“Acqui-hire” transactions, which are particularly prevalent in the context of start-up technology-related M&A transactions in the U.S., focus on acquiring a company primarily to obtain its employees and their skills, in addition to other possible assets (see our earlier post on acqui-hires). In these type of transactions, it is thought that the greatest perceived value in the target lies in its employee base or segment(s) thereof. If there is also perceived value in the intellectual property (IP) or other assets of the target company, an acquiror might purchase those assets and possibly license them back. In some cases, the acquiror may be willing to allow the IP and other assets to revert back to the target’s shareholders and/or investors.
The terms and the structure of an acqui-hire transaction can vary depending on the size of the target company and the number of employees. The consideration paid and any remaining assets are distributed to shareholders, while the talent is retained. Although acqui-hire structures can vary, one common element can be contentious – purchase price allocation between the employee(s) being acqui-hired and the target’s remaining employees, investors and shareholders.
Structuring the purchase price
A common feature of the acqui-hire model is the two-tier structure for the purchase price.
The first tier is used to acquire the startup itself. This will usually consist of cash or stock and can be used to pay for the release of the acquiror from any claims, to acquire assets and/or stock, or to serve as consideration in a merger. This consideration will be used to compensate the investors and shareholders of the startup. For investors in the target, this can be an attractive exit scenario, particularly in a situation where the startup is not performing as well.
The second tier is intended as compensation for key employees. This can take the form of equity in the acquiror, such as stock options or restricted stock. An acquiror can include incentives to ensure that the key employees being acquired are able to align their interests with that of the acquiror by having compensation mechanisms vest over a period of time. An advantage of this approach is that it requires a lower amount for the upfront purchase price. Typically, the second tier will be paid solely to the target’s employees that are brought over as part of the acqui-hire, and investors, shareholders and non-hired employees will not receive a portion of this compensation. When making offers to employees, it is important to keep in mind that subsequent defections are a possibility. To that end, structuring the employment offers in a way that provides for an extended time horizon over which the full benefit of the compensation will materialize is often top of mind for acquirors.
Why the purchase price allocation matters
It is important that an acquiror carefully consider the competing interests and potential deal tension created over how the purchase price is allocated in order to avoid stalling a transaction. Parties, particularly investors, who are not being brought into the acquiror will want to ensure that more of the purchase price is allocated to the first tier (described above).
On the other hand, an acquiror would typically consider that the employee skill set is unique to their capabilities, and that of the team. As this is where the acquiror derives value, the acquiror would determine that a greater amount of the purchase price should be allocated towards the compensation of key employees that are moving to the acquiror. Skewing the allocation towards compensation also provides the acquiror with the ability to create that much more of an attractive incentive structure to retain key employees.
Canadian market place to keep an eye out
This structure has been appearing more frequently in the Canadian marketplace over time due to Canada’s active technology industry. In particular, Canada has been establishing itself as a hotbed for the development of artificial intelligence and associated technologies. This is in part because of policies in place designed to attract skillful innovators to Canada. To that end, Canadian acquirors of companies would do well to consider the issues discussed in greater detail early on. Proper planning can provide a road map to ease potential tensions that could arise due to questions surrounding fair allocation of the purchase price.
Those seeking advice on transaction structuring should contact a member of NRFC’s M&A team.
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