Orrick Legal Ninja Snapshots
11 minute read | September.16.2025
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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 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.
Purchase agreements in distressed M&A transactions follow their own rules. As we discuss the economic considerations and purchase price options in detail in OLNS#13, we will limit ourselves here to some key considerations around the transaction scope and provisions around risk allocation and some additionally important provisions.
In any asset deal, the transaction scope is critical. It is necessary to outline exactly what assets are sold and transferred and what contractual relationships the buyer will (economically) assume. These sections of the agreement must be meticulously detailed to avoid ambiguity and ensure both parties understand what is included in the transaction.
Assets: The agreement should specify all tangible and intangible assets being sold and transferred. Tangible assets might include equipment, machinery, inventory and real estate. Intangible assets could encompass IP (patents, trademarks, copyrights), software, customer lists etc. Each asset should be clearly identified, and any necessary documentation or registration (e.g., for IP rights) should be addressed. "Catch-all" provisions are possible provided that the acquired assets are identified/identifiable.
Contractual Relationships: The scope should also cover existing contracts and business relationships that are meant to be (economically) assumed (technically, this is not a transfer). This includes customer and supplier contracts, leases, licenses and any other agreements essential to the ongoing operations of the business.
The agreement should outline the process for obtaining any required consents from third parties to assign these contracts, as well as the consequences if such consents cannot be obtained. If a consent is rejected, the asset deal agreement can provide for a "synthetic transfer," i.e. that the buyer shall economically be put in the position the buyer would be if the consent had been granted. That can also enable the start-up to fulfill its obligation under the respective contract (keep in mind that the start-up is still the contractual counterparty but may after the asset deal closes no longer have the means and employees required to fulfill its obligations).
Employment Relationships: If a "business unit" of the start-up (referred to as a transfer of undertaking or in German "Betriebsübergang") is acquired by means of an asset deal, all employment relationships dedicated to that business unit will be transferred to the buyer by operation of law according to the Acquired Rights Directive (implemented in Germany in sec. 613a German Civil Code).
According to sec. 613a para. 1 s. 1 German Civil Code, a transfer of undertaking is triggered if:
Under German labour law, a transfer of undertaking is always subject to the requirement that the economic unit is transferred without losing its identity. The definition of an economic unit normally refers to an operation or part of an operation. The Federal German Labor Court (Bundesarbeitsgericht), under the guidance of the European Court of Justice, has developed a test to determine whether a transaction represents a transfer of business under sec. 613a German Civil Code. The test considers seven criteria:
In each individual case, all these criteria must be considered comprehensively. This means that single criteria may be weighted differently depending on the type of the business in question and not all of them need to be fulfilled.
To enable the employees to consider whether they want their employment relationships to be transferred to the buyer or to remain with the start-up, German labour law provides an obligation to inform the affected employees. Either the buyer or the target, or both jointly, have to inform them in writing prior to the transfer of:
To inform employees, it suffices to send a standardized letter to all employees which as a matter of principle must state the specific circumstances of the transfer of undertaking. Though the employees must be informed in writing, no handwritten signature is required for each letter. Such notification should take place before the transfer of undertaking.
After being informed, concerned employees may object to the transfer of their employment relationship within one month upon receipt of the information without giving grounds. As a result of such objection, their employment relationship would remain with the start-up. The start-up may terminate the employment relationship for operational reasons if it can prove that the requirements for such termination are met. Correctly executing notifications is crucial to trigger the commencement of the objection period and avoid future uncertainties about with which entity the employees now have their employment relationships.
Public Permits and Licences: As a general rule, public licences and permits relating to the operation of the business (e.g., building permissions) will be transferred to the buyer. On the other hand, licences and permits relating to a specific person, especially if a certain kind of knowledge or expertise was a precondition to granting the licence, cannot easily be transferred from the target company to the buyer but might well need to be reapplied and reissued.
Risk allocation is a crucial aspect of an asset deal agreement, as it determines how various risks associated with the transaction are distributed between the start-up (and thereby economically ultimately its shareholders) and the buyer. This section typically includes representations and warranties, indemnities, and specific risk allocation clauses. By addressing these key aspects in the asset deal agreement, the parties involved can ensure a clear understanding of the transaction terms, effectively manage risks and facilitate a smooth(er) transfer of the business.
Representations and Warranties: The start-up usually provides representations and warranties about the assets being sold, such as their ownership, third-party rights and encumbrances and characteristics of the sold assets. The scope and duration of these warranties are often heavily negotiated, with the seller seeking to limit their extent and the buyer aiming for comprehensive coverage.
Indemnities: Indemnity clauses are designed to protect the buyer from specific risks by obligating the target company to compensate for certain losses or liabilities. For example, the start-up might indemnify the buyer against pre-closing liabilities, environmental issues or legal disputes related to the transferred assets (provided they are assumed by or can affect the buyer). The agreement should clearly define the scope of indemnities, the process for making claims and any caps or limitations on the start-up's liability.
The buyer might doubt the start-up's ability to pay damages in case of a breached representation or a triggered indemnification obligation. Often times, time constraints might make obtaining a W&I insurance difficult and the buyer will instead request an escrow or holdback arrangement instead. We discuss all these concepts and their practical implementation in detail in OLNS#13.
Cherry Picking and Assumption of Risks and Liabilities: With respect to the acquisition of assets and contractual relationships, the buyer can "cherry pick," but, as we have described above, when it comes to the transfer of employment relationships, restrictions under German law need to be observed. With regard to the assumption of liabilities and risks, the buyer will usually assume only those liabilities and risks pertaining to the acquired assets and contractual relationship to the extent they relate to the period after the effective date.
Note that there are certain exceptions under mandatory law. This applies in particular to sec. 75 German Fiscal Code (Abgabenordnung) which addresses the liability of a business acquirer for the tax obligations of the seller (i.e. the start-up). Specifically, it stipulates that if a business or a significant part of a business is transferred, the acquirer becomes liable for the seller’s outstanding tax liabilities related to the transferred business.
This liability is limited to the value of the acquired assets at the time of the transfer. The provision aims to ensure that tax obligations are not evaded through the transfer of business assets and provides a mechanism for the tax authorities to recover unpaid taxes from the new owner.
In addition to transaction scope and risk allocation, several other contract provisions are relevant in an asset deal. These provisions help ensure a smooth transaction and address various practical and legal considerations and include for example:
A distressed M&A deal comes with its own typical set of additional tax topics. We have already discussed some of them, notably the buyer’s potential liability for certain tax liabilities of the start-up pursuant to sec. 75 German Fiscal Code. We will limit ourselves in this section to a few others:
In Germany, most employment participation programs have historically been designed as so-called virtual share option programs ("VSOP"), sometimes fancifully referred to as "phantom equity." We have dedicated an entire OLNS edition to VSOPs and their equity-based alternatives (see OLNS#8) and refer our interested readers to that edition.
German market VSOPs usually tie the proceeds under the program to the amount received by a holder of a common share in an exit. As a result, "heavy" liquidation preferences can give management pause because their virtual shares are at the bottom of the liquidation waterfall. If key executives can only expect little or nothing under their current VSOP allocations, this might severely impair their morale and eagerness to support the exit process. To have a meaningful chance to unlock any residual exit value, the elephant in the room might need to be addressed. As the late U.S. comedian Joan Rivers said: "People say that money is not the key to happiness, but I always figured if you have enough money, you can have a key made."
The considerations set forth below apply equally to a situation where the key executives hold growth or hurdle shares or shares and equity-like instruments (in particular profit participation rights (Genussrechte)) issued in accordance with the tax deferral provisions in sec. 19a German Income Tax Act. Yet most or all of the exit proceeds typically will flow to the holders of preferred shares to satisfy their liquidation preferences.
"Reloading" Virtual Shares: For a VSOP, one option could be to "re-load" or reprice the existing virtual shares by issuing additional virtual shares with lower base prices or reducing the base prices of existing virtual shares. However, if the virtual shares derive their value from the purchase price that trickles down to the holders of common shares (as they usually do), this reloading might not be enough if it stands to reason that common shareholders will not get much of the available exit proceeds (in severe cases, they may not get anything). Here are some other tools available in a distressed exit scenario to keep the core managers incentivized:
Management Carve-out Plans: One way to provide management an "up stack" incentive at the top of the waterfall is via a so-called Management Carve-out Plan. These plans sit below debt, but above equity or between the most senior equity and the next level(s). They effectively "carve out" value that otherwise would go to shareholders and transfer that value to designated key employees. This is done by providing participants in the plan a right to payments at, and contingent on, a sale of the start-up or its assets.
For reference, in its 2024 SRS Acquiom M&A Deal Terms Study, the service provider SRS found that in U.S. market M&A deals in 2023 about 6.1 % contained some kind of management carve-out plan with an median size of 6.8 % of the transaction value while for 2022 such plans showed up in 3.6 % of all cases but had a median size of 10 % of the transaction value.
Exit Bonuses: A straight-forward and flexible way to focus key executives’ attention on the exit and the underlying process is a one-time bonus linked to the success of the exit. These bonuses can be based on targets such as the sale price, timing of the deal or other metrics. This ensures that key employees are motivated to work towards a smooth and successful exit.
To accommodate for the famous "extra mile" efforts, we like to add a qualitative element, e.g., a discretionary right of the company’s advisory board to increase the bonus amount by a factor of up to 2x or similar. The size of the bonus can correspond to their role and impact on the exit. The bonuses need to be substantial enough to make a meaningful difference to employees.
Retention Bonuses: In some cases, key personnel who are at risk (or financially struggling) may be offered retention bonuses to keep them inside the fold.