Yeah, I suspected it might be artificial pressure, but the pressure is only to sign an LoI, and their justification is plausible (we need to cut the other deal loose).
After signing the LoI there is 45 days to complete the deal during which everyone will do due-diligence.
> Other issues: - You get paid more if they take longer to pay => You're going to work for a company that you hope doesn't blow up tomorrow (because you get paid more if they blow up in 4 years). => This is a dangerous spot to be in; your incentives are not aligned with theirs.
Yes, I did point it out to them. Their response was a polite version of "that's our problem".
> - It might be tempting to think that the acquirer could pay you with the proceeds of their next round even if their business does not take off. But $6M in short-term debt will likely scare off VCs who might fund them in their next round...
I think if the business doesn't take off, we get our technology back and we keep whatever they've paid us to-date. It doesn't seem like a terribly bad worst-case-scenario.
> Yes, I did point it out to them. Their response was a polite version of "that's our problem".
But it's not actually just their problem, because you don't get paid if they don't succeed...
I'm sure you've already realized this. :)
> I think if the business doesn't take off, we get our technology back and we keep whatever they've paid us to-date. It doesn't seem like a terribly bad worst-case-scenario.
Good point. Still the opportunity cost of your time to consider (all that time you spent watching them fail, you could be spending building your own business) and your technology's shelf-life.
Also, it might be difficult to build a business around tech that failed somewhere else (even if your acquirer's failure had nothing to do with you or your tech). I don't know the specifics of your situation, but I would imagine good early hires might be wary, potential investors would be skittish, etc.
I think you make a good point regarding taking the risk of their business, without getting compensated like an equity holder. I may be able to use that to negotiate for some equity as part of the deal.
The risk to us is relatively limited though, as we get the technology back if they can't pay for it. The main risk is that we won't have made progress on it during that time, but that could have happened regardless (given it's experimental nature, we didn't really have much of an idea how we would market it).
Great points.
Another thing to think about: unsure about the exact repayment circumstances. But financially, the current offer has some similarities to venture debt, and that may be a useful way to think about what you're getting into.
Key consideration about venture debt: the lender (you) is basically making a bet about financing risk. If the venture (your acquirer) gets a subsequent round of VC money, they will pay you back. If they do not get another round, they will not.
Venture lenders typically don't look at their borrowers' business fundamentals too much, but they are very careful about who else is investing with them and how many rounds the venture has raised. Basically, if a new venture is (1) raising their first round and (2) backed by a big-name VC firm (Kleiner Perkins, Bessemer, etc.), the venture will almost always get another round of funding and the loan is safe. Other investors are always willing to give a KPCB-backed venture another shot. If (1) or (2) is not true, the loan is much riskier.
> what advice can anyone here offer without knowing the exact details of the deal, doing a little research on the company, reading the loi, etc? i seems obvious that the only route of action to take would be to talk to a lawyer (or possibly two) that can advise you.
Just because I'm asking you lot doesn't mean that I won't also seek advice elsewhere.
> Just a character evaluation here, but if they are willing to cut this other company loose, I think you should evaluate how binding they consider contracts to be before you enter into one with them yourself
I'm fairly sure they don't have a contract with the other company, the time pressure is that they were about to sign an LoI with them.
> At the very least I would ask them to make a substantial (500K minimum) deposit against the balance up front. If the don't have the cash to do that, I would not deal with them as they probably shouldn't be doing acquisitions.
I'm not sure, they've been open about their financial situation and I understand why they've proposed the deal structure that they have.
> Other crazy idea: this is HUGE validation, go raise VC against this offer and make it a real business.
Problem is that I've already got other projects that would be extremely difficult for me to abandon.
> Also, if they are truly in the enterprise space and can afford to acquire companies to "solve a difficult problem for them" they should be able to pay you serious money and $2m in first 12 months should be no big deal.
Like I said, I'm familiar with their finances, and that isn't an option for them.
> Another thought, If you are really going to get in the business of giving a $6M loan over 3 years with your 3 cofounders, you should consult a lawyer about more than the LOI. The entire corporate structure needs to be designed to make sure people get paid out correctly and that taxes are accounted for.
Lawyers and accountants will all get to have their say before anything is signed.
Did they already sign a LoI with the other company? If so, then while this not as bad a breaking a signed contract, it is a big warning sign as well. It means they probably have told your "competitor" also how great they are, how important their software is for their business etc - just to keep on looking for something else. Would be a big red flag with regards to trustworthiness.
hmmm, "almost" 2.5m round and $10m in revenue "booked for next year" is not that credible of a company. you are taking a lot of risk that the money does not come through.
if you sign a deal w/ everything "on the come" they can jack you around pretty hard.
venture backed companies _consume_ cash, they usually don't throw it off (6m extra in a few years) until later.
> hmmm, "almost" 2.5m round and $10m in revenue "booked for next year" is not that credible of a company. you are taking a lot of risk that the money does not come through.
What is the risk? Only that we end up back where we were before their offer, so far as I can see.
Their fundraising deal seems well underway, I've raised venture capital myself, and these guys know what they are doing.
> venture backed companies _consume_ cash, they usually don't throw it off (6m extra in a few years) until later.
It's a line item for them, they pass the cost directly to their customers.
There are plenty of risks ranging from the minimal (they waste a little bit of your time and you don't get paid) to rather extreme (they waste loads of your time for years and you lose your IP to legal wrangling).
Book a competent lawyer who has dealt with this sort of problem to nail it down and make sure the risk stays minimal. Ditto in the accountancy department. Everyone does their due diligence, everyone stays happy down the road.
I'm not sure how that could happen. We have the source code, if they renege on the agreement then we just go do something else with it and sue them if they continue to use it.
Sure. Most of what you lose is opportunity cost, time, bureaucratic overhead, and the possibility that they just take your code and go.
Yes, you could sue them. This is harder than it sounds, especially if they're optimizing to be sued -- companies that are out to screw people often optimize to be sued, roughly speaking.
Again, not saying "OMG! This must be pure evil!". Just, y'know, you sound awfully confident that nothing can go wrong and I don't think that's justified in this case.
You're loaning them millions of dollars at interest. Without a down payment. With all of the interest paid at the back end. With a cap on the accumulated interest.
My bet is you'll never see the money. Either there will be a clause hidden in the agreement that allows them to reverse the sale if their project doesn't pan out. Or they are on the brink of bankruptcy. Either way, they are structuring the deal as if they know they'll only have to pay if the project is a home run.
By then it will be too late. It is right now legal advice can help you. The term sheet you have in your hand looks good to you, but only someone with experience from a hundred deals that went awry can look at that term sheet and see what is missing. You have the wrong view of how you use lawyers.
Your process is basically the same as having a lawyer write the code for your web app and then have a programmer review the code just before you launch. Now you are probably thinking "no that's not the same because that won't work". Well, exactly. It won't work.
Reading all your answers here you come across as either very inexperienced or drunk with the prospect of striking it rich or both.
this is why HN needs to show points. I upvoted you, and I imagine many others have too, but OP will never know if you're just a lone voice or if you have the approval of 20 other HNers.
No, it's basically they get a discount the faster they pay. 12 months it only costs them $2M (they've said this is very unlikely).
It gives them an incentive to pay me as quickly as possible.
There is no "earn"out, but we do need to provide them with some support - but we get to charge whatever we want for this (they pass the cost on to their customers). We certainly don't have to work full-time for them, and they know we can do this (we all have other gigs).
This payment plan and the amount of discount strikes me as a point of concern. Why is it "unlikely" that they can pay the $2M over a year? Why such an extreme discount? I'd start digging there. Is their business viable for 3 years?
Why don't you to ask them to borrow $5M, pay you that amount now, then let them pay off the loan over 3 years? At 12.5% interest, total payments come to about $6M for a 3 year loan term.
It's a way of shifting risk from you to them. Somehow, I doubt they'll agree; but their response may be very informative and helpful for further negotiation.
> Why is it "unlikely" that they can pay the $2M over a year?
Because this will be a new product for them, they expect it will take several months before they start to make any revenue with it.
> Why such an extreme discount? I'd start digging there.
Yeah, it seems like a big jump. I asked if it could be monthly pro-rata and they agreed to that.
> Is their business viable for 3 years?
I think so, or they'll get acquired.
> Why don't you to ask them to borrow $5M, pay you that amount now, then let them pay off the loan over 3 years? At 12.5% interest, total payments come to about $6M for a 3 year loan term.
Because they don't know that they'll be able to sell the product that they'll be building around my product. This way if they can't they can cut their losses without being on the hook for the entire amount.
I don't see that I'm taking much of a risk, if they terminate the agreement we get to keep whatever we've been paid to-date.
With everything you've posted (including the comments) it sounds like the company is trying to make you and your partners believe they wont be able to pay the $2M within 12 months in order to get you to agree to the deal. You're under the impression that you'll make a cool $6M and that's what their betting on. In all honesty I think they have the money all ready. Probably more too. You mentioned they where on the verge of making a deal with another company right? Who's to say the other company didn't demand $4M+ up front and the whole reason they're bailing is because they can get it from you for $2M?
I know it's depressing to hear but you really need to think about it and do some financial research on the company. Get legal advice. Don't be forced into signing anything just because the company is "short on time". Remember they want YOUR product. If they want it bad enough they'll stick around for a few weeks. Hell they may even offer more money.
Part of me wants to say that is a paranoid view, but I must confess that the degree to which the purchase price ramps up so quickly is a source of concern for me.
$2M to $6M is a dramatic difference. It's plausible to say that they're trying to do a deal that sounds like $6M but is, in reality, $2M.
After signing the LoI there is 45 days to complete the deal during which everyone will do due-diligence.