PALO ALTO — When Google Inc. swooped in to buy Nest Labs for $3.2 billion earlier this year, the deal table was crowded.
Nestled amongst the lawyers for the buyer and seller was a Goodwin Procter team led by partner Larry Chu. They were hired by the consortium of venture-capital funds who had pumped millions into the younger company and stood to reap significant rewards.
Investor counsel have been spotted on a number of venture-backed M&A deals. Even if they don’t alter the deal terms, their presence can change the dynamics of the negotiations.
“I’ve heard from a lot of our VC clients that having another voice at the table can sometimes balance the David-Goliath construct that sometimes emerges with these big buyers and relatively smaller targets,” Chu said.
The sale of private companies has always been complicated, though on many issues the interests of the acquisition target and its primary investors are aligned. But deal lawyers say that today’s market is a bit different: As values head into the stratosphere, employment and other matters require more focus and buyers have gotten bolder about pushing for terms that increase investor or seller’s liability.
Indeed, bringing in investor counsel isn’t simply for the optics, said one attorney. There have been instances in which investor counsel has identified an issue or added a comment that “flat-out increased the consideration or identified a substantial issue that in the end lessens liability. That’s not to say company counsel couldn’t have come up with that, but often a different set of eyes brings new perspectives.”
AN EXTRA SET OF HANDS
One of the primary reasons VCs such as Kleiner Perkins Caufield & Byers choose to engage outside counsel is to help the deal move forward, said Paul Vronsky, general counsel at KPCB. “There are a ton of moving pieces—elements of the deal itself, management’s employment packages in the go-forward entity, among other things—so we’re just trying to be helpful by offering an additional set of hands.”
Chu said he first started getting calls from investors in these deals about five years ago. Back then, the situation was a bit more informal. “It was more like, ‘Hey can you take a look at these papers and tell me if there’s anything I can’t live with or if there’s a big red flag?’”
These days, the exercise is a little different. VCs often want counsel engaged when the term sheet rolls in. After all, there’s a lot at stake. “We’re reaching another echelon of premiums, where in some cases the amounts being made are creating generational wealth,” Chu noted.
Private-company transactions in the billion-dollar range have been almost unheard of, particularly since the dot-com crash. When companies reach those valuations, they frequently opt for initial public offerings, given that few buyers can fork over the kind of cash needed for any meaningful return. But in 2014, there have already been two such deals: Google’s purchase of the smart home device maker Nest and Facebook’s $19 billion WhatsApp buy.
Nest had more than five key investors; WhatsApp just had one. Both companies will continue to operate mostly independently from under the acquirer’s roof, making employment agreements of particular importance. In fact, Mark Leahy, a corporate partner at Fenwick & West, says he’s seen more executives hiring their own independent counsel to advise them on their employment agreements when a sale is in the works. That’s perhaps predictable: “You’re talking about their livelihood,” he said.
All parties share the goal of closing the deal. But when venture capitalists sit on the target’s board, as is common, they also have certain fiduciary duties to consider.
Views on deal terms between the target and its investors may also diverge, points out Orrick partner Mark Seneca, who advised Nest and works with a number of other companies.
Well-heeled buyers like Google and Facebook have been around the block. In general, such acquirers are unafraid to act in their interests by pushing on indemnity provisions and escrow extensions, deal lawyers observed. If some buyers had it their way, one attorney said, the indemnification provisions “would be like handing over a blank check.”
Moreover, buyers want responsibilities to be clear, ensuring investors understand they’re on the hook now rather than relying on something signed after close, Leahy said. “That makes it that much more real,” and much more important to review carefully.
THE DEAL DYNAMICS
For law firms, the emerging role of investor counsel is creating another seat in what can already resemble a game of musical chairs.
“The great thing that happens is that company and investor counsel rotate, so a lot of the same players tend to pop up,” said Vronsky, the Kleiner Perkins GC. “In our experience, you get the ‘best of.’ Bringing on one more great firm helps everyone.”
On the Nest deal, Orrick, Herrington & Sutcliffe represented Nest, Wilson Sonsini Goodrich & Rosati represented Google, and Goodwin showed up for the investors.
In the WhatsApp deal, Fenwick—which had repped Facebook in its purchase of Instagram in 2012—advised target WhatsApp. Neither Fenwick nor WhatsApp investor Sequoia Capital would say whether investors were represented by counsel.
Although lawyers said three-way negotiations are typically friendly, it’s sometimes apparent that the buyer would prefer to “streamline” things by dealing with fewer lawyers.
“Buyer or buyer’s counsel would prefer not to have to negotiate with two sets of counsel,” Leahy said. “They’ll push on that.”
Often, that means company and investor counsel are called on to hammer out details before getting to the table.
Working through competing demands is part of any deal process, Leahy said. “But in these cases, company counsel is in a position of negotiating with two sides for a package that makes sense. At some point, on all sides of the table, you can’t have everything exactly how you want it.”
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