Kashish Khattar is a 4th year student at Amity Law School, Delhi. This article is a discussion about the various aspects related to Acquihire transactions.
“Someone who is exceptional in their role is not just a little better than someone who is pretty good, they are 100 times better.”
– Mark Zuckerberg, Facebook, Inc.
Swiggy, the Bengaluru based unicorn just made their first acqui-hire of 2019, the transaction involved the acquisition of Kint.io, which is a Bengaluru based AI startup.
The move for Kint.io will ensure that the unicorn startup has a better computer vision and a premium experience for its customers by leveraging the war chest resources and the network of the swiggy ecosystem. Swiggy, on the other hand, gets to scale their tech team by bringing in an entrepreneurial team which solves the unique customer problems they didn’t have to build from scratch.
That is what an Acqui-hire transaction gets to the table, a win-win transaction for both the sides. But that is not the case every time, let us find out how an acquihire transaction goes on and try to analyse the various aspects related to it.
What is an acqui-hire transaction?
Acqui-hire transactions can be defined as the kind of transactions where a company is acquired for its people and talent and not for its products, services or earning streams. They are quite common in the technology sector. The acquirer is a mature tech company or a well-to-do startup backed by venture capital firm. Typically, the acquirer acquires the whole of the team of a young startup.
The acquirer by looking at the performance of the startup has reason to believe that the team can work together and solve a unique market problem which is in synch with his vision of the company.
Why does an acquirer do it?
It is quite a simple task for an acquirer to acquire a team from a young startup instead of hiring a team from scratch and solve a contemplated problem. He has already found a team which works together brilliantly on a similar problem identified in the market.
Acquire v. Acquihire
Acquihire is basically done when the acquirer values the team and their talent, skills more than the company and the business that they have helped build. An acquisition, on the other hand, is when the acquirer values both the business and the team associated with it. In my opinion, the acquirer is still paying to buy the ‘unique’ idea, in the case of an acquisition, it is the idea that the business built up by the team can solve a unique problem. Whereas, in the case of an acquihire, the acquirer is buying the idea that the team is skilled enough to solve similar problems that it wants to solve.
What kind of sectors and startups tend to get picked up?
Acquihire, typically happen on the nascent stage of a startup, MNCs tend to buy smaller startups typically being run because they are bootstrapped or are at the stage of seed funding. These startups are in a sweet spot as they are mature enough to build their technological capabilities yet young enough to be seen as a potential target company for the acquirer.
Upcoming sectors like the internet of things (IoT), the blockchain technology, 3D printing, predictive analysis, augmented reality (AR), artificial intelligence (AI), virtual reality (VR) and machine learning (ML) are cherry-picked by MNCs for their niche expertise.
A startup that is doing well or is able to raise good money or reaches the product market fit will not want to be acqui-hired. However, the failure rate in startups is very high. And if you have either failed or staring at failure, acquihire is a good way out. Just because a startup fails doesn’t mean that the team is not stellar. Bigger startups recognise and value this.
In a way, acquihire provides a very necessary safety net for good product teams that take up very ambitious projects and fail to achieve traction.
Finding good tech talent, or building a well functioning unit that works well together is hard. This kind of transactions, therefore, has got great value for fast-growing companies.
What kind of a deal structure is followed?
The acqui-hire arrangement is a mixture of Intellectual Property assignments, transfer of various web assets and an employment agreement:
- Asset purchase of typically tech related assets of the startup: websites, domains, etc. (Optional). Sometimes, the acquihiring entity may not be interested in any of these.
- Intellectual property assignment in the work produced by the team (this may not always be part of the deal though). This is important if the team will continue to work on same technology or similar product and will use what they created in the startup as a base or use a part of that technology.
- A smooth transition of the team from one entity to another is the main focus. They may be paid a joining bonus or given small stakes or ESOPs as a part of the deal. Usually, their compensation is the main focus of the negotiations.
- Consideration for all the work and the assets mentioned above, it can be a lump sum amount that can be paid to the promoters. Usually, investors and founders don’t get much out of such a transaction though. Founders are usually glad that their team is going to be gainfully employed and not face uncertainty and that they may get to work together on interesting projects. Often that is the biggest takeaway for the startup founders.
The deal structure discussed above works irrespective of what business structure the target company uses. If it’s a private limited company, it is not essential for its shares to be acquired by the acquirer. However, this decision is mainly dependent on any stamp duty or tax benefit for the companies involved.
Further, it goes unsaid that the target company has no debts or they are repaid by the time it is getting acquired or the acquirer is well aware of these debts and has agreed to pay them or the promoters will make sure that they repay the debts on their own. If the target company is not being acquired, liabilities may remain in that entity and simply the team is hired by the acquihiring company which therefore takes no responsibility for existing debts of the target. Several employment contracts are also executed of all the team members of the acquiring company, there are several terms mentioned in these contracts:
- A minimum period of employment clause (say one or two years)
- A non compete clause for the promoters
- Vesting of the acquirer’s or its parent company’s shares
What kind of a deal structure are we talking about?
The deal structure mainly depends on how valuable the new technology is to the company and what it brings to the table. The startups are typically acquired on a price that is lesser than their valuation. These structures can be of various forms:
- They can be cash deals (here) or
- Founders are made to run their startups as a subsidiary of the big business house (here). This however is quite unusual in acquihiring scenario.
Other aspects regarding the deal
There has to be an approval from the board of directors and management from the Acquirer’s company. However, even this is not always necessary. One may simply hire the employees for executing acquihiring provided that the acquiring company is not interested in anything else other than the talent. Even the technology from the old company can be acquired if necessary by executing a simple assignment contract which may or may not require board and shareholders’ approval depending on what is written in constitutional documents of the company (AoA) and Shareholders’ Agreement, if any.
Should you do a due diligence before acqui-hire?
A basic due-diligence of the financials and legal documents of the young company should be done just to be sure about their debt, corporate structure and compliance situation. Checking the existing employment agreements and constitutional documents of the target company is mandatory. However, due diligence will be very limited as usually the target company is not acquired and just the team is hired.
Advantages of such a transaction?
The biggest advantage in this transaction is that these employees do not require any training and are already well versed with the latest technology that they are going to work on.
Think of the humongous cost benefits in terms of training that the acquirer saves upon. They are ready to add value to the company from day one. Apart from adding people to the talent pool, the acquirer gets his hands on the special market intelligence and the IP created by the young startup which can be a game-changer and reduce time taken to develop a product or hit the market or iterate.
For the target company, the entrepreneurs this get access to resources and capital which can help them make solve the particular problem which made them start this business. Entrepreneurs also think of this as a safe exit and can now move on to bigger and better things. This acquisition can just show them as being credible entrepreneurs which can help them get funding in their future ventures.
When can an Acqui-hire go wrong
A study by MIT’s Sloan School of Management states that 33 per cent of acquired workers left in the first year of their startup’s purchase. They go on to analyse the reasons as to why this happens. Let me try to explain what I could gather from my research:
- Assessing the talent pool should be one of the first things that should be done by the acquirer. The acquirer should first try to understand as to what exactly they are acquiring. Is the team exceptional enough or is it just one or two employees in the team who lift it up to exceptional levels.
- People join a startup to be a part of the thrill that it offers and not the stability that a good company could offer to them. They like that they don’t have a schedule and that they don’t know what they will end up doing for the business tomorrow. That’s what makes them tick. Being acquired by a large MNC almost defeats the purpose for the team which likes to do things their way. Startup employees, particularly non-funding individuals have virtually no choice on who buys them. This lack of choice in organisational changes can be termed as an organisational mismatch. Further, these people are not scared of being on their own and starting something from scratch, the acquirer is actually looking at potential rivals in the future.
- Analysis and understanding of the company is paramount. The big business should first determine if they run an entrepreneurial firm or do they have a complex conservative hierarchy system. The point of turbulence regarding bruised egos should also not be missed, the smaller team who works in a niche area is now a part of the big pond where it has all these niche specialised teams working on the cutthroat technology of the future.
- The point is to try and understand how both the acquirer and the target company works. And then try to acquire the target company. Acquihires can be highly destructive, the MNC and the young startup may have different goals and visions. The employees may not be able to connect when they get acquired. The employees may not be able to fit into the corporate culture they have always wanted to escape and hence, work in a startup.
- Career paths may not be attractive for everyone – a cultural mismatch is not something that you can overlook on, big MNCs have defined career paths and titles, unlike a startup. This may not go down well with everyone in the team and may create quite a problem in the transitioning of the team.
The last few years have been quite exciting for the startup sphere as a whole and acquihire is picking up big time. Many acqui-hired firms have tried not to integrate their teams with bigger companies and kept the integration to a bare minimum. There have been instances where teams have found it difficult to accommodate the changes and left. However, you could have guessed that the acqui-hiring can only be done by companies who have the cash to spend. Medium and small-sized companies hiring still depends on interviewing and networking.
Acqui-hiring is here to stay. Lawyers need to learn how to structure these deals and be proficient at it. Entrepreneurs trying to grow fast also can benefit tremendously from understanding laws and documentation that goes into an acqui-hire deal.