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Cashing Out Entrepreneurs Gets More Complicated

Oxford Entrepreneurs Whitepaper

Delayed Payments, Reduced Prices: Long After Deal Is Struck

For acquisitions of private companies backed by venture capital, it’s becoming increasingly complicated to collect cash after the deal has been signed.

In contrast to a decade ago, when many such deals went through with little trouble, today’s venture-backed acquisitions are fraught with landmines that can result in delayed payments and reduced purchase prices long after the
deal has been struck, say venture capitalists, Entrepreneurs and deal attorneys.

Such complications were evident in the $125.2 million acquisition of privately held surveillance-technology firm Era Systems Corp. by SRA International Inc., a tech supplier to the federal government. While the deal was struck in mid-2008, Era’s shareholders took a haircut on their purchase price and didn’t collect their reduced amount until last year, partly because of a disagreement during the escrow period.

More venture-backed acquisitions are subject to contentious escrow periods—where 10% to 20% of a deal’s proceeds are held back to protect a buyer in case of a contract breach—with buyers and sellers dickering over the pot of money being held, sometimes leading to legal fights.

Many of the deals also now include earnouts—where part of the deal’s value is pegged to the purchased company hitting a performance milestone later—some of which never ends up being paid out. As a result, investors and Entrepreneurs are ending up with far less of the purchase price than the number upon which they originally agreed. That’s having a knock-on effect on Entrepreneurial wealth and venture-capital returns and distributions.

“There’s a lot more friction in a lot of relationships now, with a higher percentage of escrows being challenged,” said Dave Tabors, a venture capitalist at Battery Ventures, who adds that his firm currently has $20 million tied up in escrows.