Exits: The Last Complications

The pie is so close you can almost taste it. But wait a second!

Escrow accounts

In most transactions, the buyer will insist that some of the proceeds are set aside into an escrow account. Why?

Despite all the diligence an acquirer might do on a company, they cannot know everything they might want to – in part because the selling company might not know everything. An acquirer has to rely on certain “representations and warranties” from the selling company’s management team about what kind of pie this company is and what condition it is in. Those “reps” might be made in good faith and to the best knowledge of everyone involved, but still be wrong.

For example, as an under-the-radar startup, you are hopefully not in the crosshairs of many lawsuits. Once the $100 million transaction announcement goes out, though, lots of people now have an incentive to make a claim: no point suing a cashless startup; but lots of point suing a company being acquired for $100 million.

So instead of letting the selling shareholders have all their pie and eat it, some of the filling gets left behind to potentially pay for dealing with these surprises. In our experience, a “holdback” of 5-10% of the proceeds, set aside into an escrow account for generally 12-18 months, is fairly typical. These holdbacks can also be subdivided into a number of different buckets – indemnity escrows, tax escrows, PPP escrows, and others, depending on how everyone negotiates.

As a seller, therefore, you should not expect a complete piece of the pie. The 5-10% is sitting on the shelf, and though you might hope to eat it all next year, you shouldn’t expect to; these unexpected challenges (and the fees those create) mean others will be nibbling away at your slice.

Oh, also, the sellers have to pay an escrow agent some fees for the privilege of looking after this money. Another few mouthfuls or watery gallons gone.


Wait! In many transactions, the buyer will insist that some of the proceeds are only payable if the acquired company hits some particular targets. Revenue goals for the next couple of years, for example. What happens now?

Well, obviously the selling shareholders shouldn’t pocket that money now – getting it back if the targets aren’t hit would be impossible. So that consideration is simply not included yet. If the headline price of $100 million consisted of 50% at the closing date of the transaction and 50% if the company hit its targets, you have to go back to the top of the waterfall and re-calculate based on $50 million.

Some of that recalculation will be easy; some not, or a bit more arguable. For example, does the investment banking fee get paid on the whole $100 million now, or not? Does the liquidation preference get calculated assuming there’s no earnout, or not? Most of these things are covered in the contracts, but it all requires thorough review to get right.

Aside from more math, what should a selling shareholder assume about getting this money? Sadly, it is a pretty safe working assumption that you will not get paid any consideration promised through an earnout. I’m sure there are good statistics out there to improve our anecdotes, but in general acquired companies (just like early-stage startups) do not hit budgets, and earnouts generally disappoint.

There are many good reasons (just as there are many good reasons that startups don’t hit their projection models!); but in the same way a sensible investor will “haircut” a projection hockey-stick, a prudent buyer will not assume the acquired company will perform as advertised, and so will set earnouts to protect against it. A prudent seller should be skeptical of the chances of seeing any of that earnout.

Carried Interest

Wait! Now VentureSouth gets a cut! Or Angelist, or the venture capital fund, or whoever else manages the fund or investment vehicle through which you invested.

In general, as we’ve covered before, you expect to see somewhere around 20% of the net gain going out in carried interest. This can vary – a bargain at 10% at VentureSouth; 20-25% at VC funds; potentially even more at Angelist or other platforms – but it’s only ever zero if you invested directly in the company without these other groups involved. If you have the time, deal flow, administrative staff, and everything else to do that, great – but you have a whole different set of costs to consider to do that.

Still, a small sliver of your pie slice is feeding fund managers’ bellies through carried interest.

Are we done losing pie yet? Not quite. Come back tomorrow for one last complication.