Monday, March 17, 2008

The Nigerian Mergers and Acquisitions Scam

Let me tell y'all about the Nigerian M&A scam. Here's how it goes, a small company (Smallco) gets an offer to be acquired by a large company (Bigco) and all the founders are thrilled because they're about to become multi-millionaires. Bigco feeds on Smallco's greed to rub out Smallco. Here's how the burn works;
  • Smallco spends hundreds of thousands in legal fees during due diligence
  • Bigco ties Smallco down in a 'no-shop' agreement that means Smallco can't go get re-financed
  • Bigco stresses everybody out at Smallco and Smallco's business suffers because everybody is working hard on retiring
  • Smallco employees and founders are shopping for yachts, watching Bigco stock prices and ignoring their business
  • Bigco examines all of Smallco's customers, technology, share structure and decides that there's patent/intellectual property/scalability etc. issues and drops the offer by half at the last minute
  • Bigco now decides that the offer is all stock and the shares are restricted and are in escrow (i.e. very hard to sell for a long long time)
  • Smallco is out of money and accepts the offer
  • Smallco founders get stuck with shares in Bigco that they can't sell for years and watch the stock drop to pennies
  • Smallco founders likely owe significant taxes based on the capital gain at the time the acquisition took place and not at the time the founders can sell their paper

All in all, the Smallco founders are fucked and lost a crazy amount of real money (vs make believe stock money) and are probably broke and demoralized. Variations of this story happened a thousand times over in the dot com days and will keep happening in more subtle variations over time. This is just like a corporate version of the Nigerian scam.

Things to learn from this scam:

  • Find a lawyer/firm who'll spot these problems and let you know about them on day 1 of your deal
  • Don't confuse shares for cash
  • Escrow sucks, get at least 2 X cash value of the Company in cash and enough cash to cover taxes & legal fees
  • Restricted stock sucks
  • Cap gains taxes suck, get good tax advice
  • Get a deposit from Bigco
  • Find 2 Bigcos and let them bid against each other

As for me, I've been burned by escrow, legal fees and no-shops. Luckily I never sold my company for Bigco stock, it would mostly be good for toilet paper today. As my NDA's have expired, I can tell you that my Bigco's were Intervu, Akamai, Yahoo and Microsoft. Intervu sucked us dry and luckily I told them to keep their paper which is why my I no longer have any business partners. We never got very far with the others so I can't say if they would have tried all of the dirty tricks but from what I've heard Cisco made the playbook.

1 comment:

Anonymous said...

young ignorant kids trying to play with the big boys will get burned. luckily your post may help a few.