On more than one occasion, a client has excitedly told me that they have a potential Buyer who is willing to lay down good money for an option to acquire their business down the road. Usually, my stomach clenches. Don’t get me wrong, it’s great business for the lawyers. The level of complexity of these options deals almost never fails to amaze. The lawyers, accountants, bankers and other advisors have work for days, mapping out and documenting the myriad routes and possibilities that options can take. But is it a good deal for the Founder and their business?
A recent deal was instructive. A wholly owned subsidiary of Tessera Defense and Homeland Security Inc. (NYSE: HLSQ) acquired an option to acquire a controlling stake (51%) in Israeli firm RT LTA Systems Ltd. (RT). Make no mistake, the issuer received payment for the option: a cool $1,000,000. However, if Tessera decides in its sole discretion to terminate or not exercise the option in the next 90 days, it is entitled to a full refund of its $1,000,000 down payment. If Tessera exercises the option, the transaction remains subject to due diligence satisfactory to Tessera in its sole and absolute discretion. The purchase price was capped and based on a multi-part and multi-year EBITDA and revenue formula. They also negotiated a non-exclusive perpetual license to commercialize the seller’s technology and intellectual property.
You have to wonder, why not just do the full acquisition already?
Certainly, a Founder will get excited at the chance to pocket 7+ figures for an option, and the strong signal it sends to the market. But, consider this: if ever the devil is in the details, it is especially so in an option deal. Your (potential) Buyer and their advisors will move quickly from the ‘headline terms’ into documenting the actual deal.
The Buyer will impose conditions and strings at every turn. Why? Because there are endless possibilities. Who gets to exercise the option: Buyer or Seller, or both? Under what conditions? How long do they have? Options periods are typically lengthy, often 1-2 years or more. A business will face ups and downs in that year… what effect does that have on the option? What if the Buyer itself has cash constraints down the road when the Seller is ready to close?
You expect to face these questions in a full M&A negotiation, because at least there is the expectation of closing soon and the ultimate payday. But, in an option, “success” means you sign an option agreement that is merely an interim step toward more process. Like an LOI, but with a much longer exclusivity/no-shop clause. Which, ironically, takes the Founder out of the M&A market they wanted to tap into. Instead, why not see if your Buyer can structure their payments as an investment, potentially allowing the Founders a partial cash-out event, but one where the Buyer is joining your other investors on the cap table.
Keith Bova