How to Structure an Acquihire Deal in the AI Talent Race

How often do you get to spend 2 hours with hundreds of corp dev leaders who are all working through the same problems you are? That's what the BioLed M&A Summit is on August 18th. I'll be presenting the State of AI in M&A 2026 report live for the first time before it goes public. If you listen to this podcast, this is the kind of conversation you show up for, and August 18th is where it's happening. Every registrant gets a free copy of the report when it drops. It's completely free. It's virtual, 11:30 to 1:30 Eastern. Register at dealroom.net/summit or link in the show notes. That's dealroom.net/summit. Now back to the episode. I'm Kison Patel and you're listening to M&A Science, where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies, and what actually happened during M&A deals. Hello, M&A scientists.

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Let's jump in. I'm your host, Kison Patel, Chief Scientist at M&A Science. My guest today is Derek Lu, M&A partner at Baker McKinsey in San Francisco. Baker McKenzie is one of the largest law firms in the world with one of the most active tech M&A practices in the country. Derek's personally signed over $110 billion in transactions. He's worked both sides, sell side with startups and buy side with the big acquirers. And right now he's watching the acquihire go from a $20,000K soft landing to a $2 billion talent war. The product doesn't matter anymore.

The people do. Today we're going to talk about deal structure, diligence when you don't want the product, and why California's non-compete ban is a nightmare.

Derek, how you doing?

Doing well, Kison Patel, and thank you so much for having me.

Thanks for hosting me here live in San Francisco.

Absolutely. You brought the weather and you brought the World Cup. Yeah.

So far, getting around pretty good.

Can we kick things off with a little bit about your background?

I started my career in New York with a law firm called Wachtell Lipton. So it's one of the larger law firms.

Never heard of it.

Never, never heard of it.

Not if you're Lebanese.

Actually, it's a small boutique firm. Little known fact. Back then it was about 200 or so lawyers. So it is small but mighty. It punches above its weight. I did that for 4 years, really kind of learning the craft. And then around 2013, decided that, hey, all the action's happening on the West Coast. I really wanted to be a part of it. I moved myself out to Silicon Valley and linked up with a law firm called Wilson Sonsini, which is one of the bigger tech-oriented law firms out here. So did that for 8 years. Really kind of saw the full spectrum of tech deals. Like you said, buy side, sell side, public company, private company, all over the place. And then in 2020, I got the opportunity to join on the ground floor of Baker McKenzie's build-out here in Silicon Valley. Baker's been out here forever, but they really wanted to build a targeted buy side-oriented strategic tech M&A practice. I linked up with a couple of partners, Leif King, who was run corporate at Skadden, Lawrence Lee, who used to run head of M&A at Coinbase, and we kind of just started the practice. My practice nowadays, most of it involves helping large serial acquirers with their programmatic acquisitions. So I do that for companies like Google, Salesforce, ServiceNow, Atlassian, and then I do also represent startups, represent public companies on buy-side, sell-side transactions, and the whole gamut of whatever else comes in through the door.

You're a corporate M&A lawyer.

Yes, I'm a corporate M&A lawyer.

Can we have like quick off record? I want to get a sense of the legal scene because I feel like there's a lot of maybe stereotypes of different law firms, but I want to get your perspective because you went from some pretty well-known firms at Washburn, Wilson Sonsini, now Baker McKenzie. I wanted the insider, like the reputation for the firm, but then also at the end of the day, it's the partner you're working with that I feel like carries the most weight.

What's your take?

Because I know Wachtell has its own reputation, like notoriously known for their M&A transactions and just the way they operate.

All well-deserved. Wachtell has the reputation for being incredibly intense, which it was during my time there. I would also say though that the nice thing about it is you don't go there unless you actually really like to do M&A. This is not doing it because you're doing it for a job or you want to collect a paycheck. You have to really like doing something to do it for that long and that hard. I was really fortunate to do that at the beginning part of my career because it meant that starting as a first year, second year, I was getting exposure doing things that folks at other firms weren't doing until they got to their third, fourth, fifth years. It was just a very accelerated learning process. People were given a lot of responsibility early on. People were assumed to know what they were doing and you just kind of had to run to catch up. Wilson Sonsini was ironically, you know, some of the same, some very brilliant people. The practice group that I worked with at Wilson was made of mostly New York transplants. Most of us had started our careers in New York and moved out west. There was a sort of an M&A specialty team within Wilson. We tried to run very much a New York-style practice, but in Silicon Valley. It was more Californian. You could wear hoodies. That was a big difference. Wachtell was much, very much suit and tie and all the rest of that. And Wilson was more biz cash and hoodies and baseball caps, but At the end of the day, M&A is M&A. I happened to come to Silicon Valley at a point where relative to the traditional notion, and this is a lot of New York elitism, there's a traditional notion that like, oh, New York is the center of the world and everywhere else is the backwater. The Manhattanites' view of the rest of the country is sort of like Manhattan, Brooklyn, everywhere else. That's how Wall Street lawyers saw San Francisco. But since coming out here in 2013, what I can definitively say is the practice of corporate and M&A law out here in Silicon Valley is as sophisticated as it is anywhere in the country, anywhere in the world. It is the largest companies in the world. You look at what the Mag 7 is, you look at FAANG, you look at the new ones called Mango. They're all out here. So this is where the action is right now, and it has been for the bulk of my career. We are doing things just as sophisticated as folks are doing in New York, but we're still doing it wearing hoodies sometimes. So that's the—

I like it.

Baker has just been— it's bigger, it's much more multinational. That was sort of an additional element to the challenge for me. If you're doing a lot of venture-backed deals over and over, adding the cross-border component has been just a nice challenge for me in terms of like, now I have to navigate multiple jurisdictions of laws. I have to navigate multiple kind of cultural expectations. So it's just been, as someone who personally, I was born in China, I grew up here in the US, I travel a ton. Personally, for someone who's like very much interested in cultural exposure, working at a firm like Baker has been just really cool.

You've definitely got the international footprint.

70 offices in 40 countries, something like that, but trying to be top tier in each one of those jurisdictions.

Oh, I like the story. Cut your teeth at one of the most recognized M&A law firms in New York and then moved west to strike gold or tech gold.

Yeah, absolutely. I wish I struck more gold. When I came out here, Bitcoin was just starting out and a single Bitcoin was worth about $800. And then I looked at it and said, "Oh, that'll never fly." Don't feel bad.

I did the same thing. The same thing. So speaking of gold in this market now, AquaHires is what we had a conversation about, and it kind of led to some depth. It's like, why don't we do a podcast interview about this?

Yeah, absolutely.

You used that reference point, $20K a decade ago. What's the difference between that and today?

$20K a decade ago. But if you look at What Meta did with Scale about a year ago, it's $14 billion now. So you look at the numbers on these acquihires, Scale AI, $14 billion, like I said, when Google bought Windsurf, that was a $3 billion transaction. When Microsoft bought Inflection AI, that was $650 million. These are real transactions. These are real, whether you call it mega cap or like mid-tier, these are real transactions., but they're not being done for the products. They are being done for people. These transactions have evolved Silicon Valley to being a product-driven kind of a scene to what I jokingly refer to as like, we're in the sports star era right now of Silicon Valley. These AI superstars are getting paid on the scale of a LeBron James right now. And it's a really cool evolution to watch when you're talking about like the evolution of the Valley in the time that I've been here.

What's driving that? I want to get a sense of this current ecosystem that it just moves so fast. You don't care about the product because you're building the future and now you're focused on talent that has the potential capabilities to build for the future.

Yeah, absolutely. Let me do the compare and contrast. So talent was always important in Silicon Valley. There's no doubt about that. There's always been the notion of the superstar founder, like that has not gone away. But it used to be at least the case that when you talked about buying a company, you were talking about buying that talent together with what that talent has built together with the product. And what's changed now is you've got a bunch of very well-established tech serial acquirers who are looking to scale up in the AI race, and they are looking for the talent to help them with that scale. Because you're looking for that talent to scale, you're not looking for the product that these particular individuals might have built because you don't need that. What you need is for them to take their talents and help you AI-ify— that's a term— your existing product, build in AI features to whatever you do today. That focus, that shift in focus is much less about like, hey, let's buy a company, let's fold in its features with what we have originally, like Maybe let's take on their customers. We cared about their customers. Now it's just, we need this group of people to help us evolve into the AI age. And because this is existential for so many of these companies that are doing it, if you hear all the stories about the SaaS-pocalypse, it's all about, oh, SaaS is going away because AI is going to replace it. I don't think that's quite true. What I think is true is that all of the traditional SaaS companies are looking as well to like, how do I use AI to get to the next level of my product? Because I have to, this is essential. Because it's existential, they're willing to pay up for the talent that they perceive could help them do that.

It's changed. I remember there was a— because a lot of these larger strategics do acquihires. That was a thing. There used to be— what I learned was a rule of thumb. You pay a million bucks an engineer, and I was like, how do you justify your valuation? But now some of those examples you cited off, it's just like way above and beyond. Like, how is that justified?

The million dollars per engineer, that was back in the age, and they, people still do this. People still do acquihires at a million a pop for an engineer. But that was under the predicate that what you were doing was rescuing a struggling startup. You had a team that came together to build something. It didn't quite go the way they wanted it to. It's still a good team. It's still a team that the acquirer wanted to find a home for. And so as a rough ball metric, the million per engineer was somewhat of a, hey, this is how much it would've cost for us to go hire a headhunter and do the work of actually bringing a team together. This is how much roughly it would've cost. So let's just pay that to the company so that we can bring these folks over. That was the old traditional acquihire structure. It was more, I would say, driven by two things. One, convenience, and then two, just saving face. It's maybe the term for it. That way the founders get to say, I had a quote unquote exit. For a valuation undisclosed. And whenever you read that, you kind of like, oh yeah, it wasn't disclosed because it wasn't material. That's the old way of the world. Now these acquihires are being done in situations where genuinely the acquirers just don't care about the product. They only care about the people. And so they're using the structure and the terminology of an acquihire, but what they're really talking about is like, these are mission-critical people. That we have to have. And if we don't have it, then whatever the consequences.

But they're paying billions of dollars.

They're paying hundreds of millions or billions of dollars for it. Absolutely.

They just forecast like a market outcome from so many years out. And that's how they justify paying for billions of dollars for these.

That's more of a question for the biz dev teams that I'm sure you'll also talk to. I mean, my, my personal sense though, you look at the SaaSpocalypse, you look at all these SaaS companies, who've had 20, 30, 40% of their market cap just vanish because of a perception, not reality, but a perception that their business is going to be challenged. Some of my clients in the SaaS space, they're having their best years ever and they're still having trade market cap issues. Why? Because there's this narrative out there that, hey, AI's gonna eat your business. All of them are grappling with that and they're saying like, okay, Yes, a couple hundred million is a lot of money, but if it allows us to tell the story in such a way that the Street can now say, okay, actually we do believe you, we see your AI story, then it's worth it.

The new LeBron James is an AI engineer.

Yeah, that's right. If you're a basketball fan, what was LeBron worth to the Cleveland Cavs? They were nothing. And this is not a perfect analogy, right? Most of, most of these companies were, are something. But the point is, if you can get a quote unquote generational talent How much is that worth?

Yeah, I mean, Anthropic's like a prime example. You got a group of folks that left OpenAI and then built something bigger, better.

That's fair. Although I do think that Anthropic is much more of a team effort from everything I've seen. A lot of like just really good engineers going together. But I take your point. A lot of very smart people are being appropriately compensated for perceived value.

I think that's part of it too. If you know somebody else has that reputation in the market, you know, others that'll follow as well. Can we break down technical definition between an acquihire and just doing a regular acquisition?

The term gets thrown around colloquially. So let me talk about the colloquial usage first, and then let me talk a little bit about deal structure because it actually matters. From a colloquial perspective, what we mean when we say acquihire is just any transaction where the talent is at the core of the transaction. What that usually means is that you're buying the people. You might take a license to the IP, but you don't really care about the IP. You're not so interested in the business itself. Now, as a matter of fact, there are plenty of acquihires that actually get done as a share purchase, but that's just legal structuring. Then onto the legal structuring part. Traditionally, the way that acquihires were done is as either an asset sale or as a, what they called a sign and release. An asset sale just means that instead of selling the entire company with 100% stock to someone, you sell a select group of assets to that buyer. So in the case of an acquihire, it would be you're selling the rights to the employees by a contract, and you are selling some IP. That's a traditional asset sale acquihire. An even more simplified form of that was the sign and release. In a sign and release, what's happening is the acquirer doesn't buy anything. The acquirer literally buys a contractual right to hire a certain subset of the target's employees and then gets a release. That's the release part of it. Gets a release from the seller that says, hey, we won't sue you for poaching all of our employees. And the nice thing about those two structures when we're in the world of about a million bucks per engineer, the nice thing about those structures is They're super simple to execute. You don't have to do a whole lot of due diligence. You don't have to worry about the customer contracts. You don't have to worry about the legacy liabilities. You just say like, hey, here's 10 people. We want to make offers to these 10 people and maybe we'll take a license to your IP. We can get this done in a week. So that was kind of like the nice, clean, simple, traditional acquihire structure. A stock purchase, on the other hand, is you buy all of the stock of a company. You take on all the historical liabilities, all the customer contracts., and all the shareholders get paid out as capital gains. How it's now playing out in the acquihire space is the traditional way of doing these acquihires. Well, I said asset sale or sign and release. They're very tax inefficient because it's, it's a little technical, but basically because the sellers have to pay two layers of taxes. They have to pay one layer of taxes at the corporate level for selling the assets, and then they have to pay another layer of taxes when they distribute those proceeds up to the shareholders.

Okay.

Double taxation. No one likes double taxation. That didn't really matter as much when you were talking about purchase prices that were maybe $5 million, $10 million. So what? There's a little bit of tax leakage, but we all save a bunch of money and we don't have to pay the lawyers as much. Great. Let's do it. When you are talking about purchase prices that are $100 million, $300 million, $1 billion, that starts to sting, right? The tax leakage really starts to sting. People start looking back at stock purchases as being maybe that's the appropriate way of doing these transactions, but it does come with all of the downsides of doing a stock purchase when all you really wanted were the people. So even though all you wanted were the employees, you still now have to deal with— figure out if there's historical liabilities. You still have to figure out if they misclassified their employees, if they didn't pay their taxes on time, if they stiffed their suppliers. It starts having to turn itself back into a more or less traditional M&A deal just to do this. Now, another variation we should talk about on the structure is a variation on the sign and release structure. Now recall in a sign and release, what's happening is that money is being paid to the target company, and in exchange for that, the target company is allowing the acquirer to basically hire away individuals and to give potentially a non-exclusive license. Well, in the MetaScale transaction, they tweaked it a little bit for tax efficiency purposes in a way that I thought was really clever. Instead of having the higher part be a consideration payment to the target, they had it be an investment. So you might say, what's the difference? Well, by having it as an investment, the payment to the target company is not taxable. It's an investment. Like if you invest $10 in a company, the company's not paying $10 on that tax. What the target did in these transactions is that they take that investment amount and they make a special distribution and distribute it up to their existing shareholders. So it functionally has the same economic impact as a payment, But the difference is the acquirer ends up owning some percentage of the target company, which could have some value or could have no value because of the fact that the stub company may have nothing. But in any case, the second part of this structure is functionally the same, same as a release and hire structure, where basically the acquirer gets to hire away the target employees and potentially take on a non-exclusive license. So the big delta from a sign and release structure is just By doing it as an investment, you avoid half of the double tax issue that we were talking about earlier. It's still not as good of a tax treatment as a pure equity structure, an equity purchase structure, but it has a lot of benefits from a tax perspective relative to the asset sale or the sign and release structure, because it does avoid the layer of corporate taxes. Just one other double-click on the MetaScale transaction in particular. There was a lot of commentary around whether this structure was all being done and engineered to avoid antitrust scrutiny. By taking non-voting stock, by having a non-exclusive license, by hiring employees, the transaction was indeed one that didn't require HSR approval, which to me, I mean, was quite clever because it made it so that they could get the deal done faster, get the talent on-boarded faster. There is an interesting, I would say, policy question that commentators have written about of, look, are you doing this to circumvent the HSR rules? Certainly the antitrust regulators have made noise on that front, but you kind of do have to look at it from the perspective that at the end of the day, Meta was not getting a business, right? Circling back to what this whole podcast is about, Meta was not really buying an entire business. They were buying a team of people. And so from that perspective, I think you should rightly ask the question of like, is this really the kind of transaction that the antitrust laws were meant to cover? We generally think that antitrust laws are not meant to be used for employment transactions for good reason, right? We don't want antitrust laws to apply every time we make an offer to an employee. If you just think about an acquihire as a, as a really big employee hire, I think there are legitimate questions about like whether that's even the right policy outcome for antitrust laws to cover it. But I'll put that to the side. It's not a philosophical debate to engage in, but for the moment, I would just say it is a clever and interesting structure that you're starting to see gain some traction by practitioners in that it bridges the speed and efficiency of the asset structure while preserving some of the tax benefits, at least of the stock structure. But nonetheless, the structural challenges remain. On the one hand, you can buy the stock of a company, and that's tax efficient, but you have to deal with all the historical baggage. Or you can buy the assets or just the employees in a much simpler transaction, but you are then dealing with potential for higher taxes. That's the trade-off in these two structures.

Why do you end up with higher taxes? I feel like that was so common is to do an asset sale.

It's that double layer of taxation I mentioned. So what that means is that let's say you sell the rights to your workforce for $100. So first there has to be a corporate layer of tax. So that means in about 20% or so, just taken off the top that the corporation receives. Now the corporation could have an NOL to offset that. And sometimes that's what we see. But if there are no NOLs, then the corporation itself has to pay 20% tax or so. Then that proceed is still stuck in the corporation. So when they dividend it up to their shareholders, the shareholders then have to pay another layer of tax. So that's where you end up with sort of like 40-ish% plus state and local. So that's how the taxes become significantly more than if you sold the stock and just did it with regular long-term capital gains. And sometimes with stock deals, you can also get QSBS, which is an even better treatment. So there's a lot of tax advantages to doing a stock deal. And again, this is part of what the Meta scale structure solved for by avoiding that first layer of taxation. So that you only have the second layer of the distributions. But what it doesn't solve for is preserving QSBS treatment. It doesn't solve for recognizing the basis that existing shareholders have in the company. It's still not quite as good as a stock structure. And so for that reason, I still think that the stock structure remains on the table for acquihires.

And so that's why we see that now is just doing more of a stock purchase and absorbing all those liabilities, cuz now you, take over the whole company and any baggage and bugs and everything that comes with it. What do they do when they don't want the business? They just want the talent. Do they just wind that business down? They fold it in, they take it to the backyard and light it on fire.

What do they do?

It's actually a really challenging issue for acquirers, and it's one that we've been dealing with a lot of our clients. So let's break down the big buckets. One is customer contracts. You're buying a business, that business has a certain number or a certain amount of time to use that product. If you want to wind down that business, oftentimes you can't just turn off a contract on a dime. You have to give customers notice, you have to negotiate with them, help them with their transition. These may be, by the way, the very same customers that the acquirer has. So you don't want to just completely piss off your own customers. But the problem is, let's say it takes 6 months, a year to wind down those customer contracts. That's a period of time that's distracting the team that you just paid a lot of money for because presumably there's some amount of effort and work that has to go to servicing those customers. So in an ideal world, you want your team to basically start working on your stuff day one, no distractions, no encumbrances. But because of this, the customer contracts, there has to be a little bit of a dance of like, all right, how do we do this in a way that's minimally distracting to you? Where we're not incurring a lot of liabilities, and at the end of the day, everyone kind of walks away happy. So that's one category that my clients have had to navigate. Another category, the employees that you don't want. In a stock deal, you take on everyone. It's a little bit unfortunate, but sometimes the acquirer doesn't have a role for everyone in the organization, particularly in these acquihire situations where they may very well be just interested in a core team. They don't care about the sales and marketing team because they're not going to sell the product anymore. G&A always got laid off in every M&A deal, so that doesn't change. Unfortunately, Lawyers always get laid off. That's one lesson for your listeners, right? Product support. You don't need product support people anymore. So those folks, acquirers trying to get the target to terminate them beforehand so that they don't have to deal with them. But it's a little bit of a dance. If you're talking about distributed teams, it could be hard to fire people in jurisdictions outside the US. You may have to give them notices. So there's all sorts of constraints that folks now have to deal with on the employee end. All of that rolls up into sort of this question of liability. You ideally want as quick of a process as possible. You want these people on board yesterday. That's the whole urgency of all of this is you want these folks on yesterday. But now when you have to do all of the due diligence and you have to figure out the wind-down plans, all of that just is adding friction to the system of doing these deals. Because now you have to negotiate this stuff.

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You can't just buy this in a stock and just kill the company. There's like still obligations. Essentially, you are going to do some cutting and end up with basically a zombie business.

Yeah, yeah.

To let it die on the vine.

Aqua Hire scenarios. That were done as asset deals, there were significant stub businesses that were left behind. And it did become an interesting question as to whether those businesses minus the superstars that led them could still be valuable in some way. My heart goes out to the employees in some of those businesses. Like, imagine that you're a tech engineer You accept a job offer for a hot new AI startup. You join, you're excited. I don't know, you move your family out to the Bay Area and then you get the news the next day, hey, the company's being acquired. But oh, by the way, you're not among the select that got acquired. You're going to stay behind in this business that has lost its leadership. It's a tough situation, no doubt about it.

Yeah. Talent war we're in.

Yeah.

So are there any drivers between those models that we talked about in terms of which one you choose, or is it just current trend is really doing stock purchases now? I think it's maybe the size of deal, I guess, is also the threshold.

Size of deal, availability of NOLs. I would say that we're in a world where every option is on the table right now.

Yeah. I don't think it'd be pretty bespoke because if they've already optimized for a tax structure, then you might be more open to using one of the traditional approaches.

Is a residual business viable? We have one right now where the residual business may actually be viable. We're going to do our best to preserve that value. So it's very much a tailored solution in these situations.

What's due diligence look like on these deals? Because I always think of traditional diligence and you break it down by function and you're going through and IP is a big thing here to get to. But here, if it's just, that's not the big driver of the deal, it's the talent. What does due diligence look like then?

People, people, people.

Background checks. How many background checks can you do?

Yeah, exactly.

You call their school teacher in high school?

Yeah, yeah, yeah. No, not background checks, but it's actually a really fascinating dynamic. Okay, I'll go back to the old world. In the old world, when you were buying a company with a product, you usually just interviewed the key people, like the key 5 or 6 people, and you brought them under the tent before signing. And you kind of said, okay, for the rank-and-file individuals, for the line engineers, we'll deal with those later. Basically between signing and closing, we will interview them. We'll figure out who we want to give offers to. We might take some of them, we may not take some of them,, but we'll figure it out later. That's the old traditional approach. The new approach, because you're paying so much money on the assumption that you're getting the superstar and his team, whatever that team is, maybe 10 people, maybe 20 people, maybe 50 people. But like, because you're paying so much money for this quote unquote team, there is an absolute premium on is this team going to work out? What you're seeing acquirers do is they're trying to front load a lot of these interviews. Into the pre-signing period. And that itself creates a lot of tension because think about it, if you're the target, your one and only value in all of this is your talent. You have an acquirer saying, hey, by the way, can I just meet all of them today? You're thinking like, oh gosh, what happens if they just poach away my 10 best engineers? You've got a non-solicit, but what happens if they do it? There's an incredible tension right now in how do you deal with this question of From the acquirer's perspective, I really need to validate for the $100 million that I'm paying that I am getting 20, 30, whatever the number is, that I'm getting 20 or 30 good quality engineers. I'm not getting any scrubs. I'm getting truly quality people. That's the acquirer's concern. And the seller's concern is, yeah, but my people, those are my crown jewels. How can I let you get access to them before we have a committed deal? You're seeing a lot of negotiation around how to make that work. That would be the single biggest factor. And it's not just background checks, it's sort of like culture fit, it's technical know-how. These acquirers are really thinking of this as if I were to hire this engineer off the street, would this be a good fit for us? And then in terms of the other parts of due diligence, we're seeing a lot more emphasis on the wind-down due diligence that we've been talking about. So instead of just saying, hey, tell us about the customer contracts, now the question is, "Tell us how we can get out of these customer contracts." Employees, "Tell us how we can terminate these folks that we don't want." A lot of the focus ends up not being necessarily about, "Hey, make sure their IP is protected, make sure no one's infringing." That part of it on running a continual business, that part has been deprioritized, and what's being prioritized is just How do we get out of this thing for as little time and money as we can?

You plan around that. We have all these customer contracts, employment contracts, vendor contracts. We want to get out of all these things and, uh, yeah, 100%, you know, basically get out of the business. Why not poach the talent?

Yeah, it's a fascinating question. It is sort of this interesting debate because we live in the great state of California. Which for all its pros and cons, but one of them is that you cannot have employment-based non-competes in California. You cannot tell any of your employees living in the state of California that they cannot pick up and go to work for one of your competitors. Okay. There's theories about the fact—

yeah.

Can't enforce it. I want to hear the theories. What are the theories?

There's a lot of people that say that's actually what makes California great and so receptive to entrepreneurship because you have all this talent that's highly mobile. They could start one company and they could seed another company. It's as M&A practitioners, it makes us pull our hair out, but it could be part of the secret sauce in California. But the point is you can't do it. There is this interesting question. Why doesn't an acquirer just go up to the, whatever the metaphorical LeBron James is of a startup and just say like, hey, just come work for me.

Big sign-on bonus.

Yeah. Big sign-on bonus. I'll give you a nice RSU package. Forget about your equity in your old company, but I'll make it up for you in a new RSU package. It would be hard for an acquirer to do that across a population of 30 or 40 engineers. At some point you start running into sort of like tortious interference claims. At some point you start running into fiduciary duty claims. But if an acquirer were to just walk up to the metaphorical LeBron James, the single individual or two individuals, and just say, hey, come work for me. There really isn't that much that stops them from doing that today. And I do think that when you look at the outcomes on some of those acquihire deals that we've seen, that's one of the constraints that the VCs are grappling with. If you think about in the old world, you are a VC, you bet on a team, you bet on that team building a product, and you put a lot of money behind that product. The security that you get is that product is within the company. The team can't go off and just recreate that product for someone else. You have IP rights in something that was created with all this funding that you given that has real value. That was your defense. But if you're in a world where the product doesn't matter, you're a VC, you put $100, $200 million of Series A into a company or a product, and the product doesn't matter, it's just the people, then your leverage position is altered, at least not zero, but it's altered in terms of your ability to influence, hey, what happens to those people want to go work somewhere else for more pay? And I do think that's going to be a tension because if you kind of break down in any tech deal what the money goes to, I say this representing a lot of tech acquirers, tech acquirers always think about it in terms of, okay, here's how much I'm paying the cap table. Versus here's how much I'm giving in the RSU pool. And the understanding obviously is that what you pay to the cap table goes to the founder, the employees, but importantly the VCs, whereas what goes to the RSU pool, you can direct, you can say you get this much, you get that much. And importantly, none of that goes to the VCs. In a traditional product-led M&A, the Cap table proceeds were always the larger part of the deal. You would have a purchase price that was, I don't know, 100, 200, and then you would have an RSU pool that was a fraction of that, 20 or 30 or 50, because the idea was you were more or less buying the product. What I think the recalibration could be, I've seen a little bit of this, but maybe not enough data points for it to be a trend, but that could get flipped. Acquirers could say, look, I'm going to give a little bit to the cap table. I'm going to give you, the VCs, enough maybe to get your money back, or maybe at least just whatever is the bare minimum to keep you from suing us. That's what I'm going to give you, the VCs. And then everything else will just be part of the RSU package. That is going to be a potential shift in how these deals are priced and done.

I want to dig more into just how you think through retention, because I feel like I may You got key people, you think about retention. Seems like this is the biggest part of it.

Yep.

But can you break down RSUs? We don't use the word options anymore. We call them RSUs. Give me some legal-ese explanation on that.

Options and RSUs are just different instruments. The difference is options have strike prices and RSUs just have immediate value, subject to vesting, of course. Oftentimes, at least in these acquisitions, when you're being bought by a large tech acquirer, the offer packages are usually RSUs as opposed to options, because the idea is you're offering employees immediate money subject to vesting, as opposed to sort of— with options, you have to participate in the upside and in the growth of the company, whereas RSUs is immediate value. So it's easier to articulate to employees like, hey, I'm giving you a million dollars of immediate value, subject to vesting, of course, as opposed to saying, I'm giving you 1,000 options that if my stock price were to grow would be worth money, but if my stock price didn't grow would not be worth any money at all.

Is there a difference in like tax implications?

No, they're both ordinary income. Okay. Yeah, that, that part's mostly the same.

Are you liable as soon as you get the RSUs issued?

No, it's on, on vesting.

Okay.

Yeah. Going back to your question on revesting for a second, I do want to hone in on that because it's super interesting. Remember we talked about cap table proceeds versus RSU pools? It turns out that acquirers did actually have a retention trick, even for the cap table proceeds. What that hook was, was called revesting. So the basic idea was this, okay, I'm going to pay $100 to the cap table, but you, the founder, instead of getting your portion of that $100 at closing, you are going to get it subject to revesting after 2 years, 3 years, 4 years, whatever the timeframe is. You don't get it all immediately. You get it subject to closing. Subject to staying along. And the basic idea there was you don't want a situation where the founder gets such a large payout on day one that there's just no incentive to work for the business afterwards. You can imagine people locally say that, what's the amount of money it takes for someone to just go to the beach and retire, right? You're constantly trying to calibrate around that. Now there's always a tension because you also couldn't At least historically, you couldn't reinvest 100%, or it wasn't market to reinvest 100% of what a founder made in a deal because he's probably spent years and years building a product, lots of years of not eating dinner with the family and so sitting on ramen, whatever it is. You have to give him some amount of money to reward him for the product and the business that he's built. And then you hold back some portion of it to reflect retention desires. Historically, what we saw in the market was maybe 20% of the founder's proceeds get re-vested, maybe 30, maybe 40, but kind of somewhere in the sub-50% range gets re-vested because the thesis was, here's the amount for the product you've built, and here's the amount to incentivize you to stay to help us continue building that product.

Is it the same product though? Is it still RSUs? Uh, no.

So the cool thing about re-vesting at least in under US tax law, is the re-vested proceeds can be treated as capital gains. So unlike RSUs and options, which are ordinary income, those re-vested proceeds have more favorable tax treatment, which was another reason why acquirers like them so much. But here's where that's changing now. Again, that you don't have a product that you're rewarding necessarily. I'm starting to see acquirers say, hey, Instead of revesting 20 to 50%, we just revest all of it. And on the one hand, you're like, wow, that's a lot. But on the other hand, the fundamental logic is we're not paying you for what you've already built. We're paying you for purely for what you're going to do with us on that basis. Yes, we need to pay your VCs out some amount of money to make them go away, but you, the founder, all of your proceeds should get revested because This is all about the future. It's not about the past, it's all about the future. And that's a really hard conversation to have with a founder.

What's the difference between revesting and rollover equity or earnout structure?

Let's go through some terminology. Revesting was what I just talked about, which is you take a portion of the purchase price and for a specific individual, and you say, you will get this on an installment basis if you stay with me for a number of years. Earnouts are typically used when you want to reward the company as a whole for hitting performance metrics after the closing. So common earnouts might be revenue-based earnouts or product milestone-based rollouts. But the idea is, hey, if after I buy the company, I end up selling more of the product than I thought I would, or that you thought I would, I'll share some of that upside with you through an earnout. And then the final one you said was rolling over equity. Rolling over equity was just another mechanism for retention. So usually there's some amount of unvested equity in any target company because the targets themselves were issuing equity. So what was very common to do is instead of paying all that out at closing, the acquirers would basically take that equity and say, well, just convert your old unvested equity into unvested equity of our stock. And that way we'll get to preserve some of the retention benefits of that. So that was just together with the RSU pool I talked about together with revesting rollover equity is just a third mechanism that acquirers traditionally use to get at the solution of how do we keep these people who are making large amounts of money, how do we keep them in their seats?

You're moving existing equity over. Revesting is creating something new here.

Yep.

And then That is based on just continued employment. So there's essentially based on employment at will that if you walk away from this, you're walking away from your revesting schedule.

100%. And people in these transactions, there's so much money at stake that people have pretty extensive fights about what happens if you fire me, what happens if you fire me for cause, what happens if you fire me without cause, good reason, no good reason. There's pretty substantial fights that happen. So much of the money is now at stake as a result of the revest and the RSU pool and the equity rollover components all added up together.

A lot of lawyers negotiating some— now employment agreements are getting serious.

Well, that's the, that's the thing. I joked with my team, we're all trained as corporate M&A lawyers, but we all have to become benefits lawyers in a sense, because as these transactions move from being a corporate transaction to an employment transaction, it's incumbent on all M&A lawyers to get literate with What's the definition of cause? What's market for that? It's going to have to become part of our repertoire.

What are the big things you end up negotiating on these type of agreements?

Let's take revesting as an example. The big things that typically get negotiated at the client's end would be things like how much and for how long. Those are the level of—

Yeah.

What's common? What's market?

I feel like I'm going to say something and I feel like someone's going to quote this against me in a deal.

Or something's going to change in a couple months.

Yeah, exactly.

The market, quote unquote, for product-based deals— I want to be very specific there— the market for product-based deals typically was about a 20 to 50% revest for somewhere between 2 to 4 years. That's what we guided our clients to as being within kind of the 25th to 75th percentile. Obviously there's extremes in both directions, but that's kind of the bell curve in terms of what was market for product deals. For these acquihire deals, like I said, it's too early to tell what the market is. I'm starting to see people asking for much, at least much more, not much longer. The revest, people still tend to think of 4 years as being like the outer realm of what, how long you can revest someone. But yeah, people are definitely having conversations around, could we go over 50% in these revests? As far as how the lawyers have fun, we negotiate things like acceleration provisions and cause and good reason. And tax treatment. Those are the things that really get scrutinized pretty heavily now.

You don't have to give me a name, but what's the biggest deal you've seen for a talent?

The biggest one out in the ecosystem right now is probably still the Meta-Scale deal. Like that's $18 billion one. That's probably the single biggest one in terms of a primarily talent-driven deal. I was not fortunate enough to work on that, but—

How big do you think that key team was?

I don't know off the top of my head.

Yeah.

Certainly the ones that we've been doing, $300-400 million, there's people paying real money for these talent transactions.

Yeah.

I want to go interview one of them. If anybody knows one of these LeBron James AI engineers that got a, that big of a godfather deal, I would love to interview them to get their take on how they price them. So maybe there's something to learn.

And if anyone knows LeBron James, I too would like to meet LeBron James too.

If they know LeBron James, we'll get him on the podcast and then we'll contrast the two, how you negotiated your contract, you know.

That's, that's exactly right.

I want to kind of take a lot of things we talked about, and what I want to do is get a good sense of the timeline and how this flows. Yeah, I know your lawyer. I know you have a bunch of NDAs you've probably signed and client privilege. Let's just make up something. Let's make up I'm running a tech company and I know pressure's on to AI build, be competitive, and I've identified a company where I just know they have these— I don't know if people use the word rockstar ninja. I don't know what the current buzzword for LeBron James level engineer. And I want to pursue this deal. I'm going to check with my lawyer first because sometimes I rush to put an NDA on the table, then my lawyer gets mad and they're like, why didn't you run this by me before you sent this out?

Yeah.

So I want to prevent that. So I'm asking you, what should be my step? Like, how do I go approach them? I want to get a sense of one, at what point do I get an NDA? What point should I be trying to just hire them directly versus look at this as more of an acquihire deal? Can you walk me through just some guidance? This is not to be taken as legal advice, but yeah.

Where I've seen a lot of these things start, particularly because of the people aspect of this, is that a lot of this ends up starting with personal relationships. And that's frankly a little bit different than normal corp dev. Normal product-led corp dev is You're a big serial acquirer and you're like, okay, here is the feature that we're trying to buy. Here are the 5 companies in this space that have that feature, and let's go down the list and let's see which ones work well for us. And for those, let's go make an outreach and talk to them and try to get to a price. That's the traditional path. Here, what's so different is because they're such talent-driven deals, it ends up being like, hey, of this pool of the LeBron James, who does your CEO know and feel comfortable with? Because you're inherently buying that person. It's not the corp dev led, here's the Gantt chart of like the 5 different names. It's like, hey, my CTO knows this person. We think he's going to be really good. We think we want him By the way, usually a him, unfortunately. But we want this guy to be the guy that leads our AI efforts. The outreach is very different because it's much more almost like MBA land. It's much more about cultivating that personal relationship.

So I don't have to be reserved. I can go and say, go talk to that talent.

Yeah, you can go talk to that talent because so far you don't need an NDA. But like I said, it's not usually in a context of the first time you meet them and just saying, Hi, I'm Joe and I'm Bob and I'd like to hire you to run our AI efforts. It's usually like these are people that are already in your ecosystem that you've known from somewhere, and the conversation really builds as a relationship as opposed to as part of a banker-driven exercise.

But get the conversation going, invite them to our office, talk about a roadmap, they get excited about it, and then we start seeing, hey, there's some interest here. I'm not sure if I'm supposed to hire you directly or if I gotta look up in this company and when do we sign an NDA? And they call you.

That's such a fascinating dance right now because to everything that we've talked about before, if you were just interested in LeBron himself, you might not do an NDA. You might just say like, hey, rather than keep going at your current thing, how about I just make you an offer? That puts an individual in a very tough position because he'd be basically screwing over his VC, screwing over his team. You could conceivably see that happening, right?

Sign-on bonus.

Yeah. Here, let me just give you a 9-figure sign-on bonus. I don't need your team. I just need you. Come over. More often than not, they will probably do an NDA. The NDA will probably have a non-solicit in it. At this point, you'd have to almost have to. Basically, once you've signed the non-solicit, at that point, the acquirer has to route the process through the company. They have to negotiate with the board. They have to negotiate with the founder.

There's a non-solicit, then that wouldn't— like, with any of them in California, that would still be enforceable.

Yeah. A business-to-business non-solicit in the context of a sale of company transaction, that is enforceable.

Okay. So the non-compete won't hold, especially in California.

The personal ones.

Yeah.

But I guess in generally speaking, even though this wasn't in California, you'd probably still would lean more on this non-solicit as opposed to—

if you're a target company and the value of your company is in the people for the moment, the non-solicit is almost mandatory at this point.

Well, good to know. I'm going to make sure all my—

make sure that all your employees are protected.

Big time.

Kison Patel, it's a really big point that you're making. Non-competes, non-solicits that you enter into in your personal capacity, like as an employee, as an individual, those are harder in California. The business-to-business stuff is easier. Okay.

So then once you get an NDA, then it's like, oh, okay, non-solicit.

So now I have to follow now you have to go through the traditional path of negotiating with the founder. And you're probably going to want to do that anyways. You don't want the reputation in the market as being someone that's just willy-nilly going around and poaching people. But yeah, at that point you're going through the process of signing the NDA, talking to the company, figuring out who their key engineers are, and then using that to validate what it would take to buy the team.

Then you're almost like a typical M&A timeline. You're going to go ideally do enough diligence, you can put an LOI on the table. And then actually on those acquihires, what does that timeline look like going from LOI to close?

We're getting a lot of pressure from our clients, to be really honest, because it's got to be a lot faster than—

because you don't have to do all the same commercial diligence.

You would think. And this is kind of the conversation we have with our clients. And keep in mind, clients always want to move faster than their lawyers. The line from our clients is What's taking so long? All we want are the people. Just go get us the people. That's literally the conversation. We have to explain to them, you're buying the entity. We still have to look at the entity. Still have to look at all this wind-down stuff that we were talking about. And then more importantly, clients' HR teams, they need time too. It's a non-trivial task to bring over 20 LeBron Jameses into an organization. You have to level them properly. You have to compensate them properly. That's an exercise that still takes time. The emphasis definitely shifts away from diligencing IP and all that stuff, but there's still a lot to do in between getting to an LOI versus getting to the team coming over.

And then all that, you still end up with a contract. I'm wondering if the purchase agreement looks different in terms of having the big emphasis on the talent and—

That kind of just depends on whether it ends up being a stock deal or an asset deal. Certainly if it's an asset deal, it looks a lot lighter. If it's a stock deal, because we're still inheriting all the liabilities, we haven't really seen a shift away from, unfortunately, the 80 to 100 page acquisition agreement that everyone in Silicon Valley is used to signing nowadays.

You still end up with that. Is there anything that helps you in terms of when you think about this deal, it's a collaboration, you have different functional leads doing diligence, they're looking for some of the risk, they're figuring out how they're going to integrate the business, integrate these people, level set their titles. What are the key things that helps you when you're going through that? You know, like some of that input, what are some of those key things that would help tie that deal together nicely versus you're sort of doing this in a silo, you know, making more of like a little bit of a pull effort for you doing the deal versus you pushing like, all right.

What we've seen is that there's such a great amount of pressure on our clients' HR teams. In a way that we end up having to help with them to a certain extent. If you kind of think about it, in the old product-driven world, if you kind of just bought the product, you could more or less just keep everyone at their same salaries because they're going to basically come over and they're going to do pretty much what they were doing the day before they came over. They're still going to be working on the same product. They're still going to be servicing the same customers. So there was less of a pressure, not zero, because it was always complicated, but it was like less of a pressure to get it exactly right. Now, because the people are the assets and you are doing the equivalent of hiring an entire NBA team all at once, there's such a stress on getting everyone's leveling correctly, getting everyone's base and bonus and RSU package correctly, because if you hire over 30 people for a couple hundred million dollars and 5 of them leave because they're unhappy, that's a really bad day. We're seeing tremendous pressure being put on our clients' HR teams. And we as a law firm, we do what we can to help. And there's comp consultants out there that do what they can, but that's really become where the game is.

We're in a whole new market.

Yeah, 100%.

Product is a commodity. Talent is a new IP.

Exactly.

All right, Derek, I got to ask, what's the craziest thing you've seen in M&A?

This goes back to when I first joined Baker, and I joined in 2020, sort of like around the pandemic. And we were bidding on a company in bankruptcy. The way that asset sales work in bankruptcy is it's a live auction. The court puts out a set of documents, everyone bids on that, marks it up, that document, and then has a price. And then it's a live auction now. And it used to happen in these bankruptcy proceedings pre-pandemic and post-pandemic, it's a live process. But in this particular case, because it was pandemic, it was over Zoom. So we're representing a Japanese company and our clients are in a conference room on Zoom. Everyone's in their suits. And the other bidder, our competing bidder, was a German company. And we go, we show up to the bankruptcy auction. Our clients are in suits, like serious, ready to bid. The other side gets on camera, their business team, and they're in a hot tub. The entire bidder management team is seated around a hot tub on camera. It was a total intimidation tactic and it worked because they came in. Like I said, it's an auction. We put in our price. They came in and they just blew it out of the water in terms of their next bid.

Wow.

And it was like one of those blow-your-mind kind of things, but it was a complete signal. We are so confident we're going to win this thing that we're going to do this in a hot tub.

A bid from the hot tub.

Yeah, absolutely. Next time you want to intimidate someone on a Zoom call, keep that in mind.

Hot tub. What would beat a hot tub? Hot tub's up there.

Yeah.

That's a— yeah, I like that. Derek, thanks you so much for taking the time. Yeah, Kison, really appreciate it. Helping me become a better M&A scientist today. Learned a lot about acquihires. Those of you still listening, my fellow M&A scientists, brothers and sisters out there, love to hear your feedback. I know I try to get different topic coverages. Let me know what you think about this podcast. You can reach me on LinkedIn. Just make sure you mention this podcast. I get so much spam on there, but find me on LinkedIn, connect with me, give me feedback about this podcast. If there's topics I haven't hit on, criticism, I'll take it so I get better at doing this. Till next time. Here's to the deal.

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