Craig Jacoby, Cooley Godward partner..Photo by Jason Doiy.6-22-12.058-2012… ()
“We’ve been acquired! And by the way—we’re shutting down.”
It’s the kind of announcement that seems ubiquitous in Silicon Valley.
The so-called acqui-hire—a talent buy, dressed up as an acquisition—has become the transaction du jour since it first emerged at the end of the downturn.
At the time, some entrepreneurs and investors were eager for any deal, even one that offered little financial gain, and established companies were hungry for experienced engineers.
But as the economy rebounds, the practice seems to be sticking around—a by-product of the Valley’s glut of start-ups and shortage of technical talent, according to attorneys who advise such businesses. And though the transactions are now commonplace, the legal underpinnings of acqui-hires are still being hashed out.
Critics of the approach contend that it essentially allows an acquirer to take on the assets of a company, like its IP and employees, without incurring its liabilities. Traditionally, the only way for an acquirer to accomplish that would be to scoop a target out of bankruptcy.
Legal questions around acqui-hires came up recently in a Northern District privacy case. Plaintiffs in In Re: Apple iDevice Address Book Litigation, 13-453, accuse a stable of tech companies of improperly collecting user data.
One issue in the case has been a 2011 transaction between Facebook Inc. and Gowalla, a location-based ap developer. Facebook’s lawyers call the deal an “unremarkable” transaction which involved hiring some employees and transferring IP rights. They’ve moved to dismiss the case on the grounds that Facebook isn’t legally a “successor” to Gowalla.
But plaintiffs attorney David Given of Phillips, Erlewine & Given calls it a “disguised merger aimed at stripping Gowalla of its assets thereby avoiding the consequences of a merger … and frustrating the ability of creditors like our plaintiffs and the putative class from recovering for the alleged wrong associated with invading their privacy and taking their contact data without the requisite permission.”
The litigation is unlikely to disrupt acqui-hiring. However, it does highlight the legal gray area that may surround the practice.
Attorneys pointed out that deal structures vary widely depending on the type of business, integration goals and number of employees. The two things that can be counted on, though, in contrast to a straight acquisition, is that the deal size is generally lower, and considerable effort is spent locking up the employee retention agreements.
And unlike the traditional strategic acquisition, the acqui-hire isn’t based on the business a founder has built. Acqui-hire buyers care little about platform compatibility, user base or growth profile. All of that is instead merely a showcase for a team’s skills, proof the employees are valuable hires. As Mark Zuckerberg put it to a Y Combinator audience in 2010: “Facebook has not once bought a company for the company itself. We buy companies to get excellent people.”
At first, it’s a head-scratcher to think that tech giants would go through the trouble of taking on whole companies simply to harvest their talent. After all, California labor laws favor employee mobility, and a company could simply go out and recruit individuals or groups of workers.
“[Poaching] happens all the time, every day,” said Craig Jacoby, head of the emerging companies practice at Cooley.
According to University of North Carolina law professors John Coyle and Gregg Polsky, who penned the first academic paper on the topic, established companies may use acqui-hires simply because it feels less adversarial and helps preserve the symbiotic relationships that fuel Silicon Valley. While some have speculated that acquirers seek to diminish their exposure under trade secret or employment laws, Coyle and Polsky’s findings largely discredit the idea. “In our interviews with acqui-hiring participants, we were told repeatedly that no investor in Silicon Valley would ever sue its entrepreneurs,” they state.
From the target company’s perspective, there can be tax benefits for the entrepreneurs. Founders’ stock sales, in contrast to regular employment agreements, are taxed at capital gains rates, which are lower than income taxes. Additionally, approaching the mass transfer of employees as an acquisition allows founders of floundering companies to save face. Perhaps, most importantly, according to Cooley’s Jacoby, it lets founders exit a company without leaving their early investors “in the lurch.”
Even so, acqui-hires can create tension between start-ups and their investors, who stand to walk away with relatively little.
“One of the dynamics here is that as an investor, you find out how much you matter,” Jacoby said. “You discover a lot about the character of the founders and whether you have any importance to the acquiring company.”
One of the reasons there hasn’t been more pushback from investors is likely the Valley’s relationship-driven culture, said David Goldenberg, founding partner at VLP Law Group.
Entrepreneurs who take part in acqui-hires may want to scratch the start-up itch again. And prominent investors don’t want to be left out of the next big thing, he said.
“It’s a small Valley—none of these people are going anywhere,” Goldenberg said. “If investors get a reputation for not letting the guy take a job at Facebook, for example,” that could hamstring them later on.
Currently, there isn’t a hard-and-fast rule for how deal proceeds get allocated between the employees and investors. Though Coyle and Polsky predict that more formalization may be on the way, for now it’s generally an ad hoc negotiation.
Attorneys who advise the earliest-stage start-ups say the practice seems here to stay, becoming a key conversation ahead of embarking on fundraising or making other decisions.
“Some of these are companies that can grow to be significant independent enterprises. But some are better described as features,” Jacoby said. “Sometimes that’s a difficult realization.”
Other longtime Valley observers agree.
“There’s more talent here than the rest of the world combined—it’s fundamental to the whole ecosystem here,” said IP litigator Fabio Marino, a partner at McDermott, Will & Emery. “So if there’s a way to formalize, capitalize on this talent, it’s even more important.”
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