How to choose the best deal structure when selling your startup? Selling a startup is a major decision for any entrepreneur. However, before the actual sale of the startup can take place, there are many sub decisions that the owners need to make. One such sub-decision is choosing the right deal structure for your business sale transaction. The right deal structure will not only make the transaction simpler but will also improve the chances of a successful sale, and the ultimate outcome. The deal structure allows both the buyer and the seller to specify terms that both parties need to accept in order to complete the sale.
The goal of a deal structure is to make sure that the ownership of your startup is smoothly transferred to the new owner, and that you get a good return for the time and money you invested in growing your startup. With that said, the deal structure is an often overlooked aspect of a startup sale, and most owners aren’t even sure how to choose the best deal structure in the first place.
Planning on selling your startup? Then we suggest you keep reading to the end. Because by the end of this article, you should know exactly how to choose the best deal structure when selling your startup.
Remember that mastering the storytelling side and how you are positioning your business is critical when it comes to engaging and speeding up the process. This is done via your acquisition memorandum. This is super important to reach a successful acquisition. For a winning acquisition, memorandum template take a look at the one I recently covered (see it here) or unlock the acquisition memorandum template directly below.
Here is the content that we will cover in this post. Let’s get started.
- 1. What exactly is a deal structure in an acquisition process?
- 2. What parties are involved in a startup sale deal?
- 3. Seller (Startup)
- 4. Buyer
- 5. Advisors
- 6. Government authorities
- 7. What are the different types of deal structures you can choose from when selling your startup?
- 8. Asset acquisition
- 9. Stock Purchase
- 10. Merger
- 11. How to choose the right deal structure based on the pros and cons of each structure
- 12. Asset acquisition
- 13. Stock purchase
- 14. Merger
- 15. Bonus tips for creating a beneficial acquisition deal
- 16. Conclusion
What exactly is a deal structure in an acquisition process?
Selling a startup is never a one-sided matter, and it involves coordination and agreement between two companies. A deal structure is just another way to help both parties in reaching an agreement and find common ground during the sale process. So in its most basic form, a deal structure is a set of terms that both entities agree upon and are willing to follow through with.
Before both parties agree upon a deal structure, however, it is important for the seller to carefully consider which deal structure will benefit them the most. Figuring out the correct deal structure takes careful evaluation, and it takes some level of experience as well. So if it is your first time selling a business, it is best to get an expert opinion from someone who has structured acquisition deals before. Like a professional M&A advisor.
A well-drafted deal structure is going to specify what the startup and the potential buyer will get out of the transaction. Naturally, a good deal structure will also consider any future issues that might arise during the deal and help resolve them beforehand. Before the deal structure can be finalized, both parties must take the following steps:
- Specify any potential risks and how they can be handled
- Specify how they will approach the negotiation
- Set out cancellation conditions for the negotiations
- Indicate how much risk they are willing to accept
- Set durations or time limits for completing various activities involved in the sale
- Consider how the math will differ based on different types of sales
What parties are involved in a startup sale deal?
A startup sale involves various parties that either get value from the transaction or hold some form of stake in the process. With that said, here are all the parties that may be involved in a startup sale transaction:
The seller, which in this case is a startup, is a crucial stakeholder in the sale deal, and directly benefits from the success of the deal. However, the term seller in a startup sale is used to describe stakeholders within the startup including the shareholders, management, owners, CEOs, and any other stakeholders that may be affected by its sale. The stakeholders within the startup that is being sold will try to get the maximum amount of benefit from the deal, so they can transfer the benefits of a favorable deal to the shareholders of the company.
A buyer is an entity that is willing to purchase a portion of the startup or the complete startup to improve its business. Similar to the seller, the buyer is also going to have stakeholders within the company that will want to spend as little as possible to create the most value for their company. The buyer is actively involved in negotiations with the seller over the terms of the deal and usually has the final say in the closure of the deal.
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Advisors are a part of the startup sale process on behalf of their respective clients (buyer or the seller). Their major stake in the startup sale deal is to protect the interest of their client. In most cases, an advisor’s fee for their services is associated with the success of the deal itself. So they also have an incentive in making sure that their client achieves the goals they have set for the sale.
Government authorities may not be directly involved in a startup sale deal, however, they do have some level of involvement in the transaction between the buyer and the seller. Regardless of the size of the company being sold, the role of government authorities is to make sure the deal doesn’t affect the consumers in a negative way.
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What are the different types of deal structures you can choose from when selling your startup?
Now that you know what a deal structure is all about, it is time to learn about the different types of deal structures that you can use. As we have mentioned, choosing the right deal structure when selling your startup is extremely important if you want to get the most out of the transaction. However, unless you know what deal structures you can choose from, it is nearly impossible to get it right. There are three main deal structures that you can use when selling your startup.
- Asset acquisition
- Stock purchase
These three deal structures are the most commonly used structures for most mergers and acquisitions. Each of these structures has its own distinct characteristics, and here is how they differ from one another.
Asset acquisitions are a common way to structure a startup sale, and this structure has been in use for a long time for acquisition transactions. The reason why this deal structure is preferred by most buyers and sellers is that it allows them to buy or sell specific assets instead of buying or selling the whole company.
Once the buyer has specified the assets they want to acquire and the seller agrees to sell them, the deal is usually completed with the buyer paying cash to the seller for the acquired assets.
Startup owners can also negotiate to transfer any liabilities associated with the assets that the buyer wants to acquire. So if you want to get rid of certain assets and the unwanted liabilities associated with them, then the asset acquisition deal structure may work great for you.
With that said, this type of deal structure is not always ideal for selling non-transferable assets including patents, goodwill, or licenses.
Stock purchase is another form of acquisition-based deal structure that startups can go for when structuring their business sale. When this deal structure is used, the buyer will typically buy a majority of the startup’s stock, or in some cases all of the target’s stock.
This transaction structure is extremely beneficial since the buyer assumes all of the company’s assets and liabilities when acquiring the majority of the shares. From the buyer’s point of view, this deal structure when selling your startup allows them to acquire intellectual property such as licenses, patents, etc. Since a stock purchase involves selling the company’s stock, startups may be required to get shareholders’ consent before going with this deal structure.
The third used deal structure when selling a startup is a merger. During a merger, another company that is willing to combine operations with the startup will join forces to form a single entity. These types of startup transactions can either result in the startup becoming a part of the other company, or both companies involved in a merger may cease to exist and form a new company.
Unlike stock purchase, a merger is only going to require majority shareholders to approve the transaction. So in general, this deal structure is less complicated and can result in quick closure of the deal.
How to choose the right deal structure based on the pros and cons of each structure
The best way to choose the right deal structure when selling your startup sale is to make sure you know the pros and cons of each structure. There are situations where a certain deal structure may be more suitable compared to the other. With that said, here are the pros and cons of the three deal structures that will help you pick the right one for your situation:
- The startup can continue its operations through an asset acquisition, as it only sells a few selected assets instead of the entire company.
- The seller has the opportunity to transfer any liabilities associated with the assets to the buyer.
- Sellers can’t sell non-transferable assets using the asset acquisition deal structure. So if your startup has valuable intellectual property that you want to cash in on, you will have to choose another deal structure.
- Asset sales are also taxed differently.
- Stock purchase deals often involve lower tax rates for both parties compared to asset purchases. If a startup is looking to be purchased, the stock purchase agreement structure offers exceptionally low tax rates for them.
- Stock purchase deals can be closed quickly due to clearer valuations and fewer possible complications.
- A stock purchase deal is frequently less expensive for the seller to process.
- Stock purchases may include a lot more legal requirements to be fulfilled, and they can also come with additional financial liabilities.
- A stock purchase deal can be rendered unsuccessful if the minority shareholders of the startup don’t approve of the transaction.
- Startups don’t have to worry about outstanding liabilities after the merger is completed.
- A merger only requires the approval of the majority shareholders of the startup. Therefore, it is easier to get a merger approved compared to a stock acquisition.
Buyers may be at a disadvantage in a merger deal structure because they have to assume all the assets and associated liabilities of the other party. Integration can also be a problem after the closing.
The most critical facet of getting the best deal for your startup is knowing how to value your company. If you would like more in-depth information on how to do that, check out this video I have created.
Bonus tips for creating a beneficial acquisition deal
Once you have chosen the right deal structure when selling your startup based on the information provided in the previous sections of this article, you can move on to the actual creation of the deal.
Here are some tips to help you form a strong deal structure:
- Get an independent valuation of your startup to make sure you aren’t underselling your business
- Learn more about the potential buyer and make sure they have a good track record with mergers or acquisitions
- Take steps to increase the value of your company prior to the actual sale
- If you are drafting an acquisition deal for the first time, make sure you have the required expertise to do so. It is always a good idea to involve legal experts and M&A advisors to help protect your interests during the deal
- Leave some flexibility where possible to ensure a successful deal for all parties
Each startup acquisition is going to be unique and has different factors affecting it. So there is no clear framework to know which deal structure would work best for your startup sale. There may be situations where the buyer may propose a different deal structure than the one you are trying to move forward with. So at the end of the day, it is extremely important that you communicate clearly with the buyer before coming up with a deal structure when selling your startup.
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