Notes on the acquisition process

Ten years ago, startup financing was an insider’s game. Since then, the topic has been widely discussed on blogs, to the great benefit of entrepreneurs. Comparatively little, however, has been written about the important transaction at the other end many startups’ life, acquisitions. Here are some things I’ve learned about the acquisition process over the years.

- There is an old saying that startups are bought not sold. Clearly it is better to be in high demand and have inbound interest. But for product and tech acquisitions especially, it is often about getting the attention of the right people at the acquirer. Sometimes the right person is corp dev, other times product or business unit leads, and other times C-level management.

- Don’t use a banker unless your company is late stage and you are selling based on a multiple of profits or revenues. I’ve seen many acquisitions bungled by bankers who were either too aggressive on terms or upset the relationship between the startup and acquirer.

- Research the potential acquirer before the first meeting. Try to understand management’s priorities, especially as they relate to your company.  Talk to people who work in the same sector. Talk to industry analysts, investors, etc. If an acquirer is public, Wall Street analyst reports can be helpful.

- Develop relationships with key people – corp dev, management, product and business unit leads. The earlier the better.

- Don’t try to be cute. Leaking rumors to the press, creating a false sense of competition, etc. is generally a bad idea. Besides being ethically questionable, it can create ill will.

- What you tell employees is particularly tricky. Being open with employees can lead to press leaks and can annoy acquirers. Moreover, some public companies insist that you don’t talk to employees until the deal is closed or almost closed. Employees usually get a sense that something is going on and this can put you in the awkward situation of being forced to lie to them. I don’t know of a good solution to this problem.

- Understand the process and what each milestone along the way means. As with financings, acquisitions take a long time and involve lots of meetings and difficult decisions. Inexperienced entrepreneurs tend to get overly excited about a few good meetings.

- Strike while the iron is hot. Just as with financings, you need to be opportunistic. Waiting 6 months to hit another milestone might improve your fundamentals, but the acquirer’s interest might wane.

- There are two schools of thought on price negotiation: anchor early or wait until you’ve gotten strong interest. Obviously having multiple interested parties makes finding a fair price a lot easier.

- Deal structure: the cap table is an agreement between you and the shareholders that says, in effect: “If we sell the company, this is how we pay out founders, employees, and investors.” Acquirers have gotten increasingly aggressive about rewriting cap tables to 1) hold back key employee payouts for retention purposes, and 2) give a greater share of proceeds to employees/founders.  Some even go so far as to try to cut side deals with key employees to entice them to abandon the other employees and investors. In terms of ethics and reputations, it is important to be fair to all parties involved: the acquirer, founders, employees, and investors.

- Research the reputation of the acquirer, especially how they have behave between LOI and closing (good people to talk to: investors, other acquired startups, startup lawfirms). This is when acquirers have all the leverage and can mistreat you. Some acquirers treat LOIs the way VCs treat term sheets, as a contract they’ll honor unless they discover egregious issues like material misrepresentations. Others treat them as an opportunity to get free market intelligence.

- Certain terms beyond price can be deal killers. The most prominent one lately is “IP indemnification.” This is a complicated issue, but in short, as a response to patent trolls going after IP escrows, acquirers have been trying to get clawbacks from investors in case of IP claims. This term is a non-starter to institutional investors (and most individual investors). You need to understand all the potential deal-killer terms and hire an experienced startup law firm to help you.

- Ignore the cynical blog chatter about “acqui-hires” (or, as they used to be called, “talent acquisitions”). Only people who have been through the process understand that sometimes these outcomes are good for everyone involved (including users when the alternative is shutting down).

Finally, acquisitions should be thought of as partnerships that will last long after the deal closes. Besides the commitments you make as part of the deal, your professional reputation will be closely tied to the fate of the acquisition. This is one more reason why you should only raise money if you are prepared for a long-term commitment.

 

53 thoughts on “Notes on the acquisition process

  1. SteveSampson11 says:

    I would add the dreaded “earn-out” clause where the acquirer imposes a set of performances with a retention on the sale price. The bigger the deal, the stricter the impositions. Keep the time period as short as possible. They will integrate your business, change the philosophy as well as the chain of command – unsettling your staff at best, making them take the disloyal oath at worst. Firing them if they’re back of house and surplus to the new requirements. I sold a business to a much bigger media player with a six month turnover clause. Easy peasy. I have seen some where you are locked in for three years. Unless you have a fabulous relationship with the acquirer you will end up hating them and walking.
    Would make an interesting piece to see how many acquired entrepreneurs stayed for any length of time. A small percentage I wager.
    Last thought on tax. If you have sold once before, you have already been burned. So-called advisors are generally rotten and are adding up the fee in their heads while promising the earth. Best advice – ask another entrepreneur who has sold and follow his/her advice… which will be free and writ in blood.
    Oh. One last personal thought. Make NO change in your lifestyle for one full year after selling. Buy a car, some decent wine. No personal capex. Take stock slowly. In truth you will be away from them and looking for the nex challenge sooner than you know. It’s why you built it in the first place. Keep believing.

  2. Earn outs: definitely agree. Thankfully, entrepreneurs seem to have gotten wise to earn-outs and they seem less popular. But agree they are an invitation for lawsuits and acrimony.

    Tax: you mean tax advisors or money managers? I’ve found good tax advisors. Much rarer to find help on money managers.

    Your advice re personal spending is dead on.

  3. Samuel Hulick says:

    I imagine there must be some problem spaces to work in that are more likely to result in multiple interested acquirers than others – if so, which are the top ones you see for the next three years?

  4. a spike in acqui-hires is another sign of a bubble, as the money supply is expanded, and flows from banks to funds to public companies to private companies. when this is the flow that leads to acqui-hires, the by-product is a concentration of wealth borne out of politicization of money. folks can ignore it, and entrepreneurs who are fortunate to get a piece of the trickle down fairly high up the food chain should probably take it, but the inevitable consequence of collective ignorance will be collective suffering.

  5. Well, I should say I would never recommend starting a company (or investing in a company) with the strategy of trying to get acquired. Which also means don’t choose a space that way. But generally the places where acquisitions are most likely are 1) spaces going through lots of changes, 2) spaces where big players control distribution and therefore new products can have multiplicative value to them (e.g. security, enterprise infrastructure).

  6. I think a spike in acqui-hirers is reflection of the spike in seed funding 1-2 years ago, along with the corresponding fragmentation of talent. But I know you will disagree :)

  7. i don’t entirely disagree. but where did the spike in seed funding come from? and more importantly, where did the money to buy the acqui-hires come from? google, amazon, facebook, twitter, and zynga made a whole bunch of those acqui-hires, many of which were paid in shares. how did those share prices get high enough to afford acqui-hires? P/E ratio has risen noticeably since 2008, suggesting it is not coming from earnings (rather the expectation of future earnings, or speculation).

    http://www.multpl.com/shiller-pe/

  8. Solid post. Here are few more suggestions: (i) remember that your strongest leverage as a seller is prior to the execution of the LOI; (ii) accordingly, negotiate all the material terms as part of the LOI – it’s in the buyer’s interest to keep the LOI short and general (and to make the exclusivity period as long as possible); (iii) the highest bidder is not necessarily the best choice — particularly if you’ll be working for them (as noted above, due your diligence and weigh the different terms); (iv) cap your liability at 10% of the purchase price (or make the escrow the buyer’s exclusive remedy); and (v) watch-out for earn-outs – the devil is in the detail.

  9. A lot of those companies are profitable. And at least in the companies I was an investor in almost all of those companies used cash. But certainly the money supply affects the broader economy and therefore profitability of those companies etc.

  10. Re: what you tell employees, I’ve always been a fan of the idea that the people who are involved with this process are insulating the rest of the organization from distraction.

    You can answer a direct question with something as simple as “i’ve met with them a few times, but nothing big to update the team on yet. It’s my job to take meetings like this because while they might turn out to be valuable, they are usually just huge distractions and time sucks. So part of my value is shielding the rest of the org from wild goose chases.”

  11. Foundersuite says:

    Chris this is a killer list and some pretty original observations / tips. A couple I’d add or elaborate on:

    +Focus on selling to / winning the heart of / getting buy-in from the product guy who has the authority to push the deal through; if you can do this, the Corp Dev guys mostly become just deal processors.

    +You need leverage– ideally in the form of multiple suitors, but at a minimum by holding a key asset, market foothold, or IP that the acquirer needs– if you want to get any real price premium or “strategic value” premium above a baseline revenue multiple (boring) or price-per-engineer multiple.

    +If you have any sort of earn-out consideration or other contingent “payday,” then spend as much time negotiating what levers you’ll have post-deal (i.e., marketing budget, hiring control, etc.) as you do negotiating the price and terms.

    +On a related note, spend a healthy amount of time on the post-acquisition integration plan, as many / most deals fall apart within 6 months or so, often due to 1000 little instances of misaligned expectations or simply “not being on the same page.”

    Agreed that startup M&A is still very opaque– it’s the reason I started StartupExits.com 18 mos ago and compiled all the interviews (with M&A guys from Google, Facebook, Twitter, Google, LinkedIn, Salesforce, eBay, Yahoo, Adobe, Evernote, etc) into video.startupexits.com. You want to do one this fall in SF? :)

  12. Great post. The other note I’d add is the strongest leverage you have in any negotiation is simply the ability to say ‘no’ and walk away. If you have an impending financing in your back pocket or your operating performance is heading up and to the right you are in good position to responsibly negotiate hard to drive incremental value in the deal. If you don’t have it in you to say ‘no’ you shouldn’t be the one driving the deal negotiation.

  13. I’m curious about your experience with business unit leads as the buyer whose attention one gets — save for the largest technology companies (ebay?) acquisitions can be in response to their failures to deliver; they can be opponents of the deal.

    I think getting buy-in from CFOs of the acquiring companies is also paramount. They will (sometimes appropriately) take a devil’s advocate role they can act as gremlins in the transition from LOI to final terms.

  14. great additions to the list. Your point about ‘post-acquisition integration plan’ would probably be indicative of the seriousness of the acquired and acquirer to keep the service going – I would hope that this would be honored post acquisition.

  15. agree…and because of course I can’t resist an opportunity to self-promote…even though Chris doesn’t have a search feature installed on his blog, this entire conversation is searchable via gawk.it ( example -> http://gawk.it/rc )

    :-)

  16. TedHoward says:

    How about when you’re a product manager who isn’t even supposed to know that a large public company is about to acquire your employer. Your CxO’s suddenly start making ridiculous demands for product changes that only make sense in the context of the acquisition/acquirer. You get to convince your team to make those changes happen. Do you possibly violate SEC rules, refuse your CxO’s requests, or make up a lame reason (aka lie)? I choose lie. :)

  17. TedHoward says:

    I’ve love to learn the non-cynical explanation for acqui-hires. If I’m Google, why would I buy a bankrupt startup when I could just hire its employees?

  18. Great notes Chris, i would not agree more, despite the fact that i have limited experience, i had the opportunity to be contacted by the search giant just 2 months after we launched, back in 2006, the reason? timing was great and managed to get the attention of the right people as you said.

  19. Just to add to this from an acquirer’s perspective: be as transparent as possible early on without giving away the farm: discovering things late in DD, after a term sheet has been signed can cost you (the target) credibility and lots of $ in lawyer’s fees!

  20. Teams aren’t commodities. Sometimes it is better to get a team with good working relationships and specific skills than hire individuals. Same logic that applies to buying an assembled product vs its parts.

  21. TedHoward says:

    Acquirer walks in, says “You’re screwed. Tell your investors that you’re dead and they’ll never see any money back. Tell your team we want you all. We’ll give everyone an extra $20k bonus and you get a $100k, but only as a group-recruitment bonus if 80% stay at least 90 days.”
    If a company is worthless, I don’t see any (non-cynical) reason why an acquirer would allow any amount of money to flow to the investors who funded the now-failure.

  22. You can cut side deals when you are buying a house to cut out the broker etc. But if you are a repeat buyer you won’t stay in business long if no one trusts you. I also think you are dramatically overestimating what investors get back on these deals.

  23. TedHoward says:

    I would count both of those among my cynical arguments:
    Google knows that it’s in its interests, and (very cynically) particularly in its exec’s and board members’ interests, to make sure that major VC’s know that they are the VC’s “friends” (almost mafia-style). They could just go to the startups’ investors and say “Hey. Your startup is screwed so you get nothing. That’s fair because … your startup is screwed.” but instead they say “Hey. Here’s a little something back even though your startup is screwed.”
    Since the original theme of the post is transparency, of a sort, one thing that’s not at all transparent is the relationship between LP and VC. I would imagine that some important key metrics when raising a new fund would be % of deals that are totally wiped out and % of deals that return at least the invested amount. As long as the investor has preferred stock, they should get > $0 and at least 1x back when their startup is acqui-hired. So there’s a very strong motivation to get something back and the acquirer (and it’s execs and board members) know that.

    As I said, cynical arguments. However, I do actually want to understand why Google will buy a company solely for its employees in a structure which rewards the company’s investors despite the fact that the company failed (or never even did anything).

  24. Stephen Balaban says:

    Great post and advice. Having been through one myself, I whole-heartedly with your perspective on acqui-hires—and with ignoring noisy information channels in general.

  25. magdalenaday says:

    I really liked your perspective. Though I was never involved in that process I´ve worked with entrepreneurs who were desperate about the “selling”, more than the “building” something. And that´s probably I never felt they were looking for a long-term commitment. Great post.

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