When an M&A Buyer acquires a company these days – especially a tech company – more often than not they compel the business’s Founders and key employees to enter into a re-vesting agreement.
In re-vesting, a Seller doesn’t receive the full proceeds of an M&A transaction at closing. They must wait a period of time to receive their full share of the proceeds.
In a Silicon Valley landscape, where what’s in the head of a Founder and their intimate experience with their products is just as important – or more so – than a company’s physical assets, technology, or even intellectual property, re-vesting is a no-brainer. It gives the Buyer confidence that the Seller will stay on and work hard to see the new venture succeed.
The more cutting-edge, the more disruptive the technology or business is, the more necessary it is to have Founders stick around.
When you pay a lot of money for a company you don’t want people with insight into the technology to leave. If that happens, a huge part of the value you paid for would be gone.
Re-vesting has become increasingly common – basically required – by serial tech acquirers who want to see their investment flourish, especially when they have such an extensive portfolio of companies that they can’t dedicate too much time to individual businesses.
Here’s how re-vesting works.
Say a large corporation acquires a small tech operation for $100 million. The two Founders get 60% of that, with the rest going to their investors.
Under a re-vesting agreement, each Founder gets only $10 million at closing. They get another $10 million after a year and the last $10 million after the second year. The key is for the Founders to continue their work in the new company.
Spreading out the payment keeps them coming to work each day. You can see why this sort of arrangement is sometimes referred to as the “golden handcuffs.”
This sort of retention tool greatly favors the Buyer because they pay less upfront.
In our example, only $60 million was paid at closing, with $40 million going to the acquired company’s investors (shareholder and VCs aren’t subject to any re-vesting) and $10 million to each of the Founders. It’s like they get the acquisition at a discount.
Re-vesting appears similar to an earnout, but there are key differences. In an earnout, a portion of the sale price is paid to the Seller at a future date, as long as agreed milestones are reached, or financial or performance goals are met. The details are enshrined in the purchase and sales agreement.
Founders are reluctant to agree to earnouts because post-closing, they have little or no control over the metrics that determine their future pay-out. Re-vesting, however, largely requires the Founders to simply “show up for work” during the duration of the re-vesting period.
Re-vesting does have advantages for the Sellers, too.
They get to influence the future direction of their company, which was their baby, so to speak.
Re-vesting allows them the time to be in a role of hands-on guidance before they cash out. With the resources available at the often, larger acquiring company, they have more resources at their disposal to fulfill their vision.
Another important benefit: a Buyer is usually willing to pay more for the company if they can lock down key individuals post-closing versus the risk of things falling apart without them around. Investors understand this and will actively participate with the acquirer to persuade the Founders to move forward.
Of course, re-vesting can go wrong. You might have heard that WhatsApp’s Jan Koum and Brian Acton didn’t exactly get along with their new bosses at Facebook. Specifically, the Founders of this messaging service valued user privacy, while Facebook pushed for access to user personal data to serve ads.
Acton quit in November of 2017, which meant he left $900 million in unvested shares. Koum is set to depart this August, leaving behind $400 million. If they had stayed until November 2018, each would have received their full share.
The acquisition was subject to a four-year vesting agreement, starting when Facebook bought WhatsApp for $22 billion in 2014.
Of course, Acton and Koum still have billions in the bank. So, don’t feel too sorry for them.
One thing to always keep in mind with re-vesting is the tax implications. Attorneys on both sides must collaborate to get the most favorable structure of the deal to minimize the tax obligations.
Structured one way, re-vested funds can be taxed as compensation, resulting in prohibitively high tax rates – especially in California. Alternatively, re-vested funds can be structured to be recognized at the significantly lower capital gains tax rate.
It is essential for Sellers to secure representation from experienced M&A attorneys that can provide access to their tax partners with the requisite capabilities to achieve the most favorable treatment.
While re-vesting has been popular in Silicon Valley for the last 10 years or so, it’s expanding its reach across the country and in many different industries.
In businesses where the product sold is a commodity and only needs a good manager… re-vesting would not be appropriate.
But re-vesting will work in any industry where people’s talent is highly valued and closely tied to business or assets being purchased. It could work in entertainment deals where creative people are involved.
Running in the background of this phenomenon of the rise of re-vesting is the fact that M&A activity across the board is booming. There are many contributing factors.
If you’re considering using M&A as your exit strategy or are involved in the buy side of the equation, it pays to know more about this trend.
Download this free guide for more details: The 13 Factors Contributing to the M&A Boom.