The LathamTECH Podcast — Demystifying the Tech Acquihire Wave

Tessa Bernhardt:

Hello, and welcome to The LathamTech Podcast, where we survey the latest trends in the world of tech and explore their impacts on your company – both the opportunities and the risks. I'm Tessa Bernhardt, a partner in Latham's M&A and private equity practice in the Bay Area. And joining me today is my fellow partner, Greg Roussel. Greg helps acquihires build long-term value through strategic transactions. Welcome, Greg.

Greg Roussel:

Thank you for having me.

Tessa Bernhardt:

In this episode, we're diving into acquihires. This transaction model has been around for many years, and is gaining increased attention given recent high-profile ones we've seen in the Bay area. So when I started my M&A practice, I started in a more East Coast M&A practice. I moved here in 2018 and I had heard of acquihires, but I'd never seen one beyond Silicon Valley, the TV show. And I remember doing my first one with you, and I was actually really surprised by the documentation and what went into it. It was very different than what I expected. And I think in the media, they're kind of described very liberally in a way that I think is a little confusing to understand exactly what goes into an acquihire. And I think that also translates into our relationships with clients who come in and say, “I really like this team. I want to do an acquihire.” And then but they don't know what it is, right? And that's a common question I had at myself when I first started. And so I think it'd be helpful to start off by just kind of describing what an actual acquihire is from a legal perspective.

Greg Roussel:

That's a great question. And I get it all the time from clients and friends and everybody else. So probably the best way to distinguish the two is go back to whenever we came up with it. This is probably 2009, at the risk of data myself here. We had just done a deal over like 3 or 4 days over the weekend, and it was a traditional acquisition. And it became very clear throughout the process that, when you only have a little bit of time, it really forces everybody to focus on what's most important. And not surprisingly, it's not the 50 pages of reps and warranties that the lawyers all negotiated and all these deals. And so really, the traditional acquisition structure was not that well suited to the transaction. I mean, sure, we want to make sure we don't have a lot of liabilities, but really, the whole weekend was very much focused on both motivating and retaining the key engineers of that company.

And then coincidentally the next weekend, same client gives us a call: “Hey, we have another deal. We want to do it just like the last one.” And it turns out that this deal with, the company was even less relevant, going forward. I don't think they even had a product yet. I think they were going to go out of, business pretty soon. It was ran out of money, and it was really about bringing over the team. And so I just kind of asked them, “why do we really even need to buy the company?” Like, we can still get money to the shareholders, we can still hire the team, and we can avoid liabilities, but we don't have to take on that corporate entity, or we don't actually have to buy the assets if you don't want them. And so that was how we came up with the release and waiver structure.

And so that's kind of how I would distinguish the two. And so if you're actually buying the entire company, even if it doesn't, you know, involve motivating the team and having different, you know, employment packages and things like that, you know, that's still more of a traditional acquisition if you structure it where we are just going to hire the team. There are some value that goes to the company or the shareholders as part of that, for the value that was created there. And as a way to maybe avoid, you know, particular like liabilities during unification or something like that. Then that's more of an actual acquihire because you're not taking on, you know, those typical assets or the corporate entity like you would in a typical structure.

Tessa Bernhardt:

I think that's a really helpful explanation. You have these two typical kinds of structures. You have the acquihire, which is really about the employees. It's a release and waiver document. It's a very short document. It's not focused on lots of reps and warranties, it doesn't have long indemnity, it’s just a very specific. And typically there's also a plan of liquidation or something attached to it with respect to the remaining company. And then you have, on the other hand, your acquisition, which doesn't mean you don't care about the employees. Many of our clients really care about the employees, and acquisition and retention is a key piece. But then they also care about the business – so they want all the reps, they want all the liabilities, they want covenants. And so I think that's the key is I think some people think oh acquihires is any deal where you care about the employees. And I think that's a little bit broader than the reality. I think a lot of our clients care about employees, regardless if it's an acquihire or a full acquisition. I think an acquihire is just you really only care about the employees, and then just protecting yourself on the back end, like you said, with respect to kind of certain liabilities.

I think over the years I've seen such a wide kind of example, what ends up happening to the companies where you do these acquihires. What is the typical, what is happening to these companies after an acquihire takes place there? Once these employees leave, what are you seeing happening to these companies?

Greg Roussel:

And that's a great question. And we've seen that, just proliferate over time because initially, the scenario we saw was, like I mentioned before, where the company was maybe going to go under and the team wanted a soft landing. And it turns out, they're really smart and had worked together really well, and so there was value created there, even if it wasn't what was owned by the company. And so by just hiring the team, you didn't really need the company to stick around much longer. And so a lot of times they would just be wound down. Maybe they would sell off a few assets if there was value there. As we're seeing over time, that model has changed a little bit because, there's all kind of different scenarios in the current environment where maybe there is a lot of value to that company, and a lot of times it's just they didn't quite need that particular team of engineers. And it was a great way for the company to realize value, either by way of future financing or some kind of other commercial agreement with the buyer. And, so there's a lot of things that can happen to a company after a group of people leave, in exchange for some kind of payment.

Tessa Bernhardt:

Yeah. I mean, that's interesting. And I think it hits on a question that I get a lot of – I'm sure you get this question a lot, too – is, I'll have a client who wants to do an acquihire, and they're like, “well, what do I pay the remaining company?” and you're like, well, it really depends. You know, I see can this number ranges so widely. I've seen thousand dollar acquihires to millions of dollars. And then in the news you're seeing billions of dollars in acquihires. And so various factors go into that. And the number of employees, what does the business look like at the end? Like what are you leaving behind? What is the license, look like that you're going to receive as part of the release and waiver? I think there's a lot of different factors that go into that. But because we're seeing values for acquihires that start to approach what an acquisition value is, why are people doing acquihires instead of an acquisition, when sometimes the value might be exactly the same? It's not necessarily cheaper. Why is that?

Greg Roussel:

There's a lot to unpack there. I think I would start with the fundamental question of what is the strategic value that the buyer is looking for. And so it could be one person, it could be ten people, it could be actually be “we want all of the employees.” Then it could also include “we actually do want some of the IP” and maybe there are some assets that are included as part of the purchase price, and that's up for the parties to negotiate. And it becomes very difficult to ascribe a particular value per engineer, like a lot of people talk about in the news. Whenever you have actually a lot of other assets coming over, you have a more complex commercial arrangement. And some of these employees are tremendously valuable, so they're not all the same. You can't just say $1 million per employee for an acquihire, whenever some of the people are worth $100 million and some are, you know, a half million, in terms of just the ability to hire somebody, in addition to whatever they're being compensated going forward. And so it is really a tough question to say what they should be valued at.

I probably would mention one rule of thumb that there's no magic to it, but coincidentally, we do see a lot of deals, like when I mentioned earlier where the company might be going under, where there's effectively a return of capital. And so if they raised $5 million, that's a good proxy or a frontier just as for what an acquirer were going to come in, return the money to their investors, they live to fight another day when a better investment. And then they will compensate the team going forward.

Tessa Bernhardt:

Which seems like, typically a very good result for those employees and the investors too. Now obviously not every deal is an acquihire, and that's probably because it's not the right structure for a lot of different transactions. And so what are some of the pitfalls that you see and reasons why you would not want to use an acquihire kind of release and waiver structure in a deal?

Greg Roussel:

I would say the biggest problem with the pure acquihire deal is that it's very, very tax inefficient. And so if you were going to do $1 billion acquihire, then that's going to be first of all, taxable to the company, just as if it were a license or other commercial deal. And then you have to then distribute those proceeds to the investors, at which time it will be taxable again. And so for a high-dollar acquihire like that, you're going to be paying tax twice on a lot of money. As the numbers get smaller, it actually makes a lot more sense from a tax perspective because the company might have enough wells to cover that payment. You could just be having a return of capital to the investors so that they don't actually incur more tax .

Tessa Bernhardt:

So break even.

Greg Roussel:

Right. And so that's why it just varies from every deal that every other deal.

Tessa Bernhardt:

I think that's really important, because people come in and they think, “oh, well we just really want this team.” And sometimes when you unpack that, you start to learn that maybe they want more than the team, right? Maybe they want more IP. Maybe they do care about some of these products. Maybe they discover in some kind of light diligence that there's certain customer contracts that are actually quite valuable and, and that they want. And so you maybe want to talk about a little bit about how this kind of evolves over the course as you learn more about what your client's objectives are, how these deals kind of can turn into acquihires or can kind of move away from acquihires, right?

Greg Roussel:

It happens literally all the time. And, you know, we'll talk to the legal team and corp dev: “Are you sure you just want the team, need anything else?” And then like, “no, no, no, we just want the team.” And then as they negotiate further and as they talk to the team, it turns out, oh, maybe we just need that other patent or it would be great to have our code or. “oh, it would be great to.” It turns out it's really the whole company. And at that point if you're trying to renegotiate price, , then you've like effectively like doubled your purchase price because, it turns out you needed a lot more than just the team. And the investor is going to be looking to get whatever they can for, the company, if you're actually going to take the whole company. So I think you have to really be thoughtful as your structuring it and as you're talking about the economics and make sure you have a good picture of what the team is actually looking for.

Tessa Bernhardt:

I think that's great advice – it's just kind of as an iterative process. Another question that I'm sure we both are getting all the time from clients is kind of the purpose of the IP license as part of an acquihire. Most of the acquihires that we're doing, these release and waivers, they also have an IP license or an IP assignment. And I think we typically describe that as a defensive measure., and so that the employees, when they go to their new companies, if they're using know how there's no questions about there being any kind of IP infringement or anything with the remaining company. So we do get this question a lot, but I would now that we're starting to see kind of acquihires happen at larger companies where they might remain and continue to operate and be ongoing. What are you advising clients with respect to the IP license, both as the kind of acquiring company and the company where there's an acquihire taking place but the company remains?

Greg Roussel:

It's a great question, and it's really all over the map. Many times the companies may have an existing commercial relationship and then this just expands on it, and there's a different kind of license that goes along with that. Other times they don't, but they should have a license like that. And then people will license particular technology in exchange for some other value that goes to the company. I think, sometimes whenever the company is maybe going to be shut down, or there the board will be looking to sell off different assets, what you would want to avoid is a situation where you hire a bunch of really smart people, in a very niche area, and then all of a sudden, your biggest competitor buys up the rest of the company, including all the IP, and then they come after you because those employees are using the knowhow or they have some kind of trade secret claim or something like this that, would prevent them from be able to do what you wanted them to do. So to avoid that sometimes we’ll bake in a covenant not to sue we’ll bake in some other kind of short form license just to make sure that the employees are able to do what you expect them to do, separate from what happens to that remaining company.

Tessa Bernhardt:

I think that's fascinating and really important piece of how our Latham team, we work together with our IP team on these. I view them – the IP team – as sitting right next to us on these acquihires for that very reason to avoid these lingering issues that could happen down the road. The common question is what are the advantages of an acquire? Why would you do an acquire over your typical acquisition?

Greg Roussel:

That's probably three important things. One, you have the cost and speed of being able to do an acquihire. So instead of negotiating a 100-page merger agreement, you've got like a seven-page agreement that there's probably five things to talk about. And so the parties are really happy whenever the teams can actually start work before you would actually even get a turn of the draft out. I think the second thing is that you can really minimize liability this way. And we actually had a court case, it was where the client just had the team come over. They did not buy the company, they did not take any assets over, there was no their license. And the court found that you can't have successor liability whenever you just have the team come over. And so that allows you to move much faster, not worry as much about the existing liabilities of a company when you're just bringing the team over. And then I think third, it really allows the investors to capture some value here because I think at a certain level – the employees, if they want to leave, they're going to leave. And if whether the company is going under or just isn't the $100 billion opportunity everybody thought it was, the employees might get enticed to go somewhere else. And so it's kind of better for the investors to realize some of that value for what they put together, you know, through an actual hiring process, even if it doesn't mean a full acquisition of the company.

Tessa Bernhardt:

That's a really good point. So since you've developed acquihires back in the day, how have you seen them evolve?

Greg Roussel:

It's only really been limited by people's creativity and how they make deals. And we've seen it solve a lot of other problems that, that companies face. And so, by way of example, it could be that it is a way to strengthen a commercial relationship between parties. Whenever some engineers come over to the buyer and but they still work with the target. Other times we've seen it as a financing vehicle where there is some kind of debt or equity financing in connection with the team coming over, rather than just a pay out to the company, as well as we've seen what I would maybe even call a reverse acquihire where the team gets hired somewhere else, leaving a lot of employees, a lot of customers, a lot of technology behind. And somebody else will come in and say, “oh, there's a lot of value there – why don't you come work for me?” And so people have really been able to get creative with how they split up companies and divide value, among the different constituencies.

Tessa Bernhardt:

That's fascinating. And I think that's it's exciting to see this kind of space of all that and being in the Bay area, you know, I think we're really in the middle of it. So it's been it's been great learning from you and working with you on these. And I'm excited to see how acquihires continue to develop and shape the ecosystem here in the Bay area. It was great having you, Greg. Thanks for joining us.

Greg Roussel:

Thank you for having me.

Tessa Bernhardt:

And thank you for joining as well. We'll see you next time.