Is an acqui-hire a good idea for me?
An acqui-hire is the acquisition of a business or company not for their products, business or customers, but instead primarily to capture a particular person or a team of talent.
Acquisition of a target for their proprietary intellectual property is also often a complimentary motive, however, a true aqui-hire is driven by the talent alone. The talent may comprise a few founders or an entire development and design team.
Acqui-hires or talent acquisitions are a regular part of business for the largest tech companies in the United States and they are growing in popularity among mid-market companies there also. Many of the same benefits of an acqui-hire are applicable for a buyer and seller in Australia, so growth in their popularity should be expected here as well.
Yahoo has undertaken at least 3 acqui-hires in the past year buying social news start-up snipit, location-discovery app alike and travel tool milewise and shutting each down almost straight away.
Facebook undertook 12 acqui-hires in 2010 through to 2012 including acquiring social activity site Hot Potato for around $US10m and social sharing site Drop.io for a similar price. Google, Twitter and Zynga have also completed acquisitions with similar motives and now have key senior executives roles filled by the sellers.
Acqui-hires can be problematic, with retention of the talented people (after the end of an earn out period) being one of the key challenges.
In the right circumstances, however, acqui-hires can be an excellent strategic choice. Australian corporates who are looking to innovate and start-up founders who are considering packing in their company and a return to a paid salary, should pay particular attention to the acqui-hire possibility.
THE BENEFITS FOR A BUYER
The acqui-hire strategy originated in the United States tech scene when large tech firms were restricted from hiring each other’s talent because of “non-poach” agreements, with the acqui-hire providing a way around the restrictions. Those agreements are now non-existent, however, the strategy has expanded as talent has become more expensive and as innovative development and design teams have become a key requirement for every large company.
For the buyer, the acqui-hire strategy enables the simultaneous recruitment of a team of innovators who know each other and who have developed methods of collaborating together. The acquisition can either be integrated into an existing development team, or kept separate to avoid integration tension or the stifling of creativity.
The purchase price can be structured to include a large proportion (or all) as an earn out or a payment conditional on development milestones. This can be an effective driver of productivity. Employment terms with the target team can also be linked to a mix of short and long term incentives. Equity in the buyer can be offered as part of the purchase price or incentives, with vesting cliffs attached.
The transaction can also provide a means to introduce a new leader of a particular division or a new way to doing business and often with less negativity generated amongst the incumbent team.
It can also be a powerful public relations tool for customers and suppliers.
THE BENEFITS FOR A SELLER
An acqui-hire can be attractive for multiple reasons for a start-up founder who is considering packing everything in and returning to a fixed salary.
The sale can be structured so that the purchase price reflects the value in the talent for the buyer, plus any assets which are to come to across. An earn out or conditional payment can also be included to give sellers upside if the value turns out to be more than initially assessed or as an incentive for particular milestones to be met.
There may be a tax advantage if the purchase price is be taxed on capital account (where the seller is selling shares in a start-up) and the seller is able to obtain the 50% capital gains tax discount, as opposed to paying income tax on a salary at top marginal rates. Smaller businesses may also be entitled to a further discount to their capital gains or there may be CGT rollover relief available, which means the sellers may have no capital gains tax due immediately (i.e. they get to rollover their capital gains tax gain until a later time).
Founders are also often re-energised by the prospect of being part of something bigger after a time spent independent and can flourish without the distraction of many of the day to day management tasks.
A silo approach to acquisitions, where the target is left as an autonomous division, is also becoming more common for corporates meaning the sellers and their employees may still have many of the benefits of a start-up culture. Yahoo’s acquisition of Tumblr and Google’s acquisition of Waze (each in 2013) are two examples of that approach.
The experience and book-end provided by a sale to a corporate is also far more preferable for a founder’s CV and reputation as compared to a liquidation or shut down.
GETTING PEOPLE TO STAY IS A KEY CHALLENGE
Making an entire team (or most of them) feel positive about an acqui-hire and ensuring they are engaged with and aligned to the buyer’s broader commercial motives, but at the same time not limiting their innovation and creativity, can be very difficult.
A well-designed acquisition strategy, including key motives, messages (like Yahoo’s promise “Not to screw it up”) and an implementation step plan, is important to achieve this.
It is also important that the legal approach to the acquisition reflects this strategy closely. In particular, the purchase price, compensation packages and option schemes for the entire target team need to reflect any key milestones sought by the buyer. They must also promote a long term focus for the target team, that disincentives departures or disengagement.
In designing any strategy, a buyer and seller also need to be aware that most start-ups who have received funding will have a liquidation and exit preference for the benefit of their VC or angel investors, which can impact on how talent are rewarded at the outset. For many of the high profile United States acqui-hires this has meant little or no return from the initial purchase price for founders.
STRIKING THE RIGHT BALANCE TO CONTROL IS IMPORTANT
For all parties, striking the right balance between control of the new division for the buyer and day to day autonomy for the target team is important and very difficult to arrive at. Managing the expectations of each side at the outset is crucial to this. Corporate buyers cannot generally give up control over any part of their business and this should be the starting expectation of all parties, unless otherwise agreed.
A TAILORED DUE DILIGENCE IS NECESSARY TO AVOID GETTING PARTIES OFFSIDE
Buyers and sellers also need to bear in mind that due diligence is still very important for an acqui-hire, particularly given that most are structured as share sales where the buyer takes over all obligations and liabilities of the target.
For a buyer this means developing an understanding of the risks they will be assuming and how best to mitigate them (keeping in mind that warranty enforcement is not usually an option if the talent is to be kept on side). Tax liabilities and the protection of the benefits (such as those created by R&D tax credit applications) and historic intellectual property infringements are two key focus areas.
For a seller, understanding who you are dealing with, their approach to business and management and whether your expectations of the future are realistic are commonly the most important issues, which are best addressed by speaking to people who have dealt with the buyer before.
In our experience the standard due diligence template from a law firm and accounting firm is usually not appropriate (it tends to put people off side almost every time). A tailored approach to due diligence should always reflect the acquisition strategy and key motives of the buyer and see any risks in the context of those overall objectives.
The greatest benefits of an acqui-hire are often those which cannot be easily measured, like the injection of confidence it brings to a team’s morale or the insights to developing technology and changing consumer behaviours which a corporate would find very difficult and costly to obtain otherwise.
With technology rapidly disrupting most incumbent businesses in Australia, we expect many executive teams will feel compelled to do acqui-hires at some time in the near future and, provided the strategy and implementation is well prepared and tightly controlled, they will be rewarded quickly for their bravery in doing so.
This is a guest post by Joel Cox who is a senior associate at global business law firm, DLA Piper, and specialises in all aspects of fundraising law and M&A transactions for technology companies and investors.