A friend’s startup was recently approached by an interested buyer, which spurred me to write up some thoughts on M&A in hopes that they could be useful to other entrepreneurs. For those that do not know my background, I have both sold a startup and managed multiple tech deals as an investment banker at Broadview (now Jefferies). Here is my take, for what that is worth, on some basic questions people might have:
How do I get the price up?
What do I tell my team?
What is the process like?
The buyer is asking for a lot of sensitive information up front, what do I do?
The buyer has asked me to sign a no-shop agreement, what do I do?
What advisors do I need?
Any tips for negotiation?
Who are my likely buyers?
You want to be bought, not sold. With privately-held startups, price is really determined by supply and demand. Valuation comparables from public companies and similar M&A deals will help set a range but to drive a good price, you either need competition among buyers *or* a desperate buyer with nowhere else to go.
If you get approached and are seriously considering selling the business, get other suitors into the race. This has to be done with subtlety. Highly connected friends, advisors, and investors can help you. They can whisper to a potential buyer that you might be getting purchased and spur a new entrant without you waving a “for sale” flag around. You do not want competitors to use acquisition rumors against you.
Every business owner has their own level of transparency with management and employees. Most likely you will need senior management on board for the due diligence process. You certainly want to make sure that interested buyers are hearing consistent messaging and data points across your whole team. The most critical thing is to prevent the deal process from distracting the operations of the business.
Like raising money, a sale will be very time consuming and emotionally draining for you, the CEO. It is essential to keep the rest of the team focused on execution! Remember: most deals never get to the finish line, so do not let this process derail your company or lead to missed targets.
Intense and stressful — expect it. As CEO, you have to carefully manage the process, each suitor, your investors, your team, and sometimes even personal relationships. You are going to need to doing a fair amount of internal selling and coaching to get people on the same page as much as possible, keep the process running smoothly, etc.
Deals always take longer than you expect, even when you are a young company without any skeletons in the closet. Misunderstandings between buyer and seller will happen.
Don’t be surprised if the buyer suddenly slows down because someone went on vacation or a fire drill has distracted their team. Know that behind the unified front they show you, there are legal, finance, and strategy people arguing over deal terms, and sometimes this can cause what appears to be sketchy, shifty behavior.
Try to keep the lines of communication healthy and flowing both ways. Side tip: create and distribute a list of all parties involved in the transaction from both sides, and include areas of expertise and contact information including email and cell phone.
Remember that many approaches are just companies sniffing around. Do not disclose everything up front. Instead, be an onion and open yourself up as trust builds and a deal structure solidifies. Yes, you will need to share some key metrics but before you both commit the time to full-on due diligence and expose all your sensitive information, demand a non-binding ballpark on the total consideration they are thinking about (this can be a range) as well as type of consideration (cash/stock).
For example, a buyer might claim they need to look at your source code to understand scalability and quality before making an offer. That isn’t true — they can just work off of the assumption that your code is good. Yes, they will probably try to negotiate you down later based on deeper due diligence, but I think it is easier to fight off downward nickel-and-dime tactics (especially if you have competition for the deal).
As with all things, there is balance here. Be realistic as to what truly is critical, confidential information and try to avoid frustrating the buyer with excessively elusive behavior.
Expect your most aggressive suitor to demand a no-shop agreement, which means that you cannot approach other companies or discuss a potential deal with anyone else. Their motivation is obvious — they want to avoid a bidding war. You, on the other hand, want competition. All of this depends on your position of strength. You want to delay this as long as possible, and if and when you do sign this, try to negotiate an aggressive time limit on the no-shop, as well as a break-up fee if the buyer walks away from the table.
1. The most critical person is a good lawyer who has been through the process before, can push back on opposing counsel, and can help you spot danger zones in terms. (Update: my personal belief is that during heavy negotiation you want to have the lawyers on each side talk to each other, and the business people on each side talk to each other. Be careful crossing the two.)
2. Have a trustworthy person who will let you vent during this process, but don’t use one of your investors for this — that can backfire. But having this outlet can be healthy because, believe me, it is an emotional and stressful process. It is one of those experiences you just cannot understand until you have been a CEO going through it.
3. This is not a must, but there are good reasons to have a buffer between you and the buyer. When I sold my startup Ithority, the buyer had an investment banker and his involvement saved the deal. When I was a banker, I also saved deals on behalf of my clients. The reason is simple, and very human: in deal negotiation, emotions run high, and a motivated third party (re: motivation, see “hard-ass” below) prevents things from overheating past the point of no return. You don’t need a big bank, just an experienced boutique or individual, but make sure they have very, very solid references before you take them on and get experienced advice on how you structure their compensation.
4. Lastly, it is very useful to have someone in your camp who can play the role of “hard ass”. This is usually an investor who can, in theory, block the deal. Their role is to pound their fist on the table demanding better terms and more money. This person does not negotiate directly with the buyer, but rather plays bad cop off-stage so that the CEO can play semi-good cop and keep his/her relationship with the buyer intact.
If you do have a banker, the role of hard ass is also important. Most banker compensation structures reward for a higher price, but pay very little if a deal does not happen. So to the banker, any deal is better than no deal. The hard-ass’s job is to make the bankers as worried about you walking away from the table as the buyer walking away!
I learned the effectiveness of this when running the sale of Tax Partners to Thomson. Tax Partners, our client, had a board member who was an absolute fireball. He pushed us to fight hard. Thomson is a very aggressive negotiator when it comes to deals, and I had a lot of phone calls talking to an angry seller, and talking to an angry buyer (separately). We managed to keep everyone at the table and get a phenomenal deal done. Afterwards, this board member was thrilled and even surprised we did so well, and while there were several factors involved, I knew that his hitting us with a mental stick behind the scenes definitely played a part!
When it comes to negotiations themselves, there are many different tactics employed and the right ones often depend on the type of people sitting across the table from you. I belong to the win-win school of thought:
- take a strong stand, but structure a deal where both parties can be happy;
- make sure your opposite knows that you understand their position even while pushing for your own;
- keep the negotiations from becoming emotional or personal in a negative or belligerent way;
- avoid excessive brinkmanship but use it when absolutely necessary;
- prioritize the points you need versus those you can give; always be aware of what will make you walk away from the table.
Here are some other key thoughts:
1. In general, try to think through every possible downside and figure out how you can protect yourself. Think through which protections are the ones you really want to fight for versus can be used as negotiating chits.
2. Remember that unless something is in the legal documents, all promises from the buyer are subject to change once the deal is done. That includes who has a job and what role, what happens with the product, the resources made available, etc etc. Everything. You might not want to stall or risk negotiations by hammering out every detail, but keep this in mind.
3. The devil will be in the details. The big issues often get hammered out early, but you will soon find yourself arguing over small but essential points. If the buyer has not done many acquisitions, they may suddenly bring up items late in the game, such as employment contract terms, that you never discussed. Try not to get too frustrated, remember that the cause may be inexperience rather than sneakiness, and keep perspective on what is really a deal-breaker versus a workable issue.
4. You want to prevent any part of the deal from being tied to a dependency over which you have little control. For example, product integration requires the buyer’s effort as much as your own, and revenue goals depend upon the buyer’s investments in marketing and sales. Avoid situations where you live up to your end of the bargain, they do not, and you end up absorbing the financial fallout.
5. While everything will take longer than you hope or expect, try to keep things moving along … except when you need to stall for tactical reasons (for example, to let a second suitor catch up). But in general, you want to keep up momentum. Urgency on the part of the buyer usually leads to a higher offer price. Companies are constantly shifting focus and priorities, and if you fail to strike while the iron is hot, you might find that a new interest or emergency is suddenly consuming the energies of the buyer.
For most startups a purchaser will come in the form of partners and future competitors. It is one reason to work on bizdev relationships long before your startup is truly ready for them. If you have good recurring cash flows, that also opens up the world of private equity. Once you have identified a group of potential buyers, ask some critical questions:
- Do they have a strong enough cash or equity position?
- What kind of structure have they used for previous deals?
- If you expect them to use equity for a purchase, how solid is their stock You would hate to see the monetary value of your deal drop several months after the deal is done.
- Last but not least, you want to think about the culture fit: can your organizations truly work together as one company?
If you have any questions, comments, think I’m crazy, whatever, feel free to speak up in the comments section or drop me a line at giff.constable @gmail.
Lastly, I would also point you to a great post by David Cohen called, “You have acquisition interest – now what?”