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…
Could happen! Let’s negotiate!
If you remember the verbal agreement, and there’s a chance you’ll be a founder again, I’d honor the verbal agreement. I agree that a contract is a contract, and you should point out the contract, but, losing an early champion when you have a long future is clearly about more than legalese. I’m guessing the difference in comp that you and your cof take-home is negligable, if you honor the verbal? I’m not rich, but, $450k take home doesn’t sound like life-changing retirement money. You’ll have a future. Up to you whether Investor B is part of that for you.
Do what’s best for you. It’s your company and your future.
So $1.5m has been invested and you’re selling for $1.7m? That seems like a shitty deal (particularly for investor B). On paper there’s also an earnout but that may well be worth nothing.
Does investor B have a right to veto the deal?
Might be selection bias, but I’ve not really heard many (if any) stories of these earnouts going as planned.
Investor B communicated their intention, do you/they have a copy of this? The intent might matter other than the letter of the agreement.
You should return the investor capital 100% + some interest and then you get what’s left plus 100% of the earn out.
Selling at 1.7 on a 1.5 raise seems like they are bailing on growing the business. Unless the business is stuck where it’s at or burning cash too fast. Investors are either pissed for losing money on the deal or else they are just fighting for scraps of a sale?
yeah idk how they can in good conscience do this, like they’re essentially splitting 500k of investor money or whatever the difference is
We’ll know, we are not. The investor is effectively investing the remainder of the money into the parent company and share in a much lower risk execution.
- the earnout is a mirage
- you’ll eventually want to raise money again and you’ll regret taking this deal whenever that happens
Do right by the investor. You’re trying to be sneaky and are riding high on the fact that he missed that part during signing. If this is the end of your career in this world then nothing but your conscience will affect you but if you plan to continue doing business, this is going to come back to haunt you in one form or another and then you’ll likely be playing with bigger amounts and the hit will be harder at that point. Not just that, you’re still not necessarily legally safe; depends on your location but handshake deals are not always irrelevant.
I am really not trying to be sneaky. We told Them they can add whatever clause they like regarding preference. They only added on liquidation, we copy pasted what they requested into the SHA. They did not engage our lawyers for preferences shares, they only requested preferred shares.
Do right by the investor.
100%.
Someone was willing to hand over $1M to you and you want to shit on them to make $450k.
Absolutely wild decision to me.
The earnout will never happen and the investor knows this, that’s why they are pissed.
Can you negotiate with the acquirer?
No earnout, bigger upfront?
Get a bidding war going?
Unrelated to you question but I’m curious. How do you feel about your sale price and why are you selling.
“Which it will” 🤣 no earn out in history ever went according to plan.
Ha! Yeah I get you, I think we unlikely to hit the arr numbers for a 10x return for investors but they will definitely hit a min of 2x on the earnout is my feeling on it
I think many have hit on it, but are you really prepared to burn the bridge with someone who can write a $1mm check to you(and presumably alot more in future ventures) for a $450K payout(it seems like you would still get about a $150K payout based on the numbers if you gave the investor his 1mm back first).
If it were me, I’d try to talk to acquiring company and request the following(in order):
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same upfront, stock in the acquiring company equal to the proposed payout(this gives you all upside of the acquisition, limits the cash outflow of the acquiring company) this will be the least likely scenario however
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larger upfront(2-3x larger than current offer at least, no earnings payout)
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Same upfront, OFFER TO STAY ON OVERSEEING COMPANY FOR 5 YEARS TIME(tie your payout to a 5 year performance metric). This limits the likelihood they will scrap the project and potentially screw you out if your payout
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I’m not sure there’s a distinction between “liquidation” and “sale” preference. They are usually one and the same. In any case, the justification for awarding these preferences is to avoid exactly this situation from an investor’s POV.
Why would you take $1M from someone last year and sell for $1.7M this year and call it a long hard road? You took the money to grow it and sell it for more than that. I don’t blame them for being disgruntled, and it also sounds like you’re getting a crap deal from the acquirer.
1.7 on 1.5 sounds like liquidation more than a sale…
In down rounds or sub-par exits, it would not be unusual for the the parties to negotiate a different outcome no matter what the agreements say. For example, if the acquisition value, including earnout, would have been less than $1M, and the last investor insisted on preference of $1M, you would have no (financial) incentive to stay on with the company. If the founders walked way, the deal would be dead and the last investor would get zilch.
In your place, first I would have your lawyer and the investors lawyers concretely establish what the shareholder agreement says - which is that there is no preference. Assuming you want to be fair to the last investor, from that starting point you negotiate what every one gets - which would be somewhere between $300K and $1M. For example, you could offer to buy back their shares somewhere in that range as a compromise.
I am surprised that the earn outs would be paid out to the investors - generally they are paid to the employees who stay on. Are you sure it is not some sort of escrow which will be released contingent to some terms?