M&A Issues: The Stay Package
We continue our discussion of M&A Issues this week on MBA Mondays. Today we are going to talk about the "stay package."
When a company acquires your business, they are buying the people as much as anything. Experience has shown that the most successful acquisitions require the team to stick around, at least for a while. But if everyone is getting cashed out day one, there is very little incentive to stick around. Therein lies the stay package.
There are a number of different variations on the stay package to deal with different deal scenarios. I will group them into three main categories for the purposes of this blog post but there are many variations around these three main categories. Every deal is different. There is no standard deal in the M&A business.
1) When the employee and founder equity is worth a lot of money and much of it is unvested – In this scenario, the buyer usually assumes the unvested equity, converts it to unvested equity in its cap table, and uses the remaining unvested equity as the bulk of the stay package. The buyer is likely to adjust the stay package by issuing new employee equity or cash bonuses to certain members of the team to further incent them to stay.
2) When the key employees have equity of significant value and most/all of it is vested – In this scenario, the buyer is going to have to come up with a large new employee equity grant or cash bonuses for the key employees and it often comes out of the sale price. Let's say your company is getting purchased for $300mm and the buyer believes it will take $30mm of cash or equity in the buyer to incent the key team members to stay. It is typical to see the purchase structured as $270mm for the company and $30mm for a stay package for key employees. In this scenario, the rest of the team usually has remaining unvested equity and will typically be treated similarly to scenario 1. It is common practice, but by no means standard practice, for the employee equity and investors equity to be split up and treated differently in this kind of situation. In one situation I was involved in, the founders owned 40% of the company and the investors owned 60%. The company was sold for $100mm and the investors were cashed out for $60mm and the founders got a two year stay package for $40mm plus some additional equity in the buyer's stock.
3) When the key employees' equity is worthless – This usually happens when the company is being sold for less than the total invested capital. The deal most investors make is they get their money back before the founder and employee gets paid out. In an investment that doesn't work out well, this means the founder and employee capital is worthless in a sale. But the buyers know this and won't allow all of the sale consideration to go to the investors, who don't matter to them, and none to the employees, who matter a lot to them. So what buyers typically do in this situation is create a carveout for founder and employee equity. The carveout can often be as high as 25% of the total consideration. I have seen buyers propose 50% or more but those deals don't get done because investors usually control the exits and they need to feel that they are being treated fairly. The founder and key employee carveout is usually paid in cash over a two to three year period.
The typical stay package is for two to three years. The consideration is generally paid ratably over that period. But it can be back end loaded to further incent the team to stay.
Some deals can include an "earn out" which is additional consideration based on the performance of the business. Earn outs can be for the entire shareholder base or can be made available only to the key employees. Earn outs can work well when the business is being left alone and the metrics are easy to establish and the team feels confident they can meet them within the confines of a larger organization. I don't consider earn outs to be stay packages. They are a different beast for a number of reasons. But they can be very effective at keeping the key employees around.
I'll end this post by saying that I can't think of a founder or key early employee of one of our portfolio companies that has stayed at a buyer for more than three years. Most are gone after two years and some leave well before that. There are a host of reasons for this, and most have to do with the psyche of founders. So it is wishful thinking to expect a founder or early key employee to stick around for the long haul, but getting them to stick around for a couple years can be done and should be done. So make sure your deal has a well thought out stay package. It is in everyone's interest to do so.
Comments (Archived):
“I can’t think of a founder or key early employee of one of our portfolio companies that has stayed at a buyer for more than three years”.I´m thinking about the huge rate of failures of M&A compared to companies where founders stick in after being acquired or remain on the lead after receiving funding. It seems that “Brief Stay Packages” don´t work very well for the buying side.
Really crisp and clear and instructional.I usually considered ‘earn outs’ to be part of the stay package but it is mostly different terminology not disagreement.I’ve sent this post along to friends and clients. Truly instructive and useful.Great post.
done right, an earn out could be a “keep package” 😉
I was impressed with the clarity of today’s post as well. Not to imply that Fred’s a mediocre writer normally ;), but this post flowed and transferred the concepts perfectly. Did we witness Fred level up as a master communicator?
Maybe ;)But crispness and clarity are tied to topic and intent I think.While learning occurs daily in this community, some threads are looking for the future and there is no ‘right’ answer but many directional thoughts to grease our thinking.Today’s post did a great job of sharing what I would call ‘fiscal logic’. I’ve been through a bunch of these deals but I learned some logic here that was never clearly encapsulated. How you use this logic is variable but these are core metrics that just make sense to have neatly tucked into your tool belt.
post super bowl partying effect?
I think Fred is channeling the Great Communicator given his 100th birthday. There is something truly Reaganesque about Fred. BTW, that is a compliment.
although she would get very annoyed at me for suggesting it, the gotham gal has a lot in common with Nancy
Old, old Arkansas joke:Bill Clinton and Hillary were driving around rural Arkansas and stopped to refuel. Lo and behold, the gas station attendant was an old boy friend of Hillary’s from back east.Bill had a good guffaw at Hillary’s former beau and said: “Damn, Hill, aren’t you glad you married me rather than Goober. I was President of the United States!”To which Hillary replied: “Bill, darling, if I had married Goober — HE WOULD HAVE BEEN PRESIDENT!”
i’ve heard that joke and if it not true, it should be
Great post. Very instructional for those of us who haven’t been through the process before.I wonder how this plays out in the acqui-hire scenarios that seem to be increasingly common these days. In that case the founder equity is most likely to be primarily unvested, so I’m assuming it falls under Case 1. However, when the company is being bought solely for its people, often with the intent of shuttering the company’s current product, it seems like retaining the founders becomes an even bigger concern. Any insights into how those deals have been structured recently?
in those cases, the investors often don’t own much of the company andmost of the equity is unvested. so it is most likely scenario 1, butit could be structured more like scenario 2.in these situations the stay package is the most important part of thedeal and it can also be the majority of and in some cases almost allof the consideration
Getting founders to stay is all about giving them a role with autonomy in the new organization.Andy Rubin and Rich Miner are still at Google (although Rich is at Google Ventures now). Steve Chen is still at YouTube, Chad Hurley just left a month or two ago. Android and YouTube run as largely independent units.
I don’t think steve has been at YouTube for yearsAndy Rubin is a great example of an entrepreneur who stayed at a bigcompany. It’s like Google funded his company though
Warren Buffett seems to have success getting founders/current mgmt to stick around. He’s not acquiring tech startups, but there may be some similarities. Are you familiar with the way he works? What’s he doing right?
i love what Washington Post company did with Kaplan. that was certainlyBuffett’s work behind the scenes. his and his partner Charlie Munger’spragmatic approach to business and investing is inspirational
But Kaplan left??? And they certainly grew because they moved away from his mission to getting people into schools, to building their own and getting a bunch of money via the government and student loans.Seeing how many lawsuits they currently have against them, its not for me to know or judge but seems like a sleazy business. Again not sure.Getting founders to stay who love the feeling of being founders is really tough. In every business there are hard daily decisions to be made on the direction of the company. Founders are used to making them on the fly. Yes you work with the board for overall direction, but on the day to day battlefield you are in complete control. That isn’t the case when you are acquired.Hired gun CEO’s or somebody who has spent their life at one endeavor are much easier to keep.
Berkshire acquires a lot of family-founded or -controlled businesses (e.g., Helzberg Diamonds, ISCAR) where the family members / founders usually want to stick around and maintain their company’s culture. Berkshire is their ideal buyer because if Buffett likes the company, he’ll let them do exactly that.
Even more fundamentally, BH buys going concerns and keeps them going. Rarely does he intend to do anything with or to the company.
Timely post. Any thoughts on the HuffPo acquisition? 🙂
Ariana Huffington has successfully made chicken salad out of chicken excrement and had a very nice visit to the pay window. You have to admire that gold digging person.
HA!I came here to say the following: what great timing for this post. Arianna Huffington is someone who I know took her stay package VERY seriously. :)Still not sure I believe Aol is truly giving her the keys to anything.What a great country we live in! You can run for Governor of California as a populist hero, get 1% of the vote, start a muckraking web site and make $300 million dollars.
if they can keep the tech team, it will work. HuffPost is not a content company. it is a tech company.
How do you mean?
They won because of tech. The content comes from others for the most part
At the end of the day, one of the most important elements of any acquisition is — who is going to run this thing and who knows where the bones are buried?Management continuity is an important issue in any endeavor that is going to change the name on the ownership docs. But it is just like a hundred other issues. Deal with it in due course and don’t fret.I have always erred on the side of too much management continuity. I freely admit to being lazy and substituting continuity for getting the entity assimilated quickly. That is my own fault and laziness.While there are many different approaches to this challenge, they all get down to a simple thing — is the value of the transaction impacted by or threatened by the loss of key personnel. If so, you must act appropriately to diminish that risk.This is why the documentation of systems and processes is so important to a going concern. If it is all filed in somebody’s head, then the value can be impacted by that person leaving.Whereas if the processes are well documented, then you just have to teach to the test and move on.I think that the first line of defense is to focus group or notify the existing customer base and get a read on how important it will be to them if somebody leaves.If they say: “Joey is my boy and where Joey goes I take my business.” then you better keep Joey around. If not, replace Joey with someone that the customers have a positive reaction to.There is never ever any downside to maintaining a thoughtful and sensitive relationship with someone who might be able to save your ass if something goes wrong. That costs time and money but it is truly very easy. Take the guy to lunch.
Curious to get your take on the split in the HuffPo deal — $300MM in cash, $15MM in stock. Stock piece hardly seems to be much of an incentive given a) the proportion relative to cash b) uncertainty around AOL stock.
This is nothing more than a guess, but the thought struck me that $300MM in cash has to be split up among the various equity holders. I’m guessing the $15MM is Arianna’s stay package. 🙂
i have no idea who is getting what in that deal. to say anything would be pure speculation
Legally, how does #2 work? Exactly how is it that the investors get liquid and the founders do not, when all own stock that presumably gets converted to common in a sale?
The reason is that, in most cases, a sale of the company is deemed a “Liquidation” in the shareholders agreement (verus a public offering, where everyone is forced into conversion). Under a deemed liquidation, the preferred investors get “redeemed” first, then common shareholders. The only way management (which typically only holds common)gets any proceeds woudl be through a carveout or Stay package.
that is the deal the buyer puts on the table. the board can approve it or not. if the founders don’t support it, there is a very small chance it happens.
Fred, What is your response to your alternative 2 above as an investor in the company? You will receive proceeds per the liq pref waterfall, but a healthy percentage of enterprise value is being carved off the top and given to certain employees instead (which means your total proceeds are being reduced)? Do you view this as an acceptable deal term (especially if the buyer is insisting on it), or an end-around on the liq pref waterfall (what the shareholders in the target company agreed to re how proceeds would be paid out in the event of a sale of the company)? What dynamics are you seeing between investors and management when these types of structures are offered up by buyers?
I have been on a board when I saw that get VERY ugly.Interesting because one side said: Your word is your word!, you’ll never raise money again.The other said: You get what you negotiate and that is dictated by position. When I accepted the terms of your bridge round, it felt worse that what you’re feeling.Edit…that was to Fred’s point 3.
i’ve been through that situation as well. it is ugly. and so unnecessary. it’s just a deal. and there are so many of them. as i said before, when you strike out, don’t throw the bat.
Success has many fathers failure is an orphan.I know some take offense when a VC says “my company”I’m ok with that if you own the failure as well.When you say the first phrase but say “those guys” f’ed it up.Then you are a phony.You can’t say both. You can say “the color of my money is green” or “I am smart money” not both.I know the Kid will argue about the color…..I hope he is wrong.
i learned a long time ago to avoid the use of words like my companynothing upsets entrepreneurs more than that
There is only time to be on so many boards. If it’s a failure, might as well make some concessions, and go put money to work elsewhere.
if it is not excessive, i am OK with it. as an investor you have to realize that a lot of the value is the team
What percentages are the norm in stay packages for vested equity and the sale is not a firesale?
maybe a third
As always very good info. In times of crisis, I have seen that an earnout option is the one mostly used.
Great post. The only comment that I would add to this is that in most of the M&A deals that I have been involved with, there were 2-3 core keepers that were truly integral to the M&A becoming a success, as opposed to simply being “founders” or “exec team” (e.g., it could be a key tech lead, the owner of the hot growth product, etc.).As such, it’s often disappointing to see everyone know that the success of the deal hangs on “Jim” being locked in and engaged, the Corp Dev folks also knowing this fact going in, and nonetheless, NOT structuring the retention packages accordingly — so the key “keepers” specifically see themselves as being WANTED, versus merely being golden-handcuffed.
having worked for a company that did a few acquisitions somewhat right (one of which i was involved in) and many wrong, it seems that integration is the hardest thing. the people doing deals don’t have operational perspective (corp & sr mgmt); their “big ideas” make sense, in theory, but once it’s time to begin integrating, there are turf battles, politics, and all of the nonsense that start-up founders probably left large companies for.something to consider when negotiating your own package upon a sale – if there’s $20MM waiting after 2 years, will you be able to hold out?Fred, one other interesting question, many companies don’t allow employees to buy calls on their options (not sure about RSU’s – anyone?) For companies getting bought, and having unvested options converted to the new company, is it standard practice to at least negotiate some sort of call ‘options’ into the package? (if AOL bought me for $200MM in stock, i’d want some assurances in 2 years that i could protect a large portion of that.)
do you mean puts?
sorry, yes, puts…
This is an interesting post, as they are not always buying the people if the people have little or no interest in staying with the company that acquires them, or the acquiring company is really not a direct fit and is later shut down. I sometimes wonder what Yahoo was buying when they bought Broadcast or Google when they bought Dodgeball? Both were great services, companies spent a lot on them, and they were both shut down and the entrepreneurs didn’t stay with the companies. On an aside, I wonder what Foursquare would be like if it were part of Google, would it be a more popular service or not. Was Yahoo or Google buying the entrepreneurs or some kind of hype linked to the companies? Both entrepreneurs were not passionate about the companies they sold to, yet they were tempted to sell because they were offered a great deal. I don’t think a founder of a company is always as passionate about the company that acquires them, yet more so are interested in the product or service they provide. If a great entrepreneur was offered a huge deal knowing their company was going to no longer exist in a few months, a year, etc. then I wonder if they should really want to be acquired and instead try to go public. I’ve seen too many companies acquired and the company shuts the service down, either right away, or shortly thereafter. This is the challenge with the acquisition, not many entrepreneurs want to stay when everything they put their life into is being shut down. It’s interesting to think about, and I applaud some entrepreneurs for turning down some big acquisitions from well known acquirers because they see some of the challenges that can come with being acquired too soon.
If consideration is not tied to performance but only to time, aren’t you risking paying someone just to hang around? some very charismatic guys may be worthy even in that case, but most won’t be so much if they don’t have the energy and passion they had before the acquisition and are just waiting.
yes
It sounds like every founder is only thinking about how to snatch money and abandon his company. That should be a very bad sign for investors. I think that the “real” entrepreneur is keen to stick around without any “keep package” since he strives to develop and flourish pasting together with his venture.
“Most are gone after two years and some leave well before that. There are a host of reasons for this, and most have to do with the psyche of founders”If you are saying that “stay packages” are typically a complete joke with no ROI, then I agree.Founders do not leave because of thier own “psyche” but becuase of poor management culture within the aquiring company – those who want to work under a bunch of Haavaard pricks that do not need the money, raise your hands!
Having been at another startup that was acquired and then had a misleading and disastrous earn-out program where the pool was opened to parent company employees and new employees pulled into the projects, who then basically messed them up with their incompetence and lies about schedule, I am very wary of earn-out and performance-based programs for companies that get bought out. My current company has a more straightforward retention program where it is not open to new employees or parent company employees, but the max payout is smaller and does not ramp up at the end, so the incentive to stay falls off as we approach the end of the 2 year retention period.
The founder psyche: key phrase.
issue with the earnout is it’s considered a contingent liability that need to FMV each quarter or so, no? Wouldn’t you try to stay away from that? interested in hearing your thoughts. thanks.