Acquisition interest in my part-time startup


45

I work as a software engineer at Big Software Company X, and have been hacking away on the side at my own mobile app for the past 2 years, which is publicly available. It does decently well, earning a steady stream of income to the point where I was seriously considering leaving my job and working on it full-time. But out of the blue, Big Software Company Y called me and expressed an interest (face-to-face) in acquiring my company and asking me if I was interested in working with them.

I wasn't particularly expecting this, and could use some advice. I don't have any business partners, no outside investment or anything; just me and my "weekend app". They didn't make an explicit offer; they said they wanted to meet me personally, see if it's a good fit, and will talk amongst themselves and get back to me. In fact, they were a little taken aback that this was a part-time thing for me; it seemed that they weren't expecting that. I told them about usage and some details about how it technically works, and some vague discussion about my plans and their plans. They said they are working on something very similar, that's why my app caught their attention and they really liked what I was doing with it. They couched their acquisition interest in terms of me coming and working for them - did not mention just buying me out and walking away.

So I have a bunch of questions I am hoping someone could help me with.

  • Basic question: whatever the sticker price of the 'deal', how much of it is taxed? I have a single-owner LLC, so normally income is taxed at personal rates. Would selling the company (in asset sale) also be taxed like normal income?
  • What would such a deal look like? How much value should I expect for the company itself, how much of it would be tied to my working for them. Just as an example (don't take it literally), they offer $5 million, but only 1 up-front, and 2 each after 1st and 2nd year that I work there. Is that how it usually works? Would they make an offer more in cash, or in their company stock, or a mixture of the two?
  • Would they offer market rates for salary if I work for them? Would they take into account my role at my current full-time job and offer something relative to that, or would it be relative to my status as a founder of the company they bought?
  • In this situation (more of an 'acqi-hire') should I possibly negotiate more on the value of the company, or on the retention terms? Would it signal to them that I might be interested in selling and walking away (rather than joining them), and hence turn them off on the wholesale?
  • Should I get a good lawyer involved at this point? They're expensive (ballpark legal costs?), and the deal might not even come through.

I realize that (since they now know that I'm part-time) the offer might not actually come through. But I'm not desperate to sell, or work for them. I was looking forward to working independently for a few months, see if I can really take this company to a level where I was earning much more than as a salaried employee, which I think is possible. On the other hand, if the offer is fantastic, I would take it, and I want to be prepared in case an offer does come through. Any advice would be greatly appreciated.

Acquisition

asked Feb 7 '11 at 13:22
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Anon
228 points
  • You might want to consider splitting up your questions as some of them are generally applicable to many people. i.e. I asked your first one a few days ago here: http://www.brightjourney.com/q/s-corp-purchased-sell-assets-stockMichael Pryor 6 years ago
  • Just a thought, the company acquiring your software doesn't just invest in the software, but also the client-base that you've already gained. It's not just about how long it'd take them to develop it, but also to build up a community around it. That's included in the cost. – Kieran Senior 6 years ago
  • Let u sknow how it goes with a follow up – Tim J 6 years ago
  • Thanks for all the helpful responses. I'll definitely post something as followup when there is any development. Please keep adding to the answers if you have any other good feedback; this is all very helpful. – Anon 6 years ago
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11 Answers


36

It strikes me they're looking for two things:

  1. Your product, so they don't have to develop their own.
  2. Your expertise with your product, so you can maintain and improve it for them.

Those are two quite different value propositions: there's value in your product by itself without you, and there's quite separate value in you continuing to develop it on their behalf. While they're related, you need to decouple them as much as possible.

You mentioned they were "taken aback that this was a part-time thing for me", and "they couched their acquisition interest in terms of me coming and working for them - did not mention just buying me out and walking away."

So here are some things they could be thinking, speaking as a bit of a cynic:

  • "Maybe if we offer him a nice salary, we can get his product for free." I don't imagine that's what you want.
  • The above, plus "Then we can fire him after we train some of our own people to work on it." I really don't imagine that's what you want.
  • "Wow, if he could write that on the weekends, how hard can it be? Maybe we should just keep writing our own." Then you won't hear back from them and this is all moot.

Assuming they're not thinking those things, here are a few more remarks.

What would such a deal look like? How much value should I expect for the company itself, how much of it would be tied to my working for them. Just as an example (don't take it literally), they offer $5 million, but only 1 up-front, and 2 each after 1st and 2nd year that I work there. Is that how it usually works? Would they make an offer more in cash, or in their company stock, or a mixture of the two?
I would first determine the value of your company itself, without you working there. There are formulas for that kind of thing based on the profit and growth you have. Given that you think you could make more than you do at your current employer, let's say you can make $150,000 annual profit. Using a very conservative (for software with growing sales) multiplier of 3, the business itself would be worth $450,000.

If I were you, I'd make that my primary negotiating point, and refuse to talk about becoming an employee until that's settled. I'd also either get that in cash up front, or cash plus a note or royalty payments secured against the software reverting to you on nonpayment. Unless they're a huge company with fantastic prospects, I wouldn't accept stock; if they run their company into the ground, stock will be worthless.

Once that's settled, then you can discuss coming on board as an employee. Again, if I were you, I'd make my successful entrepreneurship a negotiating point, as in, "You'll have to offer me a better deal than I could do on my own." If they really want you around, they need to offer you golden handcuffs. You should get at least the salary you're making now, preferably more, and stock and bonuses and so on. That's where you can accept things vesting over time.

Remember: you don't need them to acquire you. You can walk away from this. And whoever can afford to walk away from the negotiating table first wins.

Should I get a good lawyer involved at this point? They're expensive (ballpark legal costs?), and the deal might not even come through.
I'd get one lined up. You can figure an introductory 30-60 minute meeting with a really good business lawyer to run $1-300 - but I can tell you from experience, it's really worth it. They can give you very useful guidance that can help you get the best possible deal. Also, if Company Y thinks they can take advantage of you because you wrote this in your spare time, they'll think differently if, in your next meeting, you mention that the senior partner at Expensive, Oldschool, and Nastyincourt is advising you.
answered Feb 7 '11 at 16:31
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Bob Murphy
2,614 points
  • +1 for 'Expensive, Oldschool and NastyInCourt' :-) – 5arx 6 years ago
  • +1 for "Remember: you don't need them to acquire you. You can walk away from this. And whoever can afford to walk away from the negotiating table first wins." – Hartley Brody 6 years ago
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19

Get out your employment contract with Big Company X. Read it. NOW. It doesn't matter what they've said to you, or whether they've been cool in the past with your side project.

What matters is the terms of your employment contract.

Because every employment contract will have some clause about what work of yours belongs to the company, and what belongs to you.

And if your contract says anything that implies that BCX has some claim to this project of yours, you've got a potential headache on your hands.

Find your contract, find a good lawyer (you may need two now, given this complication). Talk to them about this.

Because all it takes is one senior person at Big Company X saying, "Wait a second... Our employee built a separate company while working for us? We have a claim on that..."

At which point, the only people who make money are the lawyers, and Big Company Y may simply decide to head elsewhere.

Don't ignore this issue, or take what your current employers have said to you at face value. What counts is what your contract says.

answered Feb 8 '11 at 02:23
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Peter L
406 points
  • What you are concerned about also depends largely on the locale. – Tim J 6 years ago
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11

I'm sorry I don't have more time to answer your question in detail right now, but one additional thing I think you should consider when making your decision is this:

You've got the entrepreneurial spark in your blood - this is clear. You've created, you've shipped, you've become cash flow positive. You've got an offer. If you sell it, you have the gold badge of having already had a successful exit. This goes a long way towards helping next time you want to do another venture in a number of ways, including raising capital.

Having an exit under your belt proves you can do it, and have done it before. You're less of a risk.

In terms of your other questions, my quick answers are:

  1. Not sure - not well versed in U.S corporate law. I suspect the advice will be something along the lines of incorporating a new entity in Delaware (C Corp) and absorb the old entity before selling. I'll let someone else field that one.
  2. Deal structure varies. It can be either all cash, all stock or a combination of both. You're correct that often the purchaser will attach an earn-out clause to the deal for key staff. IE: You get $5MM now, and another 25% over the course of 2 years.
  3. It depends - but given you're standing to make a fair whack of money from the sale, I wouldn't be too concerned with the salary, as long as it is market. In reality you're probably going to find that with a modest-life-changing event under your belt, and the ability to chose your own path for the next few years, working for the big company that just bought you won't be very tempting for long.
  4. It depends what you want out of it. If you want to up and leave and burn the earn-out a higher base purchase price would make sense. But if it isn't reasonable, then they won't buy it.
  5. Yes - I would. You can negotiate pretty good arrangements if you don't want to pay up front. A number of startup lawyers will structure fees in a way that works for everyone. The agreement could be contingent on sale, or could be a % of the sale price (capped) etc. A small upfront fee to get it going, and the balance paid out of proceeds etc. Lots of options there, and it is worth getting specialist advice.

Good luck!

answered Feb 7 '11 at 13:41
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Michael Shimmins
211 points

5

My first concern would be that Big Company X probably had you sign a contract in which you agreed to give them ownership of all of your intellectual property. They may be of the opinion that they own your side project, if they become aware of it. Big Company X just sniffing in your direction could scare off your buyer -- I'd be all over getting legal advice.

answered Feb 7 '11 at 13:43
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Peter Cardona
151 points
  • Big Company X was well-aware of my side project all along, and no one objected so far. Not sure if that affects anything. But yes, legal advice sounds like a must. – Anon 6 years ago
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3

All the other answers posted here are great, and I want to add a couple more thoughts.

It sounds to me like a big question for you is how much do you really want to sell and cash out, and how much do you want to keep working on it yourself? And how much do you want to be an employee of another company rather than doing this yourself and maintaining control of your product/vision? Sounds like you have some soul-searching to do.

This company is obviously impressed with you. Your confidence will determine how much money you can make on this deal. If you are straight and ask for 5 million and you really believe your product is worth it, you have a chance to get it.

It's a good idea to get a lawyer, but don't get bogged down with fear and legal worries. You have a great product, they want it, just take your time negotiating with them. You hold all the cards (of course be careful about what you reveal to them that they could use to take your idea and compete with you).

But just because it's a part time project doesn't mean you can't find investors other investors and go full steam ahead on your own. In fact, you might want to hint to them that you're considering doing this, and that you have other potential sources of investment capital, so they don't try to outmaneuver you just because they have deeper pockets.

Since you now know that they want to go into your business, but they have nothing yet, you have a big head start. The position you are in is way ahead of them and you're probably in a position to dominate the market, even without them.

I'm not saying you should be cocky or greedy. Just let them know you're holding all the cards.

By they way, I'm reading the book "The Facebook Effect", and the one of the things that struck me is how confident Zuckerberg was, and how straight he was with everyone, he was willing to talk openly with a lot of CEO's and companies about his vision. He got offers first for a few million, and they kept going higher and higher, but he always had total confidence in his vision and the product he was creating, and he didn't sell out.

One last thought. This does seem to be a hot market. Companies are swimming in cash that they've been hoarding, and with all the "quantitative easing" I think there's lots of money chasing good ideas. In another year there could be another market crash and the economy could turn south again. So on the other hand, if you are interested in cashing out, this may be a good time to do it! Good luck.

answered Feb 7 '11 at 21:22
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Christian
138 points

2

I can answer two of these:

(1) Taxation: if you're selling your shares/membership interests/equity in the LLC, if you've held them for I believe 2 years, you'll get capital gains treatment, rather than ordinary income treatment, and capital gains treatment will be favorable for you.

(2) Don't get a lawyer involved yet- hash out any business terms (or at least get a proposal from them) first. I am a lawyer, and while we can give guidance about "here's how these deals typically work out, and here's what you should expect", you can get free business-side guidance from non-lawyers. Legal fees now are a waste of money.

Congratulations on doing so well on this.

answered Mar 20 '11 at 00:43
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User6492
1,747 points

2

One book of interest to you will be this one: Bootstrap: Lessons Learned Building a Successful Company from Scratch. Hess talks about his own personal experience of going from full-time employee at HP, to planning a side-project after work, to leaving and starting his own company, to selling that company. Lots of sage advice in there.

Some points that are particularly relevant for you:

  • If you do decide to leave, don't tell anyone at your current employer what your plans are. People tend to get jealous and many people will not understand why you are leaving a steady income.
  • Once you've run your own company (where you are in control of everything), selling the company and becoming an 'employee' again can be a very difficult change. Negotiate your commitment to be only as necessary to facilitate the changeover, or negotiate a position of power/control (seat at the board, etc). May not apply in your case, since you're a one-man-shop, but still worth thinking about.
  • Consider the liquidity of the offer. If it's an offer of stock, when can the stock be traded? Are there restrictions about how many can be sold? If it's cash, then you can bank that straight away.
answered Feb 8 '11 at 02:48
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Grant Holliday
121 points

1

With regards to the tax issue:

Selling a company is different than personal income. It is considered a capital gain. In which case you will be taxed at the capital gains rate of ~15%.

If on the other hand your company were to sell the intellectual property, then that would be taxed at the income rate ~30%.

answered Feb 8 '11 at 05:12
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Sly
111 points

0

All great answers posted above, but I would follow the advice from Kelly Cooper and create proof of ownership for your idea/product/insight, it doesn't hurt to do it and protects you well. Also, don't over share "secret sauce" in the meeting with the BCY. It's possible they are just shopping for insight on your product or even if they don't, you could give them too much info and make them not needing to either buy your product or have them come work for you. Recording the meeting isn't a bad idea either.

I am speaking from experience - big company (and a competitor) asked for a call about a potential partnership, asked a lot of questions about the team and product development efforts, never called back with anything more to offer.

answered Feb 14 '12 at 22:35
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Webbie
2,825 points

0

One quick comment, as an addition to the other good comments. I'd sit down over this holiday week and write up a good Inventor's Notebook. Before you meet with them face-to-face. You can date it, write up all of the thoughts you had in inventing, revising, marketing, etc. Get two witnesses to sign. There are many things you've thought about, many decisions that were a part of your initial prototype to your current version. You need to protect those ideas. Your comp book, in ink, no pages torn out, etc. will provide you with some security because there are probably features you're considering they haven't run into yet simply because they're not on the market. The worst case would be if they meet with you a couple of times, you both decide to pass, and then BigCompany money gets a better version out in Q1 2012.

answered Dec 20 '11 at 06:19
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Kelly Cooper
88 points

0

At the core of all this is your intellectual property that you have created and secondarily your skills. Some good points have already been made by others about risks if you become an employee by others in this post. First, get a reputable IP/ patent lawyer. They should also have good knowledge about how to protect your IP as well as how to negotiate and value it.

I would suggest that if you do take the option to become a permanent employee that you legally separate yourself and your IP so if the working relationship sours your IP is protected and you can continue to collect royalties or even withdraw your IP from them. Depends how good the contract/agreement is. Treat yourself and your IP as separate entities. You don't want to be forced to leave the company and then also sacrifice the IP, then you would have nothing in the worst case. Good luck!

answered Feb 7 '11 at 20:23
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Giulio
163 points

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