Tip for startups - buy a filing cabinet and a bunch of folders. Come up with some system - any system - it doesn't really matter. The worst one is better than none at all. Put everything in there and don't worry about cleaning it out. I'm talking about all your insurance crap, leases, property records, blah blah...things that are not "core business"
If you want to go paperless, get a Fujitsu ScanSnap for $400 and scan everything to Evernote - or a Directory Tree - or some other DMS. You'll make life EASY EASY when compared to the alternative of having someone like me in your office for 3 weeks keeping you from running your company while I piece back together everything you've shredded.
EDIT: oh yeah - don't try and "hide" shit. M&A guys are experts at sniffing out things you're not telling us, intentional or simply forgotten. I've got forensic accountants who are incredible at their job sifting through everything under the sun finding this stuff. Most of the time, you just forgot, and thats fine. Everyone does. If you're trying to hide a skeleton, we're gonna find it. Talk to the M&A guy who's on your side (the sellers side) and be honest. We've got a better chance of presenting the information honestly that won't alter the deal.
It's easy to forget these loans from the early days, especially if there were 20 people who gave the founder little bits of money, especially if it was before he or she set up the corp accounts, etc.
Other than that, one of the worst I've knocked down uncovered a lack of assignment of IP (an early rich-media MUA) from a contractor that effectively meant the candidate company had zero value. "Who's Bob Smith of Bob Smith, Inc.? Can I talk to him about this shitty code? Oh, he owns it..."
Some commonly involve artificially boosting turnover by trying to be clever and using in-house developers as a separate concern, billing or paying through companies owned by family members. Sometimes this sort of setup is kosher (you want to smooth out and isolate capex and a friend has office space and a couple devs, or there's an overseas component, or whatever) but if money is moving between them in a semi-closed ecosystem, it's often a bad sign.
Usually, as stated, it's sloppy stuff, but sometimes you get a real weasel.
As for being a founder, having an accountant/CFO makes a huge difference. The first contract CFO I hired was a revelation. The commitment was low and the upside was huge. We were too small for a FT CFO and I was a babe in the woods and didn't even realize these people existed.
What happens in that case? Does the acquisition stop in its tracks, or does the company try to contact Bob Smith and buy the rights?
In the case I mentioned above, we left the candidate site immediately, arranged earlier flights, and flew back to Seattle. There may have been exec communication but I was just the technical DD guy at the time. But I never heard from them again.
Had the code been stellar, we may have given them time to sort it out so that the package was clean.
I did that and it was a total waste of time and space. Nowadays I just throw everything into a plastic bin marked with the current year. The bins are stacked, current year on top, and relabeled/recycled on a five-year LRU basis. It's 100x more painful to access the information than it would be if I used a formal filing system, but retrieval happens at about 1/1000 of the rate of insertion, so it's still a big win.
The worst one is better than none at all.
And sometimes better than the best one.
Even if you do everything right, an acquisition is astonishingly expensive --- low-mid six figures in a lot of cases.
If a deal is worth doing, it's probably not going to live or die based on how many tens of thousands of dollars you can whittle off closing costs.
That's not to say there aren't deal-killer sloppy mistakes to be made early on (vesting! keep cap table clean! get your contracts reviewed as you sign them!), but a lot of what I'm reading here doesn't sound like that kind of stuff.
Maybe someone on HN has a horror story about a deal they really wanted dying in warrants-and-reps DD; I'd love to read it.
(Like all my comments, this reads more demonstrative than I really mean it to; I'm really asking, more than arguing.)
I think it's like this:
- There's a base level of prep for acquisition that just falls under the category of "good operational cadence for a company". This is the basic level of keeping the books clean, organizing your papers, etc.
- Then there's a level of prep that it makes sense to do when you think you are getting close to a term sheet, or planning to start to actively seek acquisition. This is the much more detailed indexing of contracts, covenants, tracking down old shareholders, etc. Hopefully if you did the above point, this is made easier, since you're at least storing everything in one place
- Then in the DD phase, there's going to be requests that you just can't prepare for, because they're out of left-field. If you've done #1 and #2, you can invest most of your efforts on those.
But to your point:
> If a deal is worth doing, it's probably not going to live or die based on how many tens of thousands of dollars you can whittle off closing costs.
It's almost never a matter of closing costs. It's a matter of momentum and risk. Yes, if a company is 100% convinced that they absolutely must have your technology/customers/IP/whatever, they'll overlook many many flaws.
But, if you go into the due diligence process and things are overly messy, it throws up red flags and creates delays, neither of which are in the entrepreneurs favor.
The DD folks and legal counsel for the acquirer are there to be a voice of reason and caution - the messier things are, the more likely they are to start cautioning the acquirer. Typically, the corp dev guys are raring at the bit, since this is what they're there to do. Legal is meant to act as the countervailing weight to that.
Risk is unlikely to kill the deal outright, but it could delay things and create uncertainty in the acquirer. All of a sudden they start talking about putting an extra 10-15% in escrow, or doing an earn-out instead of a straight acquisition, as a hedge. Or they decide they want to interview a few more customers before they pull the trigger.
Which is where delay comes in - the longer the interval between term sheet and deal signing, the worse off for the startup. Not because of the legal costs, but because:
- it's disruptive to the business - your whole life becomes dealing with due diligence, not to mention the stress level
- it gives the acquirer the chance to rethink their decision or consider another route
- business conditions could change - your biggest competitor goes up for sale at a bargain basement price
So, in the end, you're not optimizing for cost, and prepping for DD is definitely not worth doing pre-product or at the expense of building your business. But it does reduce risk and improve the likelihood of deal close once you get to that point.
Except to keep in mind of course a few things about deal making:
a) Time kills all deals. It's more true than not.
b) Strike while the iron's is hot. [1]
c) Never make deals without some time pressure on a buyer (leads to "a" and lack of "b"). Either artificial or real. (The "never" of course needs to be qualified for the situation for sure).
d) Don't make open ended offers. Why? Time pressure (managed carefully of course) brings people closer to emotion which can make them overpay for something. Now of course everyone wants a "win win" situation so why does that matter? Because, once again and in general, people are either happy with what they have negotiated or they are not. Paying 1 billion for Facebook or 3 billion, assuming the same outcome as we have, would still be viewed as a good deal.
All of the above is generality of course and obviously specifics of the situation do matter.
[1] Go at lightning speed and don't delay. Things do happen to people you are dealing with. Health, accidents, life changes all sorts of things. (Example is Lewis Katz who perished in a plane accident about a week after closing his newspaper purchase). Oh yeah, stock market and general business climate as well. Don't play games and don't delay (other than if you are using it as a strategy of course).
However most businesses, traditional ones, and even ones that are on the web, don't have that leverage. They will get literally one ready willing and able suitor who comes along (and will pay a good dollar) and so they will have to take advantage of that opportunity. I'm not talking about people accomplished enough to be able to hire investment bankers to shop their business.
It's not that I disagree that much with what you are saying and obviously you shouldn't spend a great deal of time on this either.
Lastly people tend to feel as if they could sell at any time maybe perhaps because they've had some inquiries from time to time.
Obviously there is no disagreement as far as working on the fundamentals of the business. Otoh if your intention is to sell there are many things you can do to package your business to make it more attractive to buyers along the way.
Based on my experience of it, negotiation took a couple weeks, and warrants/reps took sixteen thousand years. My partners went into the process looking like young David Lo Pan, and ended it looking like old David Lo Pan. (I spent the whole process as the weird floating orb of goo with the big eyeball).
It's true that the legal side is onerous. We like to think that it prevents more trouble than it causes, but reasonable minds may differ.
I still think my question is an interesting one, even if it's not what you were saying. I don't know that there's any public precedent on the matter, but I imagine it's not as rare as one might think given all the different sort of public and private NDAs that exist.
https://docs.google.com/spreadsheets/d/17uAmJBwB3pztdmt4ozMy...
It's more geared toward 'physical' companies as compared to software ones, but many of the requirements are the same.
Disclosure: I work there
In you mind, leaving something out means that its not applicable.
In their mind, leaving something out means that you're hiding it.
When you pitched your first bootstrapped project for Ycombinator - did you have a team? Have you still got your original pitch? Thank you
All it takes is a document scanner and well curated Dropbox folder(s).
It all comes down to how best to spend your time. Is every minute spent pre-organizing stuff for a probability of a DD better spent in front of customers or with your engineering team? If so, then don't be too concerned too early. Of course, if the exit plan from the day 1 is to sell to a larger shop, then get those books/records in order from the get go.
There's usually some leeway in the strength of the representations and warrants. As seller you want them as weak as possible. You want minimal grounds for the buyer to come back later and claim, "You promised X would be true but it turned out not to be; and you agreed you'd make us whole". Instead you want the deal to be done so you can move on with your life.
The more complete your due diligence materials, probably the more you can negotiate the R&Ws to be milder and more reasonable for you. Or even if you can't, at least the R&Ws are covering less unknown territory.
Whereas if you have big holes in your documentation, naturally the buyer will want you to be on the hook for surprises, and may require some proceeds to be set aside in escrow, or whatever.
Thanks for highlighting this point for others!
It's all in your attitude.
Of course, this is the least sexy part of building a company and is actually quite easy to ignore as long as you're hiring highly competent people.
- Employee agreements
- Updated financials (potentially get them audited once a year)
- Insurance paperwork
- etc.
There's no reason you should ever not have those things.
But there's other stuff that can creep in - for example, we were using a variety of perl modules in our software. We had made sure from a policy perspective that all of the modules were in CPAN and licensed apporpriately. But during DD they wanted us to identify every module, and provide them with a copy of the license for every single module.
They wanted to see a written DR plan, and a list of business operational risks, both personnel and office-wise.
Just two examples of the sorts of things that can come up in DD that probably aren't worth doing day 1.
Although some people do use it just for a single deal, we try to espouse the notion that you should use a data room from the start; keeping your documents nicely organized for the day when that phone call comes, rather than scramble to compile everything together at the last minute.
Check us out at www.securedocs.com, or email me at comron@ that domain if you have questions.
"There are different levels of data encryption but AES (Advanced Encryption Standard) 256-Bit Encryption is so secure that it is certified for use by the U.S. government for top-secret documents."
I realize this is usually written for the layperson, so the ambiguity of this claim is forgivable, but can you provide a more detailed explanation for how your encryption works? As you're probably aware, simply using AES does not actually provide any security.
Organizational Documents - all your formation docs, shares, etc..
Tax - 3-5 years of historical tax information (everything), along with a depreciation schedule of any assets you have
Finance - mostly quickbooks or similar exports here - your CPA can help a lot. Tricky parts are usually the transactions between owners (their family members) and the company (capital infusions, distributions...can get messy) Intercompany stuff is also always a mess. You set up a LP to hold the stock of your LLC? stuff like this will get beat to death.
Loans & Borrowings - anything dealing with loaned money, or personal guarantees
Contracts/Confidentiality Agreements - FOR EVERYTHING. Cell Phone contracts, cleaning lady contract (or description of the agreement). They'll cross reference this with your A/P and A/R. Anything with a signature.
Customers & Vendors - lists with detailed contact information and yearly spend/revenue
HR - Everything related to employees, contractors, consultants, etc...including all your insurance, retirement, bonus, free crap you give employees (gifts and snacks)
Corp Insurance Policies - all your policies you've had for the last 5 years, claims and dollars spent.
IP - copyrights, licenses, trademarks, non-competes, confidentiality agreements, patents, blah blah. This is exhaustive with Tech Companies, since its what they're really buying (along w/ brains. not physical assets)
Legal - Any lawsuits.
Govt Compliance - Any permits required to do work? Any interaction w/ a Govt Agency other than the IRS.
Environmental - if you own property or do anything with a hazardous substance....usually its an outside firm doing an environmental survey of your property.
Property - both real and personal property - any leases you have. any offices you own (and loans associated) All your personal property you own (desks, computers, misc) with serial numbers and VIN's. What a nightmare.
Import/Export - If you import and export stuff, they want all your documents. Schedules of shipments (all of them), customs audits, all your brokers that handle this stuff.
> Marin’s team sent over a list of hundreds of technical, legal, and business questions that we’d need to answer for the deal to go through...Tracking down document after document was tedious beyond compare.
Having your ducks in a row as much as possible can make a huge difference in the complexity, risk, and overall stress of doing a sale/acquisition.
I don't mean Day 1, of course, but once you're starting to have conversations around acquisitions, it's really helpful to make sure your books are clean, that you have clearly documented your software stack, all of the third-party code you use and licenses, all of the contracts and MSAs you might have signed iwth your customers, employment agreements with contractors, and so on.
It's annoying, but once you have it done it's relatively easy to keep up to date.
When we sold our last startup, our CFO had done this 10+ times before, and on the first day of the due diligence, he handed over a URL for a data room with hundreds of documents, categorized and neatly organized. The acquirer's lawyers said it was the easiest DD they'd ever seen.
EDIT: I sentence misplaced words in a