Two years ago I sold a two-person firm to Microsoft. They had created a great product, tested it with firms like Wal-Mart and were on the verge of taking off. But they wanted out, and it took only a week to get IBM, Microsoft and several other big firms interested in a purchase. It took about two hours for me to work out an acceptable price with the corporate development officer but nearly two weeks to nail down the consideration and the hold-back. This is not common in just the technology industry-but every sector where the initial payout-the consideration, and the money that will be paid out, or "held-back" in stages, is negotiated down the penny.
I devote a long section to key phrases and topics under the chapter of acquisitions in my book, but I´m going to paraphrase. The "consideration" describes the initial amount to be paid to one partner at the start of an agreement, or acquisition. It could be the first payment on a guarantee or the up-front payment on a joint marketing agreement, licensing, joint development agreement or even acquisition. For example: Consideration. In consideration for the [agreement type], [payor] will pay [your firm] one million dollars, ($1,000,000) (the "Consideration").
The hold-back is the portion of the payment associated with an agreement that will be held back for some reason. This is used any time the firm paying the money believes it is at risk of employees leaving the company, the product delivery schedule being upheld, or any other unforeseen and unpreventable event. You are wise to employ the holdback yourself if you are faced with this situation.
Example: ($750,000) Seventy-five percent of that portion of the Consideration (the "Restricted Amount") otherwise payable to [your firm] at the [agreement] Closing shall be paid out (75 percent up front) remaining paid out over two years, in equal installments over four years, with 25 percent of the Restricted Amount payable at each of the first, second, third and fourth anniversaries of Closing.
The double-hold back is the amount held back on the total amount for the duration of the agreement. This is another insurance policy for the partner with the most at risk. Be sure to look at the paragraph carefully, as I´ve never seen an agreement that calls out a double hold-back within the main hold-back paragraph.
Example: Twenty percent (20 percent) of the Consideration will be withheld following the Closing (the "Hold-back"). [Payor] will be entitled to be indemnified from the Hold-back in the event of a breach by [your firm] or its Principles of any of their respective representations and warranties, or a failure to comply with any of the covenants, in the Definitive Agreement(s), provided that [Payor´s] right to indemnification shall not be limited to the amount of the Hold-back.
In other words, you won´t actually see 100% of the "up-front" money, rather, only 80% since the [Payor] wants to protect against any risk by keeping 20%.
Trends in the Industry
In 2001, I sold a company that received 68 percent of the consideration within the first year and the remainder within 24 months. Another company I sold 2004 received over 50 percent consideration given and a hold-back of only one and a half years. However, in both cases, what made those agreements work was typing payouts to key product deliverables and project revenue payback within the time frame. A licensing deal in early 2006 went south went the gap over the consideration and hold-backs became too large for my client and the payor decided against the risk of paying too much up front. In today´s environment, the narrow path of money now and the ability to deliver on the goods once a partnership or acquisition is complete has to be walked. And if it´s not, a potentially great relationship can be fouled by these three simple terms and conditions.