Who’s got your back? The role of investor counsel In high pressure M&A

The first quarter of 2014 has turned out to be very robust for technology M&A.

We’ve seen a spate of high-premium deals for venture-backed companies, such as Maker Studios’ sale to The Walt Disney Company and the multiple acquisitions by several stalwart serial acquirers, including Google, which acquired both Nest Labs and Deep Mind Technologies in January, and Facebook, which recently announced its two largest deals ever: WhatsApp and Oculus.

At the same time, we continued to see a steady diet of smaller “acqui-hire” deals, where buyers essentially buy pre-revenue or pre-product companies for the strength of their teams in an extremely competitive job market in technology. There’s also been a smattering of distressed deals for companies that never made it in a very crowded startup landscape.

In all these circumstances, a new trend is emerging. The venture capital firms that invest in these companies are more often engaging their own counsel to both represent their interests and be a partner to company counsel in often pressure-filled and sometimes complicated exits. Often one counsel will be hired to represent a consortium of institutional investors, thereby leveraging the bargaining power of the group while, at the same time, sharing costs.

We’ve been fortunate as a firm to be at the forefront of this trend, having been asked to serve on a large number of these mandates over the past couple years. As a result, we’ve seen and heard the various reasons why VCs are demanding their counsel have a seat at the table in these deals and the benefits that result.

First, a venture fund’s general counsel – a position that many firms did not have five or six years ago but now is fairly common among top-tier VCs – is playing an increased role overseeing portfolio company dispositions. This in-house counsel brings a different, but necessary, perspective to deal terms that might not be top of mind to company counsel by combining his or her legal training with the operational knowledge of a fund’s fiduciary obligations, the knowledge of its partnership-agreement requirements and the judgment calls that need to be made around limited-partner distributions and potential clawbacks.

Fund general counsels want experienced outside counsel to help them watch for issues such as indemnification terms; survival periods and other limitations; fund director designee fiduciary issues; and confidentiality restrictions, particularly related to what general partners can say to limited partners. But institutional investors are also wise to the fact that adding a strategic member to the deal team can result in better terms overall for all constituencies involved. This is especially true in high-pressure situations where the interests of the founders and company management may diverge from those of the investors only because they are focused on, or prioritize, different aspects of a deal in order to get it over the finish line quickly.

Completing a deal effectively obviously requires bringing a counsel to the table who “plays well in the sandbox” and who is responsive and constructive as well as highly strategic. Fall off one side of the tightrope and you risk holding up the process and irritating the potential acquirer. But walk the tightrope deftly and you can fight hard for a bucket of deal points by using the block of institutional shares to bring more balance to an often times “David vs. Goliath” situation.

You’d think with the steadily accelerating rate at which venture-backed companies are being acquired these days, deals would become more standardized and simpler. Quite the contrary. They are becoming more complex. Serial acquirers are developing their own “personalities” with differing papers being served up, some full of traps for the unwary, others simply heavy handed, and are also more comfortable bringing indemnification claims than ever before. Higher premiums are driving more creative deal structures, such as the use of complicated earnouts with both product and financial milestones. And today’s tough hiring environment is driving larger retention pools, in many cases pushing deal consideration away from the stockholder base and into the hands of a select group of key employees.

Institutional investors know that a “deal gone bad” can result in both economic and reputational harm. It only makes sense to have someone have your back in these important transactions.

Larry Chu is a partner in Goodwin Procter’s Business Law Department and a member of its Technology Companies, M&A/Corporate Governance and Private Equity Practices. He leads the firm’s Technology M&A Practice on the West Coast.

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