Preparing Your Business and Personal Finances for an Acquisition

While every venture-backed company dreams of an IPO, the odds are low that a company exits that way. In fact, in 2021—a robust year for IPOs—M&A represented 88% of all exits.

So if an IPO is on your wish list, you may want to consider planning for an acquisition because historical data shows it's a more likely exit strategy for many startups.

A CFO's perspective on readying your finances

Evan Fein, CFO of TextNow, shared in a recent webinar how different his experience was selling to a strategic acquirer compared to other transactions. He'd previously been involved in due diligence for investment rounds and IPOs, so he thought he was prepared for an acquisition. He was wrong.

"An investor who is going to buy the whole company is making a much bigger bet than any bank, investor in an IPO or even a VC investor," Fein says. "The things they take the time to become expert on—I was really impressed with the diligence that they do."

When the level of scrutiny taken by acquiring companies surprises even experienced CFOs, getting your finances in order sooner rather than later is imperative. With this in mind, here are 10 tips for preparing your personal and business balance sheets for an acquisition.

How to prepare your business finances

Managing your business finances in advance of an acquisition can help minimize risk and improve efficiency. Albert Vanderlaan leads Orrick's Capital Markets Group, where he participates in a range of corporate legal engagements for high-growth technology companies. In his extensive work with clients during the acquisition process for both public and private companies, Vanderlaan advocates for early preparation in five key areas.

1 Ensure your corporate house is in order

Organize important documents for review, including charters, bylaws, minutes, capitalization records, securities exemptions and filings. Also verify that all corporate actions—particularly stock and option issuances—have been fully documented and properly approved by your board and, if applicable, stockholders. Organizational documents should be reviewed for required shareholder consent to prevent problems at the deal stage.

2 Review all material agreements

Comb through your contracts, license agreements, leases, agreements pertaining to intellectual property and all other commitments—written or oral—to which the company is bound. Ensure you have complete, fully executed copies with all exhibits and attachments, and review them for assignment provisions, termination features and debt covenants. Things such as notice and consent requirements could be triggered by a transaction, so prepare in advance.

3 Examine all employment terms

Clarify any employment agreements and offer letters with severance provisions or bonuses. This will ensure that you and the buyer have a mutual interpretation around additional payouts in the event of a change in control or the need for extra retention incentives. This is also a good time to review all outstanding options to understand potential acceleration provisions. One of the most important items to verify is whether all required approvals have been received. If not, remediation should be top of mind. Conducting a thorough review of your cap table can prevent rogue founders or investors from surfacing during or after the deal.

4 Assess both simple and familiar capital structures

Consider the difference between a stock-for-stock and an all-cash transaction, or some mix of the two. You might be acquired by another company, but there's also the possibility of acquisition by a private equity firm. Perform a full waterfall analysis—a review of the order and allocation that proceeds are distributed in various scenarios—to model liquidation preference and understand the financial impact across a range of possibilities. This is also a good time to consider the impact of the acquisition on equity compensation because equity plans are treated separately and can have different types of structures in an M&A event.

5 Mitigate due diligence issues early

One of the most important things to do during the preparation process is recognize and mitigate any due diligence issues before you start searching for a buyer or accepting a letter of intent, or LOI. Start with a deep review of:

• Accounting issues: Yearly and quarterly financial statements should be readily available, and buyers may also want to see a forecast of operating performance.
• Intellectual property, or IP, ownership issues: This includes any open source IP. The company should register and own—or have clear licenses to—all IP.
• Taxes: All federal, state and local tax obligations should be current. If there are deficiencies, clear explanations will be required.
• Litigation risks: It's prudent to proactively conduct IP, lien and litigation searches to find any inactive or active litigation.

How to prepare your personal finances

Organizing your business finances is only one part of preparing for an acquisition. Your personal finances will be impacted as well. From navigating cash flow needs to documenting your estate planning goals, taking proactive steps may help you and your family be more prepared for post-acquisition life.

1 Review all of your equity

Kick off personal preparation with a comprehensive review of your equity, its value and its correct documentation. More specifically, you may want to take the following steps.

Waterfall analysis

Conduct a waterfall analysis to understand the value of your common shares given the possible sale value of the company.

Equity grant agreements

Review any equity grant agreements for change-of-control provisions so you understand any acceleration clauses and when they're triggered. Most grants are double-trigger, meaning the awards accelerate vesting upon a change in control and a termination. Occasionally, grants are made that accelerate vesting on the single trigger of a change in control. It's important to know which one you have when planning for the future.

Proper titling

Confirm that your equity is properly titled. Often, founders set up a basic estate plan with a revocable trust but don't retitle shares into the name of the trust. A trust will have no effect on how your property is transferred at death if you haven't put assets into the name of the trust. Once you begin the acquisition process, you may be unable to retitle until post-closing and any escrow payments will be made in the title in existence at the time of acquisition.

2 Reflect on your values around transferring wealth

Once you understand what your equity is worth, you can decide to leverage wealth transfer strategies like gifting to charities, supporting family members or preserving your legacy in other ways.

Consider the federal estate tax exemption. If you want to maximize gifting, the transfers must be done before receiving an LOI. Engaging in estate strategies takes time, so plan accordingly.

Understand the tax implications of funding other goals, such as gifting directly to family members or charitable organizations—especially before the transition. This can help you maximize the impact of your wealth.

3 Evaluate different deal structures and timelines

You'll want to explore different deal structures as you prepare for an acquisition because each structure can have an enormously different tax impact. In addition, the ability to take advantage of the qualified small business stock, or QSBS, exemption may impact the attractiveness of the deal type.

For example, if you've only held your shares for 4 years at the time of acquisition, an all-cash deal will nullify your ability to utilize the QSBS exemption, except through a 1045 rollover. If those same shares are acquired in a stock-for-stock transaction, you may still be able to claim QSBS on the profits up to the date of sale if you continue to hold the shares an additional year and QSBS requirements continue to be met.

Finally, take the time to review your equity grants and weigh the pros and cons of exercising more shares. Acquisitions can take time, and if you have the ability to start the clock ticking for long-term capital gains on the shares, you may be able to save a significant amount in taxes.

4 Prepare for the potential impact on common shareholders

Sometimes, the outcome of an acquisition may not be positive for common shareholders. This scenario happens when the aggregate dollar amount of liquidation preferences exceeds the purchase price in the acquisition. In this case, you may want to negotiate a carve-out or management bonus for yourself and other team members.

5 Make a plan for how long you'll stay on the team

In many cases, you'll be ceding control of the company you built, so take time to reflect on your next moves. Acquisitions are often structured with escrow earnouts you receive only after you remain for a certain amount of time. Determining what you're prepared to accept can help you shape a deal that works for you and your family.

The bottom line

Whether it's an acquisition by a larger company or private equity firm, proposal to purchase the company or asset sale, it's critical to adequately prepare for an exit—not only to streamline the sales process, but perhaps more importantly to negotiate from a stronger position. Working with a private banker who has a deep understanding of the due diligence process is an important part of ensuring a successful exit.