Paul Koenig: Understanding the Post-Closing Implications of Talent-Based Acquisitions in Social Media

There are plenty of reasons to make a deal. Some targets have a crown jewel asset that is critical to the buyer’s strategic direction. Others have key customers that the buyer would love to add for future growth. Often, there are synergies between the companies that make the combined entity more valuable than the sum of its parts. In other cases, it is the team that makes the target.

Each reason for doing a deal has risks: the crown jewel asset might fail or lose strategic relevance (see Cisco’s acquisition of Pure Digital, News Corp./Myspace), a key customer might terminate a relationship that creates a massive revenue gap. Deals done to acquire talent, however, are especially tricky. This is often counterintuitive, because buyers often think they’re clean and easy, as issues such as the target’s financial condition or intellectual property ownership may not be as important. The challenge come when the key “asset” walks out the door at the end of each day, and neither party to the merger can fully control what team the acquirer will be able to retain after the deal is complete.

This is a growing issue because much of the recent M&A activity in Silicon Valley has been focused on the acquisition of talent. There is an endless need for smart, visionary professionals in the technology industry, especially in social media, where competition for intellectual capital is intense. Facebook is the poster child for talent-based deals, having acquired several companies largely for their employees.

To counter this, buyers should put in place mechanisms that require key team members to sign contracts to remain on board. Buyers can also assert a right to make claims against the escrow or claw back part of the purchase price if too many key people leave post-closing. Typically, between 10 and 20% of the purchase price is set-aside in escrow for between 12 and 24 months, and shareholders need to take into account this consideration is at risk on any type of deal.

Talent acquisitions put the selling stockholders in a tough position. They have little control over whether an employee stays or goes. And, whether an employee stays or goes after closing is largely dependent on how the acquirer treats them—not the prior owner, who often has more, personally, at stake. Even if the buyer treats them well, many employees who thrive in a start-up environment struggle with the culture of working at large public companies. Not everyone wants to “go corporate.”

When structuring a talent-based M&A transaction, the buyer and seller, including their advisors, need to thoroughly understand the strategic reasons behind the deal and focus closely on those issues. Selling shareholders, including venture capitalists, private equity firms and corporate executives, also must focus the implications to them if the changes in compensation terms that can shift based on employees’ decisions remain with the company after closing.

In managing the risks of talent acquisitions, the buyer and seller often use some combination of retention bonuses or other incentives for employees to remain with the company through a specified period. While deal structure can help to mitigate these risks, selling stockholders should also try to understand whether the team is excited about the deal and the prospect of working for the combined company. This can be tricky because people will surprise you, or might tell you what they think you want to hear rather than what they really believe. Additionally, often it’s hard to have this discussion prior to signing a merger agreement because of confidentiality concerns. The more investors can learn, however, about whether the team likes the idea and whether the companies’ cultures are compatible, the better idea they are likely to have of the level of risk of departures and ensuing claims.

Many successful deals have been primarily about acquisitions of personnel. There are compelling reasons to do these deals, especially in talent-driven industries like social media. When thinking about whether such a deal is advisable and how to structure them, the parties need to understand that the team is the primary reason behind the transaction and focus their efforts on planning for the transition. While the parties on these deals might not need to spend as much time on issues such as reviewing the financial statements, they need to think hard about the human resources issues as well.

Paul Koenig is a co-founder/managing director of Shareholder Representative Services, which serves as a professional shareholder representative following the acquisition of a VC-backed portfolio company. Read his past peHUB posts here.