8 minute read | October.26.2023
Orrick's Founder Series offers monthly top tips for UK startups on key considerations at each stage of their lifecycle, from incorporating a company through to possible exit strategies. The Series is written by members of our market-leading London Technology Companies Group (TCG), with contributions from other practice members. Our Band 1 ranked London TCG team closed over 320 growth financings and tech M&A deals totalling US$9.76bn in 2022 and has dominated the European venture capital tech market for 30 consecutive quarters (PitchBook, Q2 2023). View previous series instalments here.
Growing your company from incorporation and getting to an exit can be exciting and rewarding for a founder, but while an exit process usually takes 6 – 12 months, preparing for it can take a number of years (2 – 3 years is not uncommon). A clear strategy and careful planning with advisers can lead to a better, more profitable and tax-efficient outcome, and reduce the stress of an exit for the founder and the leadership team. In the sixteenth instalment of Orrick’s Founder Series, we offer top tips to help UK startups build to an exit and manage an M&A process (look for part two soon, on the IPO process).
1. Establish a roadmap. Key to any decision to pursue an exit should be the liquidity objectives of the company’s shareholders and the market conditions for M&A. You should be attuned to the dynamics of the company’s cap table (in terms of the “waterfall” and the motivations of your early and later-stage investors) and track M&A activity in your sub-sector. Consider the nature of potential buyers in the context of the company’s stage of growth and potential. For example, consider whether you are likely to attract “trade” buyers, i.e. bigger players that operate in the same or similar market and see the company as a strategic acquisition. Or will private equity investors back your team to take the company to the next stage of growth? The answer will help determine what an exit will mean for the company’s business, management team and employees. In this context, founders should also consider whether they want a role in the company after its sale. Being clear on these elements will allow you to align key stakeholders, establish a timeline, build operational foundations and position the company optimally for a sale.
2. Assemble an advisory team. Hiring good advisers well before embarking on the exit process is critical. They should have experience in the specialised tasks associated with selling a business, and they should know you and your marketplace. Engaging with them early will help you secure maximum value. Your financial advisers will support you with the production of the financial statements that form the basis of the company’s valuation, highlighting issues ahead of time to mitigate significant adjustments being made after financial information has been presented to a prospective buyer and avoid any significant delays to the timetable as a result. Ensuring that your legal advisers have strong M&A credentials when you embark on your journey with them at Seed or Series A will also stand you in good stead as you grow your business and start considering your exit options.
3. Create financial forecasts and business plans. To attract buyers and achieve a high valuation, it will be crucial to articulate the company’s future growth, strategy and market potential. Devote time to develop a near-term budget and longer-term financial forecasts based on a solid business plan. Anticipate that a prospective buyer will expect regular and detailed financial updates, so spend time (and take external advice) on refining your management reporting and KPIs. You should ensure the company has processes and systems in place to meet expectations.
4. Get your ducks in a row (intellectual property). Expect every aspect of your business to be subject to detailed diligence and identify gaps and weaknesses as early as possible. One of the critical areas that get examined during a diligence process, especially for innovative, intellectual property rich businesses (where a significant part of the value is tied up), is intellectual property (IP). Uncertainty around any IP ownership or deficiencies in protecting IP rights can delay or derail a transaction or result in a lower valuation. Undertake a review to identify areas of concern. Consider whether your brand has been registered as a trade mark in the jurisdictions in which you operate? Have employees and contractors properly assigned IP rights to the company? Do you have contracts for material IP used by third parties? Depending on your sector, a “freedom to operate” study may be prudent. For more on this, please see our fourth instalment on Protecting Your Ideas.
5. Get your ducks in a row (commercial contracts). Your key commercial relationships will also be central to your value proposition, and you should expect a prospective buyer to undertake “customer referencing” as part of its commercial due diligence. However, you should also consider whether selling the company jeopardises any commercial relationships, such as those with customers, suppliers or lenders. For instance, do any of your contracts have “change of control” provisions allowing the counterparty to terminate its relationship with you if the company is sold? Do any consent or notice rights apply in an acquisition? Companies can typically navigate any such issues ahead of time to avoid last-minute surprises.
6. Get your ducks in a row (group operations and structure). You may need to uncouple certain operations or assets from the core business to ensure a potential buyer receives a “clean” operation following the closing. This is often best done in advance. You may need to take specific tax advice in this context. You should also ensure that you are on top of company administration, public filings and returns, some of which directly impact the share capital of the company and the cleaning up of which can cause significant delays.
7. Prepare a data room. As soon as an exit opportunity becomes realistic, begin compiling a “data room” of financial, commercial and legal information for potential buyers. We recommend you appoint a project team familiar with your business's intricacies. This allows other staff to continue their roles without distraction during the sale process. Ask advisers to carry out a ‘health check’ to identify gaps and shore up weaknesses. For UK startups, please see our UK Startup Health Check to help identify some of these vulnerabilities and offer solutions as early as possible in the process. When the time comes, your lawyers will also advise you on making information available to a prospective buyer. Exercise caution in providing sensitive information to a trade buyer (often a competitor) – consider providing such information in phases and at the relevant time in the diligence process.
8. Negotiate deal terms. The parties to a deal typically agree on a term sheet or “letter of intent” at the outset of the process. It details the key terms of an exit deal. Although these might be labelled ‘non-binding’ and often do not appear to be overly legal, it is difficult to revisit terms once you have agreed to them with your prospective buyer. Once a term sheet is signed, the balance of negotiating power shifts to some degree from seller to prospective buyer, who will usually be granted some form of exclusivity to do the deal. Seek legal advice on the term sheet and take time to get it right. Your lawyers will also be able to advise on the commercial negotiation of the deal (in terms of things like cash or equity consideration, any ‘earn-out’ or other price adjustment mechanism and any regulatory matters that may affect how the transaction is structured).
9. Evaluate the management team. Consider whether the management team and board of directors have the background, qualifications and time to lead the company through the exit process, and bolster your deal team where needed. The company will need to build solid connections at senior levels with the prospective buyer to negotiate the terms of the sale, unblock impediments during the deal process and support the post-acquisition transition.
10. Communicate with stakeholders. The nature and timing of an exit process has the potential to cause disruption. You should consider the pattern of communications with employees, investors, customers and suppliers. Develop a communication strategy to ensure timely communication to key stakeholders.
Our London M&A and Private Equity team understand both (i) what motivates founders and their financial sponsors; and (ii) the latest deals terms and market trends for private equity and strategic buyers. As a result, we are well-equipped to offer unique insights on structuring and negotiating tech M&A deals. If you would like to discuss your technology company exit, please contact Daniel Wayte.