Startups Acquiring Startups for Equity

Great post and great ideas. Mathematically, it's definitely a pretty perfect solution, but there are other factors that come into play. Most importantly, the reason for the acquisition, and the fact who company B wants/needs to make happy:

The reasons might be a) fire sale, b) talent acquisition, c) product/asset buy, or d) merger (increasing value of the company from a to d).

in a) it will most likely go only to the investors, so scenario 1 in your case. The founders will probably not even transition, as only the assets are bought to be re-used by company B. Founders don't get money or stock, as they haven't built a successful company, yadda yadda (that's what liq prefs are for).

in b) the acquiring company will most likely want to keep the founders happy, not the investors. Like a), it's often not the best performing business, but B wants A's team to work for them. The investors will be made happy, and the founders will either receive stock outright, or get great employment contracts with lots of options. Recently, it seems to have happened more often that investors didn't end up getting lots of the proceeds, but founders were very handsomely rewarded afterwards (on a trust basis). The Milk acquisition by Google seems to have happened like that (according to le bloggers), and there's word about many more instances where the investors got screwed by handshake agreements that turned into a nice payout for the entrepreneur afterwards. This is again not a question of good vs evil, but simply a question of who has control of the deal. This situation is now finding the way into legal docs (I am sure the lawyers can weigh in).

c) is the most obvious case for your solution - company B wants to make everybody happy so the investors agree to a sale, and the founders stay on as employees of the acquiring company. But again, this depends on who the decision power lies with, and who needs to get a sale, fast. Because the company is a much smaller part of the resulting company, control needs to be ceded (depending on the A-investors' power).

in d), the investors of company A will probably want to keep control of their stock. If it is a merger of equals, this control would have to be granted, because they would otherwise not agree to a sale.

On top of that, there are other things to consider:

- How is the acquisition paid for? You assume new stock, but it might be part cash, part options from an existing pool, part share transfers from other shareholders... - What are the pay out horizons for individual investors and shareholders (especially if angels or a complicated structure is involved)

Fascinating topic.