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Privately held technology startups used to have a dance card full of the larger, publicly traded companies just waiting to take them for a twirl. These days, they have the corporate equivalent of two left feet. But with the economy in the tank and remaining a solo act a near impossibility, a number of private companies are still looking for merger partners. And increasingly, they are looking to other privately held tech players as potential mates. That means merger specialists at California’s Silicon Valley firms are increasingly serving as the Arthur Murrays of private company mergers, helping find partners and teaching the M&A mambo. But the mergers are rarely simple. Private companies can be a snake pit of personal politics and complicated financial arrangements. And even when a public company gets involved, the issues around a privately held company’s balance sheet can make a lawyer’s head spin. Just ask Diane Holt Frankle, a partner at Palo Alto, Calif.-based Gray Cary Ware & Freidenrich. Last year, she helped a privately held client through its sale to a publicly held company. The deal was worth a virtual pittance in M&A terms: $5 million. Yet it generated $400,000 in legal fees — a big ratio given the deal’s small size. The small company had complicated financing and a spate of investors who needed to sign off on every detail. “A lot of times [these deals] represent harder issues,” Frankle said. The problem, of course, is that the stock market just isn’t that hot for initial public offerings, and venture capitalists are being stingy with their cash. That makes privately held companies less flush with dough and a lot less desirable for publicly held merger mates. When Steven Tonsfeldt, a Venture Law Group partner, used to sell off a client, it was almost always to a larger publicly traded buyer. But in the past 12 months, he’s done some 25 mergers between private companies. “The normal buyers from 1998 or 1999 aren’t buying like they were, so the final answer is to find another private company where the deal isn’t an exit strategy,” Tonsfeldt said. Unlike stockholders in public companies, the holders of private company stock aren’t all equal. If things go wrong, investors will likely fight over who gets the biggest slice of the assets. VC backers have had a hard time accepting that their portfolio companies just aren’t worth as much as they were when the market was flying high. That’s made for some sticky negotiations when it comes to divvying up shares in the new company. “It’s a time when emotions enter, and it’s not just pure economics,” Tonsfeldt said. “You don’t always have rational people spending a lot of time thinking about the alternatives, and nowadays you have people fighting over relatively small sums of money.” The capital structure of the new company is a heavily negotiated item when it comes to merging private companies, Tonsfeldt said. The structure outlines how much stock each investor holds and what rights come with the shares. For venture capitalists, the deals aren’t always attractive. Not only has their initial investment in the company tanked, but they often are called upon to invest more money to make sure a company can stay afloat through the merger process. For Jeffrey Saper, a Wilson Sonsini Goodrich & Rosati partner, more and more private-private mergers are contingent on the financial backers putting in enough money to sustain the new company. “Now, the private deals have as a condition a current financing by one of the leading VCs,” Saper said. Scoring the funding is a big step toward demonstrating to the investors that the merged company still needs a boost in the assets, Saper said. “The biggest challenge in the private-private deal is getting each of the respective financial backers to acknowledge that each constituent company is damaged goods,” Saper said. The merger, however, often isn’t the end of the process. Tech lawyers are trying to foresee all that could wrong in the future. If, for example, the technology that a company trumpeted to its merger partner doesn’t work, investors demand a promise for cash back. This isn’t allowed when public companies do deals, said Richard Climan, a Cooley Godward partner. “It’s one of the headaches you have to contend with in a merger of private companies that you just don’t think about at all with public,” Climan said. “Negotiating mergers between privately held companies can be far more challenging and time-consuming than negotiating mergers between public companies.”

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