating a deal. They assume that other, more significant shareholders or institutional investors will protect their interests, allowing them to "free ride" on the efforts of others.
The problem is that the large VC investors will also have little incentive to dedicate scarce management resources to an activity that will create little value for their LPs (not to mention the general partners’ carried interest).
Depending on the specific circumstances, mitigation strategies might include: