Yesterday, I posted about acquiring a business with debt and investors. For this Bonus M&A Monday: How does the investor process work, and what terms (other than economics) will be negotiated?
When I represent a buyer with investors, in parallel with negotiating the purchase of the business, we negotiate the investor workstream.
I usually start with drafting a non-binding term sheet for the buyer to present to their investors. Then, once finalized, I draft those terms into an Operating Agreement or Shareholders Agreement. That document will be your Bible with your investors; it will dictate almost every aspect of your partnership with the investors and will usually be a thorough (i.e., long) document. I promise in some years from now an issue will come up that will make you reopen this document to see if you are allowed to do something.
The amount of negotiation will vary widely. Some investors are friends and family and are collaborative, others will be represented by their own lawyer and vigorously negotiate the terms.
Let’s discuss some of the terms that are negotiated:
Economics. In our simple Searcher model (outlined yesterday), investors will negotiate the preferred return percentage (market is about 8%-12%) and the Step-Up (market is 1.5x-2x).
Management and Salary. This section discusses who will manage the day-to-day. If it is the buyer, the salary is set, subject to annual increases.
Minority Protections. This is a heavily negotiated section. These are the rights that investors will have. Meaning, without investor’s vote, the company cannot take certain actions. Common minority rights include amending governing documents, issuing or redeeming shares, entering into affiliate agreements, taking on any other debt, selling the business or assets. Sometimes, minority rights will even restrict expenditures or purchases above a certain amount.
Drag-Along Rights. This gives the company the right, in certain scenarios to force the investor to sell their ownership alongside other sellers.
Tag-Along Rights. This gives the investor the right to sell their ownership alongside another owner if that owner is selling.
Right of First Refusal. This gives the company or other owners the right to buy shares from an owner who intends to sell their shares.
Call/Put Option. The company has the right to buy out the investor or the investor can force the company to buy them out - usually after a certain amount of time. Most agreements do not include Put Rights since it could bankrupt the company or force a sale. Those that include, usually only allow after 5 years and the company has 1 year to effect the buyout.
There are a myriad of other terms that will be negotiated with investors. This is a high-level overview.
Investors may ask about some of these terms and being knowledgeable about them will help you in your initial conversation with investors.