Hot off the press (and more press) my startup Social Agent has just been acquired by Unchained Apps Ltd. You can read all about those details in the press release, today I want to use this as a chance to explain the various ways a company can be sold, specifically for a Hong Kong company. While I will focus this in regards to a HK limited company, you can use a lot of the knowledge anywhere in the world.
Also, I learned a ton of this from my amazing advisor and mentor, Steve Forte, and this specific information I got when he spoke at a Shenzhen startup Tuesday: Exiting Tactics for a Startup a couple years ago. Thanks, Steve!
How to Start Discussions of Selling Your Company
When I first mentioned this news about Social Agent on our GFA mastermind, the eight members there were amazed, asking me how I did it, how I valued the company, and how I negotiated it. Yes, it is an extremely overwhelming process, and sometimes, especially for technical engineers (who are normally the ones doing tech startups), business owners have no idea where to start because there really aren’t any rules or process.
I’d first say if you’re a hardcore introverted programmer and engineer, it’s better to find an amazing marketing and business development co-founder for this! Teams are most valuable when you have leaders who have complementary skill sets. I put myself more on the marketing and biz dev side, and so I was the one making this deal.
What Can You Offer the Other Side?
If you are the one looking to sell (be acquired) it’s obviously not as strong of a position as the other side wanting to acquire you. But it’s not the end of the world. You need to first think what you can offer the other party, and the more creative you can be the better. Typically there are three areas of value a business builds:
- IP (intellectual property): This includes code for a web or mobile app, but also includes the brand and trademark. Brand awareness is a big one too, and hard to put a dollar value on, so you can work it.
- Customers (users) and Revenue: How many customers do have, and/or how many users (not paying) do you have? This can get into gritty details such as active users versus inactive. And you should define these clearly. Your business should also have KPI (key performance indicators), also called metrics, that you are used to measure the progress of your business. Also a sales and marketing funnel, from when the visitor visits your website until signup to paying. If you want to learn more about this, read and watch Dave McClure from 500startups talk about his AARRR – metrics for pirates presentation.
- Team: This is an asset (or sometimes a liability when dealing with legacy situations for older businesses), but in tech startups it is more of an asset, as it is hard to build a good team of developers (hackers), designers, and marketers (hustlers). So this often is something an acquirer will want, and it can help their new business.
Other ways to value the business, which may or may not work, include how much time and money you have invested in the business to get where you are and how much money it would cost the counterpart to recreate what you have already built. Especially in China, a lot of times an interested buyer will show interest, but instead try to learn as much as they can during the process and calculate the cost for them to just rebuild it from scratch without buying you. So, be a bit wary when disclosing too much information during potential merger discussions.
Examples of Bargaining Points
As I said earlier, there isn’t an exact formula for negotiating a deal, and it seems this is why lawyers and investment bankers make a lot of money. It is about how creative you are; thinking of both sides. Over the past couple of months, I read Stuart Diamond’s book Getting More and took extensive notes. The biggest takeaway I got was that you don’t just focus on one point in the negotiations, you expand the pie and find parts that one side values more than the other and use those.
Here are some examples I used:
- Cash: Obviously this is the one everyone thinks about, and thus is the most critical and difficult one.
- Equity: Will the target company receive shares in the acquiring company?
- Future Cash Earnouts on Revenue: Even though the company being acquired will be fully owned by the new company, maybe it will still operate separately in some manner. Can the metrics you were using before be used as a future barometer for success and future payouts? This can get complicated, but can be done. I recommend keeping it simple and basing it on metrics such as revenue or user growth.
- Team’s Salary: Will the team be joining the acquiring company? Most likely, yes. Then what is the package in that situation? This is a factor to put in perspective too.
- The Future of Your Product: Last, but definitely not least, is what will happen to your product once it is acquired? You should care, or maybe you don’t. But normally the founders want to see their baby continue to grow and the users stay uninterrupted. You may want to make this clear in the contract.
There are even more, but you get the idea. The more creative you can be, the better negotiations you can have. I think when you get stuck on one point neither side is willing to budge on is when you have a serious problem. Hopefully you can get through it, or you may have to move on from that deal.
Full Company Sale or an Asset Sale?
We mentioned this in a podcast, GFA33 – Selling a Company vs Asset Sale, if you want to listen. Deciding between these is where you need to think pretty clearly. I’ll break each one down as best I can, and then wrap it up with some comparison.
Will you be selling the assets, meaning the technology, the customer list, the brand, the website, and keeping the actual “company” (in this case a Hong Kong limited company)? If that is what you are doing, then this is an asset sale.
This is a bit easier to do than a full company sale, mainly because of the paperwork, but also because your buyer doesn’t need to worry about any unknown liabilities in your company. By simply buying one or more assets, the buyer will know exactly what they are getting and be less hesitant. When doing a deal, I have always learned about thinking from the other person’s perspective. They don’t know what agreements, contracts, or debts you have with someone else. If they take over the whole company and there are some surprises, it is up to them to fix it or pay for it.
Another thing about the asset sale is that as far as the company is concerned, no major changes need to be made. You can simply continue to operate the business with other assets you have or build new assets, change the company name, close it down, etc. The agreement between you and the buyer is simply a buy/sell agreement, not a full company buyout agreement.
Full Company Sale
This is the more complex and complete transaction. This is when the buyer will take over the assets and liabilities and the corporation with it. The seller will transfer the shares of the company to the buyer, and the buyer will become the owner of record in the Hong Kong limited company. Doing a share transfer is a bit involved, requiring complete audits to be completed in your company before the transfer can happen. Also there is a stamp duty of 0.1% of the amount of share capital that is being transferred, and, of course, accountant or CPA service fees for the paperwork.
In this case, you are fully transferring your company and will either be a part-owner or you will have fully sold out of your business. All bank accounts, credit cards, loans (in the company name), PayPal, and merchant accounts will be transferred to the new owners of the company. You can imagine this may be a bit of a headache, as the co-signer on a few of these may be you personally. There might be times when you have to simply close some credit cards and merchant accounts and have the new buyer re-apply in their name. While this is a minor detail, it is good to negotiate this upfront, and understand the possibilities of what can happen before getting too far along. Also if your business is dealing in recurring payments with your customers, then those customers need to re-authorize their credit cards to a new account if you change the merchant account. That can be messy, as one can imagine.
But the benefit of a full company sale is that as a seller, all your “worries” are washed away, and the buyer will have to deal with moving all the accounts over or keeping them open in addition to any overlapping accounts he or she may have in other pre-existing companies. I am sure that the buyer will make you sign a few agreements where you help them smooth things over, and also if any unexpected liabilities pop up you may be responsible. Again, these are things that you should agree on up front so that no misunderstandings arise, especially ones that could escalate to court.
Which Is Better?
I know everyone hates this answer, but when asked which of these is better, the answer is “it depends” on your situation. Generally, in my experience buyers will prefer an asset sale while sellers will prefer a full company sale. Why? Because of risk. A buyer doesn’t want to buy any liabilities such as debts or bad agreements. A seller doesn’t want to risk having those liabilities pop up after the asset sale and then having to deal with it, and the seller also doesn’t want to deal with maintaining the company after the main assets have been sold.
Of course, the tables can be turned; maybe those liabilities are valuable, such as employment contracts. Or maybe the buyer wants to buy the Hong Kong company name. It is worth noting that once a company is shut down in Hong Kong, the next day a new limited company can be established with that name. In order to keep that company name, you need to keep that company open. But please note that a Hong Kong company name is not a brand or trademark–that has to be filed separately.
What’s Your Experience?
I hope this is helpful. I believe for most smaller businesses it will be an asset sale. For Social Agent it was an asset sale, and we moved the IP and other assets of the business that Unchained Apps wanted to their company, and we will be dealing with the limited company going forward.
I’d love to hear about your experiences as well as questions. Again, I am not an accountant or lawyer; just sharing my experience and knowledge to best help you. As you commonly read, please consult an accountant and/or lawyer before doing such an important deal for your own company. Or at least get other advice and not just my words before making massive life and business-changing decisions. Cheers!