As the credit crunch continues, many buyers may have to pay a fee for not being able to close an acquisition due to a provision called a reverse breakup fee.

What is a “reverse breakup fee?”

A reverse breakup fee is paid to the target company when the buyer backs out of acquiring the target. If the acquirer fails to close the acquisition because it can’t obtain financing, the reverse breakup fee provision is triggered. (Traditionally, acquirers insisted on including “financing out” clauses allowing them to decline to close acquisitions–without penalty–if they couldn’t obtain the necessary financing.)

What’s the reasoning behind reverse breakup fees?

Target companies believed that acquirers should share the risk that the proposed (and public) deal did not go through. These risks for target companies include:

(1) securities class action lawsuits;
(2) disruption of business operations; and
(3) the potential for an unstable set of management/employees.

Therefore, as acquisition targets gained bargaining power relative to their acquirers over the past few years, reverse breakup fees were increasingly inserted into acquisition documents to re-allocate such risks. According to Factset MergerMetrics, 76 percent of all going private deals involving U.S. target companies included a reverse breakup fee provision.

How much are typical reverse breakup fees?

Reverse breakup fees usually range between 1 to 3 percent of the acquisition price. That may seem like a nominal amount, but keep in mind 3 percent can be a massive dollar amount for private equity deals.

Do reverse breakup fees have any place in smaller acquisition deals?

While reverse breakup fees are found in private equity/leveraged buyout deals, they have a place in smaller deals. At a minimum, small targets also risk that a proposed acquisition will disrupt business operations and negatively affect management/employees (2 and 3 above). And one could argue that a smaller target would suffer more on the operations and personnel side compared to a larger company. Additionally, its inclusion could help entice smaller targets to enter into a proposed acquisition. The tradeoff is that increased language in acquisition documents may scare off the buyer or seller.

Bloggers optimize. Bounce rates, feeds, heatmaps, plug-ins, keywords, and sneeze pages are just the tip of the blogger’s optimization iceburg. So why are blogs sold in such a nonoptimal way?

Blog selling is once again a hot topic. Most articles deal with what multiple of revenue or subscribers a blog will sell for on the open market. This article, however, will show you how to get the high end of any valuation formula or method. All you have to do is use a dash of corporate M&A strategy.

To fetch a high price for your blog (other than taking an unsophisticated blog purchaser to the cleaners), you must copy how the corporate world would handle a similar acquisition. The corporate world would:

(1) Stay around to blog after the sale; and

(2) Use an earnout provision in the blog sale agreement.

STAYING AROUND

In the corporate world, business buyers are concerned revenue will suffer after the purchase. If a buyer cannot reduce the risk of a post-purchase revenue dip, the seller will not get the company’s full valuation. The buyer will simply discount the valuation and pay the seller less.

Key personnel loss is the main reason why companies suffer post-purchase revenue dips. Obviously, a blog’s loss of its blogger fits right in with this scenario. A blogger is the de facto key personnel of its blog.

Corporate buyers typically require key personnel to stay around and work for a specific duration as if the purchase did not take place. This helps reduce the buyer’s risk of a post-purchase revenue dip, as the company can hopefully achieve a seamless ownership transition by the time the key personel leaves.

The blogosphere has generally realized that staying around is a good idea for the blog seller. And I’m seeing that some bloggers do stay around after the sale. For example, Blogging Fingers just sold and the selling blogger will stay on for at least one week. But one week is not long enough to achieve a smooth transition of ownership and adequately reduce the risk for potential losses. I recommend that a selling blogger stay around for at least 3 months, and if possible, 6 months. 6 months may seem like forever in blog time, but keep in mind that corporate earnouts (see below) can last for several years.

So if a selling blogger agrees to stay around after the purchase, what will ensure that he or she will put forth the same effort into the blog post-sale? And why would the selling blogger want to stick around for up to 6 months?

THE EARNOUT

An earnout is a type of business installment sale under which the final purchase price is not fixed—it is contingent on the company’s future performance. Earnout agreements are often used to resolve disputes between a seller’s asking price and a purchaser’s valuation.

Earnouts are particularly useful when the seller has a limited history or unproven, but promising prospects for revenue generation. (Sound like your blog?)

This is how a basic earnout transaction works:

Step 1: The buyer makes an up-front payment to the seller. This payment is accompanied by the buyer’s promise to pay an additional amount if the company reaches certain goals.

Step 2: The seller continues to work as if the company purchase never occurred for a specific time frame.

Step 3: At the end of the term (or at various intervals), the company’s performance is evaluated against the goal provisions of the earnout clause.

Step 4: The seller stops working for the company and receives additional amounts if the earnout’s goals were met.

WHY THE EARNOUT IS PERFECT FOR BLOG SALES

The use of an earnout when selling a blog has advantages in addition to providing the monetary incentive for the blog seller, including:

(1) The buyer’s initial guaranteed investment in the blog is reduced, as is the risk it assumes (buyer only pays more if the blog makes more);

(2) The buyer may find the purchase will pay for itself out of future profits;

(3) The buyer and seller will reconcile their differences over the blog’s valuation and purchase price (e.g., if future revenue is low, the final purchase price will be low; if future revenue is high, the purchase price will be high); and

(4) The seller may be able to obtain a much higher purchase price than he or she would have obtained if an earnout was not used.

One scenario where the earnout provision can be put to good use is when the blog to be purchased is generating some serious traffic or has many subscribers, but has not fully monetized for whatever reason.

Keep in mind that the goals of an earnout provision can be tied to other factors than revenue. There’s no reason why subscribers or unique visitors could not be substituted for or used in addition to revenue.

While the earnout is a perfect way to handle a blog sale, I’m not aware of any blog selling sites that allow blog sales to be structured with an earnout. Sitepoint doesn’t even mention anything about staying on board in their FAQs about selling a website. It’s somewhat understandable, however, because earnouts can sometimes be difficult to set up. Yet they are well worth the hassle for both seller and buyer.

CONCLUSION

If you are selling your blog, you must realize that you have just entered the corporate world. Thus, you have two choices: (1) stay around after the sale, use an earn-out provision, and get paid for all your blog is worth; or (2) allow someone to purchase your blog at a discount, thereby wasting a large chunk of your blog optimization efforts.

##UPDATE: This post was chosen to be published in the February 2008 issue of the Texas Bar Journal. Check out how it looked here (PDF format).

A leveraged buyout (”LBO”) is a strategy where someone acquires an existing company using a significant amount of borrowed funds. Typically, the assets of the company being purchased are used as collateral for the borrowed funds. This allows someone to acquire a company without having to outlay a lot of personal or business capital. Then, the purchased company’s cash flow is typically used to repay the debt.

It may not seem natural to include LBO talk in this Startup Lawyer Blog, but I believe every entrepreneur should be aware of such a strategy. LBO transactions can be a way to grow your companies–or sell them.

If you are buying a business, the process becomes expensive and tedious once the letter of intent is signed. For this reason, I recommend all buyers include a “No Shop” provision in their LOI. This provision prevents the seller from going behind your back and finding other suitors while you are busy with due diligence and financing.

Sellers should find this clause acceptable, but be prepared for them to counter with a time limit for the no shop. The seller doesn’t want to be tied up forever and will hope the time constraint gets you going faster so that the deal won’t fizzle.

An earnout is the method of paying the seller of a company based on that company’s future earnings. The earnout will call for additional payments to the seller if the company’s post-sale earnings reach a certain level.

The earnout is useful when buyer and seller do not agree about the company’s future profit stream. A buyer should be willing to pay a higher price for greater future profit, if realized, allowing the seller to get paid the company’s full value as the seller represented at the time of the deal.

When negotiations need to remain confidential, a letter of intent should obviously include a confidentiality cause. But in the case of startup companies–replete with their fresh and new ideas–a confidentiality clause is a requirement. Information will be exchanged during due diligence and the negotiations, thus the parties should agree on what information is confidential.

In most cases, the parties will expressly state that all information is confidential unless otherwise provided and that the obligation of confidentiality survives the term of the letter. Additionally, the parties should agree to the level of confidentiality that will be required regarding the terms of the letter of intent, the ongoing negotations, and any other information deemed confidential.