Welcome to a new BetaKit weekly series designed to help startups and entrepreneurs. Each week, investors Roger Chabra and Katherine Hague tackle the tough questions facing founders today. Have a question you would like answered? Tweet them with the #askaninvestor hashtag, or email them here.
There you are, chugging along, building product, hiring rock stars, flying around to customers. All of sudden, you get a phone call from one of the larger companies in your space who you’ve recently partnered with, saying “hey, we love how our partnership is going. We’ve been thinking a lot over here, and we’d like to talk about something more permanent; in fact, we’d like to buy you.”
Um, what? Really? Now?
From start to finish, an acquisition can take months. Make sure you have at least a few months of runway before entering serious acquisition talks.
As a VC-backed startup, the reality is that your company is always for sale, whether that sale ultimately results in M&A to another company like 90 percent of successful startups, or the sale of stock to the public via an IPO. The question of whether to sell at any one time is around timing, fit, shareholder motivations, and, of course, price. If you are building something important, chances are you will be repeatedly peppered with varying degrees of acquisition interest over your journey.
Note: as always with this column, our focus is going to be on seed and Series A stage startups.
To help answer this week’s question, I spoke to Brent Holliday, founder and CEO at Garibaldi Capital Advisors. Brent is a veteran tech startup guy, known to many of us in the ecosystem. He is uniquely qualified to opine on this topic as he was a VC for over a decade, and is currently a financing and M&A transaction advisor to technology companies across North America. Over the past couple of years, he’s been involved in guiding exits to Twitter, Zillow, and CBS Interactive.
According to Holliday:
“The main thing you need to do is make sure the interest is real and genuine. It’s easy to get caught up in early excitement and hear something that wasn’t really said or meant. As the founder of an early stage startup (meaning seed or Series A), you should be heavily skeptical about any unsolicited inbound acquisition interest.
Companies are bought for three reasons:
- Because you are a competitive threat.
- To fill a gap in a product roadmap.
- Because your team and/or technology are awesome.
With this in mind, if you are still interested in pursuing, you need to get the potential acquirer to an offer number on paper as fast as you can. Be prepared to give them a bit of information in order for them to get to a number. As part of this effort, you will also need to get them to sign an NDA. Your goal should be to test out the interest, find out if it is real, and get to a number you can ruminate on.
If the number you receive back is not meaningful, it’s time to move on. In order to keep relations good and keep your options open in the future, you should let them know clearly that you are heads-down and that you are not interested in an acquisition at this time. If you already have a partnership with said party, offer up ways to increase commitment to the partnership from both sides. If you don’t have a partnership, perhaps suggest exploring one. This way, both parties can crawl before they walk and before they run. If it’s not time for a partnership either, that’s okay; simply thank them for their interest and offer to stay in touch.
If you couldn’t ever fathom working for the inbound company for the next two to three years at the least, the conversation is already over, regardless of price.
Conversely, if the number is meaningful, it’s time to fortify your time and resources towards teasing this out. Although this will be a gigantic consumption of your time, as an early-stage startup with unsolicited interest from just one potential acquirer, you don’t need to engage an outside M&A advisor or banker. This is a different story for later stage startups that are further along and may have interest from multiple acquirers. For now, you’re best served running this process internally with your team, investors, and board.
Let’s dissect Brent’s feedback a bit and expand upon it.
I applaud Brent’s advice because it recognizes the time suck that pursuing M&A interest places on an early-stage company. We’ve talked a lot in this column about the effort and distraction raising a financing round places on an early-stage company. Well, that’s nothing compared to the distraction and time needed to navigate unsolicited inbound acquisition interest from another company. As much as the inbound company may need you, you are not in the driver’s seat from a leverage perspective – if only for the fact that you have fewer resources than they do to dedicate to the acquisition process. Whether the deal ultimately happens or not, the impact on your business will be much greater than the impact on the larger company looking to acquire you.
The first thing you should do, in my opinion, is to form an opinion of the inbound company. You already know this potential acquirer and you likely have strong feelings one way or another about them. If you couldn’t ever fathom working for them for the next two to three years at the least, the conversation is already over, regardless of price. It is perfectly okay to just say to the inbound that you are heads-down working on building your company, and that, while you are flattered, now is not the right time for you to think about selling.
If, however, you are intrigued by a combination, you need to work to get some more info. Quickly form a broader opinion on them based on hard facts. If they are a public company, this is relatively easy – search through their EDGAR or SEDAR filings and find out things such as: how much cash they have on hand, their history of acquiring companies, if they pay significant premiums for early-stage companies, how their stock price performing, if their revenues/profitability growing or declining, etc.
Information is power and you will need it for leverage here. If the company is private, search around the internet for some of the information I mentioned above. Most importantly, talk to people who are close to the company or who may have worked with them, or sold a company to them recently. Your VC and board members and advisors can help you here.
If you are interested, the next best step is to engage your board. If you don’t want to involve everyone upfront because you are not sure how real the interest is, phone up your lead VC and have a chat. Tell them why you are interested in exploring further, and why you think it is a good time to engage on this topic. Ask them for their thoughts and work to get alignment with this lead. Your VC will be an important ally for you as you go through the process, and look to convince the rest of your board to go deeper shortly.
Once you have your own head in the game and have an ally in your lead VC, it’s time to go back to the potential acquirer and engage a bit. Your goal here is to get some more information about them, share some limited additional information about your company, and ultimately, as Brent suggests, get a valuation from them. This last point is extremely important. Before you spend weeks engaging and then months closing, you need to be convinced that this is all going to be worth your precious time. Remember that an M&A term sheet is non-binding and that the terms can be changed at any time, and also that the offer can actually be canceled at any time.
You’ll need to share information such as financials, projections, employee bios, go-forward strategy etc. Tread carefully; remember that the acquirer may just be on a “fishing expedition” looking to get confidential information about your company.
As you send back your package of initial information, be sure to state your demands clearly. Give the acquirer a clear deadline for sending you an offer range. In order to state importance and force them to move quickly, you may want to schedule a board call or call with your lead investor in, say, a week or so, and communicate that this is happening to the potential acquirer. Tell them something like, “here is the information you requested, we are excited to explore this further with you. As a next step, we would like you to provide a valuation to us that I can present to my board or lead VC on a call we have scheduled on such and such a date…”
If the acquirer balks at committing to give you and offer by your date, it is a red flag. They are not taking the exercise seriously, or you are talking to someone who doesn’t have the authority or track record to get M&A deals within their organization. Abort mission!
In my experience, once you provide a bit of info, the acquirer will often balk at giving you a price or even a range. They will state that they are very interested in continuing the discussion, but that they need more info and face time with you to come up with an offer. You should artfully call BS on this. They have what they need to give you a range at the least, and you should continue to stick to your guns on getting them to give you a number.
As Brent suggests, if you get a number you like, it’s time to get more serious. Again, time and leverage are not on your side (many M&A deals fall apart even after a term sheet), so continue to work quickly and deliberately towards a term sheet and then a close. Remember that, just like a financing, valuation is only one important variable. Other terms such as cash versus stock payout, founder vesting schedules, post-deal key employee compensation, and founder relocation are all part of your decision tree.
Recognize that you will probably have offers come and go over the course of your startup journey. From personal experience, I have seen this in spades. Some of the ultimately most successful exits I have been involved in had numerous kicks at the acquisition can before a real exit materialized.
Finally, I love Brent’s advice because here we have a banker telling early-stage companies that they don’t need to engage a banker in this scenario. That’s real talk and it is much appreciated!
There is so much truth to Roger and Brent’s advice. Having gone through an acquisition myself, I can tell you that an acquisition process is all-consuming and mentally draining — not unlike fundraising. Deciding to pursue an acquisition offer will require a lot of your time and energy, and will distract you from anything else going on in your company.
My advice would be to shield the rest of the team from the acquisition process until the interest is vetted and there is a real deal on the table. Even then, use your judgment to engage team members on a need-to-know basis. Talk of an exit is distracting for not just the CEO, but the entire team. Many acquisitions fall apart during negotiations; as Roger said, your company may in fact come across many possible exit opportunities before an exit actually materializes. You can’t put all of your eggs in one basket, so you need to help the rest of the team stay focused on the current roadmap.
Decide on your deal breakers. What’s your lowest price? How long are you willing to work for the company?
As soon as you get acquisition interest, before there is a number on the table, I’d recommend you have a very honest conversation with yourself (or an advisor). Decide on your deal breakers. What’s your lowest price? How long are you willing to work for the company? Where do you want to be based? It’s so easy to slowly let yourself get chipped away in an early-stage acquisition conversation. Having this checkpoint to look back on will be a good way to stay true to your original intentions.
To give you a sense of how the acquisition might play out after you get a number from the acquirer, here are the steps involved in a typical acquisition process.
First, you need to get the offer in writing, generally in the form of a Letter of Offer. The Letter of Offer is basically the acquisition equivalent of a term sheet. This is the document that goes back and forth between you and the acquiring company as you iron out the details of the deal. It is during this phase, before the offer is signed, that you are generally still allowed to talk to other possible acquirers. Once both parties agree on the terms and the offer is signed, you enter due diligence. If you pass due diligence, then the deal can close.
From start to finish, an acquisition can take months. Make sure you have at least a few months of runway before entering serious acquisition talks, or else the acquirer may use your desperation to drive down price. If you don’t have enough money in the bank, your investors may be willing to provide you with a bridge round to let you see the acquisition through.
The longer the process drags out, the greater the risk the acquirer will lose motivation to close, and the more time you’ll be investing in something other than growing your company. You want to close things as fast as possible. To try to speed things along, I’d recommend picking an external event or announcement date that both parties can strive to close the deal by. Maybe it’s the acquiring company’s annual conference or quarterly board meeting. Whatever it is, use that date to rally all parties around getting the deal done.
Got a question for the investors? Email them here.