Hi everyone
Looking for some advice about what to do here. It feels like there is nothing straight forward in this startup journey :)
So we got offered to purchase our b2b saas platform for let’s say 1.7M now, with an earnout later. It is a great opportunity for us as they are leaders in our industry and almost completely derisk our earnout… it’s been a hard few years getting here.
The interesting part is the breakdown of funds for the 1.7M now.
Investor A invested 2 years ago with 500k, they now own approx 19pc. Investor B invested last year for 1M but said he wanted pref shares on liquidation. We never thought anything of it and put in shareholders agreement.
But… they omitted preference on sale of shares, ie preference shares. So there is no clause in our SHA covering preference for return of the first 1M back to them before the rest is split.
This means that in fact myself and cofounder do best out of this and clear about 450k each. While our investor B only gets 300k now and has to hope the earnout goes to plan, which it will! But that’s an aside.
But investor B is now arguing that he did in fact say this to us in person at the time… preference in sale or shares as well as liquidation.
We are unsure what to do, do we stick to our guns or agree some sort of compromise where we give a bit each to them?
What would or have people done here before?
at the time we barely understood what it meant to be honest and just deferred to the lawyer when it was asked for in the term sheet. the lawyer pretty much copy pasted the clause from the term sheet. Investor Bs mistake…
If you were able to raise 1MM a year ago then your valuation a year ago then was definitely much above 1.7MM. So the question is, what happened in a year for you to agree to a 1.7MM valuation?
If the business is really in a bad shape with limited runway, then the existing investor should agree. Because getting their $1MM investment converted to $300k plus some potential earn-out is better than the business going down to zero.
But if the business is doing fine, you have the cash and the product, then you owe it to your existing investors to try to fulfil the story you sold them, or get a better valuation such that the investor B gets back at least 1MM plus the risk-free return rate in your area (~1.04MM). The earn-out is a bonus and should not be factored in for this.
Its more this buyer has a massive customer base that we can sell our product to, they have an adjacent product, adding ours into the mix is a win win for them. They can use it to upsell to existing customers, ontop of their existing product, and even bundle it into new customers to win deals against competitors. It makes their platform play real.
We have other alternatives, but the earnout seems like a real possibility to hit serious numbers given what we know right now. It feels like it derisks us while removing the major execution risks (They are bigger, have the things and expertise we need to execute well). The buyer is also in a place where upselling our product to their existing customer base is also a massive win for them. We are tied to the ARR, and are aligned with investors regardless we will get the earnout terms pretty nailed down.
If it’s indeed as useful an acquisition to the buyer as it sounds, should you not be priced at higher than your last valuation - why are you priced lower?
This mis-pricing is what is causing investor B to lose.
Ideally you would sell at your last valuation plus some small increment so Investor B would get a “no-profit no-loss” deal with returns at least equivalent to the G-Sec rate, and later the earn-out would hopefully kick in for their reward in taking on the massive risk they took with you.
The earn-out is your reward for successful transition, handover and integration, it is in place as a risk-mitigation mechanism to avoid the firm dying out after acquisition.
Not saying this is the case here, but it’s very normal for companies to buy out smaller competitors to shut them down. A very famous example is the “face unlock” on Apple phones, which used to be a startup that used a grid of invisible infra-red laser dots to map a 3d object. This tech was licensed out, for example to the Kinect, and I even had a Lenovo laptop with this feature in the webcam, but once Apple bought them out they could no longer sell to anyone else, because Apple wanted to keep this feature exclusively for their phones only. So you never really know what happens post-acquisition.
Earn-outs are not part of the purchase price and should not be seen as such, much less sold to an existing investor in that way.