I get asked this question many times in many different ways. Sometimes people are coy about it (“someone is expressing strategic interest – what should I do?”) other times people are clear and direct (“someone wants to acquire my company – help!”).
David Cohen, the CEO of TechStars, has encountered this many times. Before starting TechStars, he was an entrepreneur who sold his company to a public company after running it with a partner for a decade. He then started a few more companies, including one that failed and one that was acquired. Finally, he started TechStars and of the 28 companies from the first three programs (there have now been 126 companies that have gone through the program to date) 8 have been acquired. He’s also invested in a number of companies as an angel investor and I know of at least a half dozen that have been acquired.
He’s got awesome advice in a blog post titled You have acquisition interest – now what? His 10 step process is:
- Assess the acquirer
- Notify the board
- Set your number
- Engage the acquirer
- Ask for the ballpark offer
- Identify mentors
- Assess the ballpark offer
- Get to know them and answer their questions.
- Push for a term sheet
Go read the post now. It’s excellent and I plan to refer people to it often whenever this question comes up.
Ah – the joys of having super smart entrepreneurs to do our writing for us. Dick Costolo has today’s post of the day up titled No Exit. In this post, he ponders the answer to the age old question “What is your exit strategy?”
I hope this – and the appropriate discussion – gets cross-posted on the AskTheMilitaryCommander blog. For the time being, however, I’ll stick with AskTheVC.
Dick had a very nice exit recently when Google acquired his company FeedBurner. And no – the question “what’s your exit strategy” never came up in a meeting that I can recall.
David Shanberg – a colleague of mine from PeoplePC (David was VP Corporate Development) – started an M&A / corp dev consultancy called Baker Pacific. He also writes a good blog on M&A and corp dev stuff. He recently sent me a short article on M&A Due Diligence which I’ve broken up into a four part series. Following is the first post on “What should I expect from the due diligence process?”
Generally, the information that an acquirer expects is broken down into the following categories:
- General Corporate Matters
- Financial, Accounting, and Taxes
- Technology and Intellectual Property
- Product / Service Offerings
- Sales and Marketing
- Human Resources and Personnel
- Legal and Regulatory
Within each category, there tend to be two distinct types of requests: document requests and questions to be answered over the phone and in meetings. Often, it possible that there will be a “priority” due diligence checklist early in the process and a more detailed one later.
Also, a savvy acquirer will want to see projections, reports, and other documents actually used by the company, as opposed to specially-created projections and reports just for the M&A process.
Ultimately, anything that could be material enough to affect the valuation of the business is fair game. Since the potential acquirer doesn’t know what is material until it asks, the initial due diligence list can be overly long, with a number of requests that are irrelevant. So, don’t panic when you see the list for the first time – a number of the requests may be able to be disposed of quickly.
Usually, the potential acquirer will want to visit your offices and speak with most of the top management team. Balancing these demands with the need for secrecy, while being reasonable and maintaining a good relationship with the potential acquirer, is certainly one of the challenges of the due diligence process.
Question: We are considering selling our VC-backed company. It may not be the optimum time so valuation is a question. My board has asked me to proposed a management carve out plan as a retention tool. What do I need to consider in formulating this proposal?
While management carve out plans were rarely used before the Internet “bubble,” they’ve evolved over time to have fairly standard terms. In general, you need to consider the amount, form of consideration, how the proceeds are distributed and implications on escrow terms.
Amount: Without knowing more about your particular situation, it’s hard to give you guidance on the particular percentage that is reasonable. Normally, these plans give the participants between 5 and 10 percent of the aggregate proceeds of the deal. I’ve also seen higher and lower. The proceeds are usually decreased by any amounts received by the participants under the liquidation preference structure.
Form: Plans should distribute the same form of consideration to the participants as the rest of the stockholder base. However, they should always have a clause that allows cash to be paid out in case the acquiror prefers this, or if you are in a situation where people would otherwise receive fractional shares.
Distribution: Proceeds under the plan can be allocated by the board, by the CEO, or a combination of both. Normally, you see the CEO proposing the distributions and the board reasonably approving his / her plan.
Escrow Considerations: One piece of negotation is whether or not the management carveout should be subject to escrow provisions. It seems fair that it should, but the question is what happens with respect to indemnification obligations that go beyond the escrow. Should management have to take cash out of their bank accounts to cover these amounts? It’s definitely a case-by-case situation, but make sure that you address this up front, not at the time of the acquisition.
One other item to consider is whether any payouts under a plan like this will trigger any “golden parachute” (280G) situations. Ask you lawyers and your accountants to do this analysis early on so that you can deal with any potential problems. What’s 280G, you ask? See our earlier post.
Once again we have a guest blog from Will Price at Hummer Winblad. We appreciate Will’s efforts in both writing a post on planning for M&A as well as introducing some MBA-speak into AsktheVC (hint: BATNA).
Question: How do you plan for M&A? Trying to build our company, thus far we went the regular path – market research, sales projection models, expenditure / P&L models, potential products/product lines and the like (text book?), but many people we met told us (“shouted”) that we should plan for a strategic partnership/ M&A, how do you do that? Should there be a special business plan?How does a P&L look in that case? How do you plan the selling of your IP to a large company? Selling after you have a finished product? Selling the company after initial sales? Letting the company grow a bit more? Is it good practice / healthy to plan your business on somebody buying you? Will it be acceptable to prospective investors/ VCs?
Plan for Independence. There is a famous VC saying, “companies are bought and not sold.” Accordingly, the best “plan” is to plan for success as an independent company.
The company’s operating plan, technology road map, and executive team should not focus on unnatural acts, in the hopes of attracting a buyer, but rather on building a company with the potential for independence. Companies built to “flip” often flop. They often flop due to the fact the team is not truly committed but, instead, looking for a quick buck. Bad motives drive bad behavior.
A fundamental concept that helps focus management on building to independence is optionality, or BATNA – which is MBA-speak for “best alternative to a negotiated agreement.” BATNA is a fundamental tool for understanding negotiating leverage and strategy. If you work to ensure you have a BATNA – for example continued independence or a higher offer – the company is able to negotiate from a position of strength. If no BATNA exists (i.e. the choice is between a fire sale or running out of cash), the company is at the mercy of the buyer and the negotiation becomes an exercise in Russian roulette. Always have a BATNA.
While the security software market is an extreme example, it is far more probable that a successful tech company will be bought rather than go public. Accordingly, while no special plan for sale should be developed, it is highly logical to expect M&A to emerge as the path to liquidity.
While VCs believe “companies are bought and not sold,” acquirers tend to believe that “successful partners make the best acquisition targets.” Successful partnerships are characterized by
- a history of successful joint customer engagements,
- successful technical integrations and co-deployments,
- a joint roadmap,
- co-marketing and sales traction, and
- management teams and team members with a track record of collaborating to reach shared objectives.
A great example of the partner-to-buy model is SAP and Virsa, although there are many such examples.
Keep Good Records: Finally, M&A is a diligence driven exercise. The final cliché is that “good record keeping makes for good diligence and good diligence makes for expedited outcomes.” Good records include:
- Articles of Incorporation/company charter
- all Board minutes, contracts, signed employee assignment of IP forms
- capitalization table
- option plan records
- prior financing documents
- audited financials
- patent filings
- documentation relating to litigation, assessments, or claims
Any material gap in records will either 1) delay the sale process and/or 2) will lead to a higher escrow to offset potential liabilities that may “appear” post-close.
In summary, all clichés are common sense and the M&A related clichés noted in this post are no different:
- build companies for independence (always have multiple BATNAs),
- partner well,
- keep good records
We’ve gotten a slew of questions like the one below. It’s impossible to give a precise answer to “is this offer a good one for my company?” when all we have is a paragraph or two to go on. So – like all good Aesop wanna-be’s – we’ll try to pull out one or two salient points from the parable to help make everyone wiser. While the answers will provide some benefit, hopefully our thought process in sizing up the question will provide even more.
Question: I’m working on AJAXifying and otherwise adding “web 2.0” functionality to my site, but there’s a lot of work to do and I am no software engineer. Suddenly I’m drowning in competitors, but still maintaining a solid number two position in the market, from publicly available data (which is sparse). I haven’t gone out looking for investors, but they often come to me. The most recent offer is with a new company working on the “incubator” model. They want 75% of my business in exchange for putting their full-time programmer and their full-time accountant onto my project for three months. I have not seen the resumes of these people. They will also pay me a salary which is about equal to my current net revenue. I am inclined to turn this offer down. Is this wise?
Answer: Unless you want to sell your company and move on, it would be very wise to turn this offer down. First of all, the offer sounds more like the “incubator” is buying your company – with you retaining 25% of the equity and getting a salary equal to your current revenue. The effective value you are getting for the three months of full-time programmer and accountant is – at best $50k (1/2 of a full time equivalent). Is this – plus the revenue you are getting from your business (and it’s unclear whether they are giving you this for 3 months, a year, or the rest of your life) – worth giving up 75% of it? While only you can answer this, it seems like a very fishy deal.