The M&A process

The M&A process

Author: Jackie Ammon
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Read time:  9 minutes
Published date:  3 April 2023
Navigating the decision requires founders to understand the dynamics of the most common M&A deal structures and evaluate personal and professional goals.

Ringing the stock exchange opening bell is the archetypal vision of an exit event, but the IPO route represents a small percentage of company exits. In fact, about 1,700 companies on the Carta platform have exited via mergers & acquisitions (M&A) deals since 2019, more than ten times the number that have gone public via an IPO, according to Carta data

In my prior career as a startup lawyer, I’ve helped dozens of companies navigate the M&A process and confront one of the most important decisions they face: Is it time to sell? In this article, I'll cover some frameworks for founders and company leaders to consider.

M&A deal structures

The board of directors and company management have a fiduciary obligation to maximize value for their shareholders, so naturally that is the guiding light when it comes to exit outcomes and goals. But maximum value depends heavily on context—macroeconomic conditions, debt-to-equity ratio, and the founders’ or investors’ desire to move on. There are many reasons companies consider selling, and certain M&A scenarios better fit what maximum value means in that context. 

Here are some of the most common M&A structures—and how they relate to the specific situation in which founders may find themselves:

Merger

A merger is a true marriage of two companies: They file paperwork with the government saying that the two are now blending into one company. Mergers typically require approval by the board of directors and approval by a percentage of shareholders. Laws differ depending on what state you’re in and the governing documents for your company. 

Stock sale 

In a stock sale, each shareholder in your company is selling their stock to a single buyer.  The selling company then becomes a subsidiary of the buyer. The feasibility of this sort of deal depends on the size and organization of your cap table, and whether you can easily coordinate every person who owns stock in your company. Legal fees could mount if the logistical aspects of this structure are difficult to accomplish.

Asset sale

An asset sale involves selling individual assets of a company (rather than selling the entire company to the new buyer, as is the case with a merger or stock sale). Examples of the types of assets sold can be intellectual property, a product line, or a subsidiary of the business. Asset sales typically exclude liabilities, like outstanding lawsuits or debts, because the buyer doesn’t want to assume the issues that go along with those liabilities.

The most common situations where M&A makes sense

While virtually all deals fall into one of the three basic M&A structures, every company’s situation is different, with implications for the founders’ motivation to sell and the leverage they have to negotiate a good deal. Here are some of the most common situations that result in an M&A.  

Fire sale

A fire sale can occur if the company has not gained traction in the market, burn rates are high, and options for additional funding look bleak. As a result, the company’s board and investors want the quickest way out, and founders may find themselves accepting a less-than-appealing offer for acquisition due to lack of other options.  

Typical deal structure: Asset sale

Pivot

Companies that achieve some degree of traction may still believe there’s a ceiling on how successful they can be. In these cases, founders may decide to pivot in a new direction—for example, targeting a slightly different market, or changing the product focus. 

Typical deal structure: Asset sale—the acquirer buys assets of the pre-pivot business that are no longer needed.

Us or them

M&As can change the landscape, and companies don’t want to get caught on the wrong side. A growing, successful company may become an acquisition target of a larger company in its space—and may decide to sell so that the large company doesn’t acquire another, competing company and supercharge a rival.

Typical deal structure: Merger or stock sale

Too good to pass up

Even if a company is doing well and has no plans to sell, founders have a fiduciary duty to their shareholders to strongly consider a compelling offer when it comes in the door. A public market example is the October 2022 acquisition by Elon Musk of Twitter, which had not been actively seeking a deal at the time. (Musk’s purchase offer was higher than the then-current stock price, which likely influenced the board’s evaluation of the offer given their fiduciary obligations.) 

Typical deal structure: Stock sale

Strategic deals

Pre-existing commercial or investment relationships between buyer and target can create strong price dynamics for founders. Because the buyer already knows the target’s executive team and has a clear view of how acquisition could help fuel their growth, they may be highly motivated to outright acquire the target. Typically the acquirer will have an internal champion pushing for the deal, such as a head of a business unit who’s worked with the target closely. 

Typical deal structure: Merger or stock sale

How founders’ goals and life situations affect M&A decisions

An often-overlooked factor in an M&A deal is where founders are in their lives and careers, and what their personal and professional goals are. Here are some common stages of the founder journey, and how they factor into whether a deal gets done.

Ready for the next adventure  

After years of building and scaling a company, some founders are ready to move on. Next steps may vary: They could be eager to start another company, take a break, focus on investing, or focus on family. The common thread is that their passion is leading them in a different direction. 

Still hungry

The opposite can also be true—founders’ deep personal connection to the ongoing challenge of building their company makes them reluctant to sell. They started the company from nothing and brought it this far, and may be eager to continue to grow their company and less inclined to cash out—even for a solid deal. 

Keep in mind that the decision to sell is not always the founder’s choice: Even if they are still hungry, for example, the board may force them to accept what it views as a good offer—or be replaced as CEO.

Ready to sell — with reservations

In cases where a founding team is joining the acquiring company as part of the sale, the post-deal dynamics are a key factor. Will the founders lead their own business unit? Who will they be reporting to? Will they continue to operate their own business as before (just with more backing), or will they have to compromise their original vision? Depending on the personalities and goals of the founders, these could be crucial issues in the decision to sell.

Looking out for your employees

A merger or acquisition can have profound effects on employees, both when it comes to their equity and their life after the deal.

Employee equity and M&A 

An exit event like a merger or acquisition is the moment when mostly-illiquid employee equity may result in a cash payout. In some circumstances, this can be a life-changing amount of money. But depending on the price of the deal, the company’s financial situation and how it compares to the valuation of the company when employees were issued equity, employees may see their equity value washed out in a merger or acquisition. 

In any kind of exit or liquidation, consideration is generally paid out in the following order and not pro rata, meaning (for example) that #1 must be paid in full before #2 gets paid:

  1. Debt holders 

  2. Preferred stock holders (mostly investors)

  3. Common stock holders (employees and founders)

  4. Option holders 

This structure is called the liquidation stack. Most investors hold preferred stock, and most employees (often including founders) hold common stock outright or resulting from the exercise of option grants. When considering the value of a deal and the scope of conditions, keep in mind that depending on the deal size, it’s possible that some people won’t make any money—including your employees and other common stockholders. 

Post-deal 

Consider life after the deal for your employees. How do the new owners plan to operate? How will your company be integrated into the parent company? Are the new owners planning to keep your team in place? (Because as much as your employees might want liquidity for their equity, they may want to keep their job even more). 

Additionally, consider: How will the new company’s culture fit with the target company’s employee expectations? Will the new benefits package match the current offering (for example, how does the new company handle parental leave)? And what will be the new remote work policies?  

These issues directly affect your employees’ lives and will be uppermost in their minds.

The stages of the M&A process

So you’ve gone through your sell options, considered any offer(s) on the table, evaluated how selling fits with your company goals, and sorted through the dynamics with your board and investors.

What happens next? Here’s a look at a typical M&A process:

Enlist the help of bankers

When companies decide to proactively seek to be acquired, the first two calls they generally make are to brokers (to help them shop the deal) and their law firm (to help them negotiate deal terms). The brokers, often investment bankers, will work with the target company to identify potential acquirers, strategize on how best to position the company as an acquisition target, conduct market analysis, determine a target acquisition price, and facilitate meetings with interested buyers. The law firm will help the target company understand potential deal structures, tax implications and market deal terms.

Intro meetings and pre-diligence 

In your first meetings with potential buyers to discuss a deal, you’ll want to get a ballpark figure for the value of the offer to make sure it’s not a waste of everyone’s time. (This applies when the company is proactively shopping itself to multiple buyers; the valuation dynamics and timing are different in cases where there is one identified buyer that has approached the company, as in an asset sale or strategic deal.) 

In these first discussions, the buyer will do some basic diligence on you and your company to confirm the buyer’s underlying assumptions about the target company are correct (the target will share some key details to add substance to your sale “pitch,” but this is not a full due diligence examination yet). During pre-diligence, you also will want to discuss any regulatory issues that may come up, and how seeking those approvals could affect the timeline or even jeopardize your deal. 

Basic terms and letter of intent 

Once you agree to move forward and align on basic terms, like the price of the deal, it’s time for the buyer to present the target company with a letter of intent (LOI), which is the M&A equivalent of a term sheet. This document will likely say what kind of deal structure is expected (stock sale, merger, asset purchase) but this will be pending diligence. Sometimes the type of deal will change between LOI and signing, depending on what potential roadblocks or complications are uncovered during diligence. 

Document drafting and diligence 

After the letter of intent breaks down basic terms of the deal, the lawyers will get to work drafting the full, detailed deal agreements. This is the stage of the deal where your outside lawyers will really take over. There will be further negotiation at this stage about the details of the deal. This takes a bit of time, and the diligence process will run in parallel.

Keep in mind that the diligence process will likely be more intense than it is for a typical funding round—potential buyers often want to start from zero and see everything. For example, a buyer might ask to see every customer contract your company has ever signed. Not every case will be like that, but that’s the sort of request that may happen during M&A diligence.  

Signing

Once the lawyers agree on a final draft of the document, it’s time to sign on the dotted line. But don’t pop the champagne quite yet—there are still a few more steps before the money hits your account. 

Regulatory approval and financing secured 

Some deals, especially larger ones or any involving a foreign company, may require approval by government regulators. Deals that could be considered to diminish competition in an industry will need to be evaluated for antitrust concerns. And deals with international companies will need to be evaluated by the Committee on Foreign Investment. 

  • Antitrust:  Antitrust laws are designed to promote “vigorous competition” and protect consumers. Deals that consolidate a significant amount of market share may run into antitrust scrutiny. Your lawyer will advise you if the deal will need to be submitted to the FTC’s Bureau of Competition for antitrust evaluation. This process may change the timeline for a potential deal, so find out early on if approval is needed and plan accordingly.

  • Committee on Foreign Investment in the United States(CFIUS): Any deal with a foreign company will need to be evaluated by this regulatory committee. Geo-political circumstances, like the relationship between the buyer’s country and the United States and its allies, will affect how likely the deal is to be approved. When evaluating a buyer, consider the global and political circumstances surrounding the deal. 

Closing the deal

In a relatively small deal, signing and closing might be simultaneous or only a few days apart. For larger deals this can take much longer, especially if regulatory approval is required.  If the deal is a merger, this point is when you file a certificate of merger with the state to make it official. And then you get paid.

Carta builds infrastructure for innovators along the entire journey, from inception to exit. With Carta, your cap table will be up to date and clean, making for a seamless transition in ownership. If you’re a Carta customer going through an M&A transition, customer support is standing by to help seamlessly offboard from one company and onboard to the new entity.

Download Carta’s definitive guide to M&A transactions

In our M&A transactions article, you’ll learn more about M&A transactions, deal structures, and deal preparation—and you can download a comprehensive guide that answers all your technical questions and connects you with Carta’s exclusive support features.

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Author: Jackie Ammon
Jackie leads Carta’s business development efforts for liquidity transactions and public markets. She spent the last decade of her career as a Silicon Valley transactional attorney, advising companies and investors on general corporate matters, fundraising, and liquidity events. Despite long nights studying and practicing law, and to the shock of colleagues, she does not drink coffee.