Today’s Agenda

• Deal Points: Key issues in structuring M&A deals in the current market

• What it’s Worth: How technology companies are valued today.

• The M&A Market: The View from Investment Bankers and VCs.

• Until the Market Window Opens: Other Exit Strategies

• Lessons Learned: M&A Lessons from Entrepreneurs

My Roadmap

• The Numbers and What They Mean

• Trends from the Trenches – What’s Really Happening Now

• The M&A Process – Current Issues

0

5,000

10,000

15,000

20,000

25,000

30,000

Sum ($M)

1 '99 2 '99 3 '99 4 '99 1 '00 2 '00 3 '00 4 '00 1 '01 2 '01 3 '01 4 '01 1 '02

Quarter

Venture-Backed M&A Activity by Quarter, 1999-2002

Source: Venture Economics and the National Venture Capital Association

Venture-Backed M&A Activity by Quarter, 1999-2002

48

90

70

6060

8987

60

68

85

68

53

82

0

10

20

30

40

50

60

70

80

90

100

1999 2000 2001 2002

Year

Total Deals

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Source: Venture Economics and the National Venture Capital Association

1 '002 '00

3 '004 '00

1 '012 '01

3 '014 '01

1 '02

Total IPOs

Total M&A

0

10

20

30

40

50

60

70

80

90

Total

Quarter

A Comparison of Venture Backed M&A and IPO Activity by Quarter

Source: Venture Economics and the National Venture Capital Association

1 '002 '00

3 '004 '00

1 '012 '01

3 '014 '01

1 '02

Total Venture-Backed IPO Offer Size

Total Purchase Price M&A Deals

0

5,000

10,000

15,000

20,000

25,000

30,000

Total Value ($M)

Quarter

A Comparison of Venture-Backed M&A and IPO Activity by Quarter, 2000-2002

Source: Venture Economics and the National Venture Capital Association

Interpreting the Numbers

• Path to liquidity still closed

• M&A only viable exit path for now

• VC Industry recovery will be slow• Needs corporate IT spending and stability of public

markets (re-open IPO window)

• Continued difficult for startups to raise $$

Trends from the Trenches

• Survival Mergers – Lots of them– 75% of M&A deals in the last year . . . but

changing?• VCs won’t continue to nurse weaker companies –

have cleared most of portfolios• Hard to do -- high risk and need lots of funding

Trends from the Trenches• More Private Company Deals

– IPO window closed . . . for now– Public acquirers are very cautious– Public acquirers need deals with immediate

impact• Cost savings - NOW• Tangible ROI

– Public stocks depressed – expensive collateral– Private deal only means of survival for most

Trends from the Trenches

• Acquisition “Flips” (e.g., Metropolitan Venture Partners – 29% IRR for last two years)

– Potentially lucrative and permit entrepreneurs to score on multiple ventures

– Avoid problems of publicly held companies• Detailed reporting requirements

• Structure, system, bureaucracy

– But, High Risk• Hard to finance

• New competitors limit liquidity path

• Typically no backup plan for longevity – all or nothing

Trends from the Trenches

• Look for money . . . get acquired– VCs looking for “sure thing”, now– VCs accepting singles and doubles rather than

homeruns

• Limited to strong companies

The M&A Process – Current Issues

• Preliminary Negotiations– Investment Banks focused on M&A

• Working with earlier stage companies• Doing VC deals, too (for 4 to 6% fees)

– Standard IB Agreement includes right to do M&A, too

– Be aware of duration, exclusivity and credit for contacts

The M&A Process – Current Issues

• The Letter of Intent– Generally non-binding, but be careful about

good faith negotiations– Currently not in favor

• Timing issues: Time to market / Acquirer’s stock

– Not generally favorable to Target anyway• Walk away – no way• Exclusivity is restrictive

The M&A Process – Current Issues

• Due Diligence– Lots of it, and lots of time dedicated to it– Primary cause for deals to falter

• Timing – market changes• Warts – finding things that wouldn’t find before

– Give them EVERYTHING• Tech deals – open kimono slowly• Service deals – time to market is more important

The M&A Process – Current Issues

• Definitive documents– Escrows – 10% for one year – sometimes

longer• Mix of stock and cash reflects deal• Acquirer wants cash first

– Earn outs • Bridge gap in valuations, but VERY unfavorable to

target – most never achieve milestones• In almost every deal now

The M&A Process – Current Issues

• Definitive Documents cont’d– Limitation of Liability

• Try to carve up liabilities (e.g., taxes, environ.)• Limit recourse to escrowed amount• Create a larger basket (higher threshold)

– 1 to 2 % of purchase price is typical

The M&A Process – Current Issues

• Fiduciary Duty and Conflicts of Interest– Different Agendas:

• VCs – cover preference, get liquidity, avoid fiduciary breach

• Management – equity acceleration, narrow non-competes, short employment agreements

• Employees – job security, acceleration• Shareholders – best price

The M&A Process – Current Issues

• Fiduciary Duty and Conflicts cont’d– Directors Duty of Care

• Act in an Informed and deliberate manner• Keep a detailed record of deliberations• Demonstrate careful, objective process – rely on

experts– Separate counsel for Management and Board Members

– Investment Bankers fairness opinion

The M&A Process – Current Issues

• Fiduciary Duty and Conflicts cont’d– Directors Duty of Loyalty

• Act in best interests of all shareholders• Try to have only disinterested directors vote

– Special committee

– Shareholder approval

What if it doesn’t happen?

• Sources of liability– Employees – priority for unpaid wages– Uncle Sam – withholding and other taxes– 401K funds – matching payments– Investors – fraud claims– Creditors – fraudulent transfers

What if it doesn’t happen?

• Company solvent– No fiduciary obligation to creditors

• Company insolvent– Fiduciary duty extends to both shareholders

AND creditors• When company is “in the vicinity” of insolvency• Business Judgment Rule applies