Financial details in transactions between private companies rarely see the public light. Yet a recently settled legal complaint between two education technology startups offers a glimpse at the numbers and terms involved in the negotiation process—and what happens when a deal goes awry.
In March, San Francisco-based BrightBytes filed suit against Hapara, claiming the latter had breached contract terms in a Letter of Intent as BrightBytes planned to purchase all of Hapara’s assets. In the suit, BrightBytes claimed Hapara broke “no-shop” and confidentiality clauses to solicit a better offer from another company.
The suit has been settled, and both companies are now charting independent paths. But the story is a window into the complex—and increasingly frequent—role that mergers and acquisitions play in the edtech industry.
Hapara offers a set of tools that allow educators to manage digital assignments and resources shared via Google’s G Suite for Education and Microsoft Office 365. BrightBytes provides a data analytics platform that aims to show educators how technology spending is linked to student outcomes.
Both companies are backed by venture capital: Hapara last raised $3.2 million in 2013, and BrightBytes’ total fundraise has been $51 million—the latest coming in a $33 million Series C round in 2015. The two also share a common investor in Rethink Education, a venture firm based outside New York City.
On Feb. 14, the CEOs of both companies—Traci Burgess from BrightBytes and Jan Zawadzki of Hapara—signed a Letter of Intent to begin the formal acquisition process. At this stage the financial terms are not binding, but rather used as a starting point for negotiations. According to this letter, BrightBytes offered to pay $5.1 million in the form of 1.66 million shares of BrightBytes’ common stock. (This calculation is based on BrightBytes’ claim that it has a valuation of $170 million.) BrightBytes would also pay another $2.3 million for “Assumed Liabilities,” the legalese term for taking ownership of whatever outstanding liabilities and obligations that Hapara had. In total, this deal would be worth $7.4 million.
According to this letter, BrightBytes offered to keep Zawadzki onboard but did not guarantee employment for the rest of Hapara’s staff. It would also make additional cash payments contingent on Hapara’s revenue performance during the 15 months after the acquisition was complete.
By signing the Letter of Intent, both companies pledged to keep the terms of the deal confidential; Hapara also said it would not solicit or entertain other offers. This “no-shop” clause is a standard term in merger and acquisition negotiations—and also a central piece of BrightByte’s complaint.
Adding a twist to the story is $500,000 that BrightBytes loaned to Hapara to keep its operations running as the two worked to finalize the terms of the deal. On Feb. 24, both parties signed a promissory note that outlined how Hapara would pay this money back.
In March, however, BrightBytes alleged Hapara became unresponsive during the due diligence process. Then on March 21, BrightBytes’ Burgess received a note from Zawadzki saying that he had received an “unsolicited offer” from PowerSchool: $17 million, all in cash. With a better offer in hand, BrightBytes contended that Zawadzki attempted to re-negotiate the financial terms of the deal and demand that the company pay all in cash, rather than in stock as originally agreed.
On March 30, BrightBytes sued Hapara to return the $500,000 loan, in addition to fees for costs incurred during the due diligence and legal process. BrightBytes accused Hapara of leaking the details of their acquisition terms to solicit other offers—thus violating the “no shop” clause.
BrightBytes and Hapara settled out of court, filing a motion on May 8 to dismiss the suit. Terms were not disclosed. BrightBytes, PowerSchool and Rethink Education all declined to comment on the story. It is plausible that PowerSchool’s all-cash offer—if real—was attractive enough to offset whatever restitution Hapara may have agreed to pay BrightBytes.
For now Hapara is operating as an independent business, according to a statement provided by Zawadzki. “Hapara is profitable and has a growing customer base. Any considerations about the future of the company are guided by what would be in the best interest of customers. At one point, considering a combination with BrightBytes might have been in the best interest of customers. Those conversations broke down and for the foreseeable future, Hapara remains independent.”
In Broader Perspective
Hapara, which launched its education product in 2010, is certainly not the only venture-backed company exploring opportunities to extend its financial runway—or even exit. Many education technology startups are entering a moment of reckoning. The mania of exuberance and free-flowing capital that defined the industry earlier this decade has given way to a sobering (if obvious) reality: Regardless of mission, goal or other noble intentions, every business has to make money.
According to EdSurge’s funding data, the tally and value of all venture capital investments for U.S. edtech startups in 2016 dropped by 30 percent and 29 percent, respectively, over the previous year. The number of Series A deals—usually the next round of institutional capital after a seed round—also dropped by 22 percent during this period.
Those making enough revenue to be cashflow positive will separate themselves from the herd. Those that cannot may be in trouble. Today, the bar for raising even seed money requires proving that you are already making some. That’s a far cry from several years ago when an idea and a team were enough to convince investors, who now say revenue plays a much bigger factor in their decisions. Most investors, after all, want to cash out on their investments within seven years.
Without additional capital, struggling companies are left with two choices: Get acquired or close shop. Those with limited revenue that have “tapped the venture capital market as far as they can are looking at a limited set of strategic buyers” looking for assets to complement their existing products and services, says industry analyst Trace Urdan.
Private equity-backed companies seem to be eyeing such opportunities. PowerSchool’s interest in Hapara is unsurprising, given that the company has shelled out more than $900 million on eight acquisitions since June 2015. (One of those deals, Sungard, commanded $850 million.) Another private equity-owned edtech company, Frontline Education, has acquired six companies in the past 18 months.
Financially distressed companies have little negotiating power, and there are signs that the education industry is becoming a buyer’s market. A report from investment bank Berkery Noyes found that while the number of M&A transactions dipped 11 percent in 2016 (from 426 last year to 378 in 2015), the total transaction value plummeted by 70 percent over the same period (from $17.75 billion to $5.32 billion). That rough math suggests the average transaction value per deal has steeply declined.
All startups must grow, and at some point companies have to decide if they’re going to “go big.” Sometimes, teaming up with another organization offers the scale needed to attract more capital. Hapara is likely joined by other small and mid-sized education startups on the shopping block. Where they end up—and what dollars they’ll command—will depend on how well their assets fit within larger companies looking to add pieces to their platforms.
