I have written articles about various aspects of M&A and have even written two, based-on-true-story case studies (titled “A Tale of Two Acquisitions”) to teach the numerous lessons I’ve learned throughout 14 acquisitions I was involved in, mostly as the buyer. But these days when I’m approach by an entrepreneur for advice related to M&A, it is almost always because they were just approached by an interested acquirer and are trying to figure out how to react, what to do next, and what to prepare for should things proceed down the acquisition path. This article intends to serve as a “Start Here” guide for such a situation.
The sections that follow are in a sequential order that should generally guide your thought process and related actions after first being approached for acquisition. You should understand that most of the insights apply to companies that are not in distress and don’t actually need to sell.
You’re Still a Long Way From Being Acquired
Companies that are active and experienced acquirers explore 10 or more possible acquisitions for every one they actually follow through with a formal Letter of Intent (LOI) to acquire. So if you meet with someone from Google or IBM and they mention the phrase “possible acquisition” during the meeting, don’t go out and buy that Ferrari you’ve been dreaming about. In fact, don’t even pull out your latest cap table to remind yourself how much equity you have so that you can calculate your net proceeds from a $20M, $100M or $500M price tag. Instead, try to figure out if the potential acquirer is really serious or just “sniffing around”.
Personal Story: I served as President for a company that is a great example of all the casual inquiries, hints and “sniffs” that never lead to an acquisition. Over the course of six years, our CEO had me meet with 5-10 companies each year to determine if an acquisition seemed like a worthwhile endeavor. So let’s just call it 40-50 “sniffs” that surely caused the founders of the companies I visited to get excited about a possible exit. As it turned out, over that same six years we only made a total of four acquisitions.
How do you know if the acquirer is serious? Later, after reading the section titled “Don’t Turn Into a Seller”, you’ll get a good idea of how to get a dialog going to determine seriousness. But if they don’t specifically come right out and say they are looking to make an acquisition in your market space, here are additional signals to look for from the potential acquirer:
- Executives are involved in the discussion
- Representatives from both the corporate development function and a product division or significant business unit are engaged. This mostly applies to large corporations.
- They have a history of making acquisitions. The more the better.
- You’ve recently been beating them in the marketplace, you fill a significant void in their product line, or you offer some other strategic value that’s obvious
Would You Consider Selling the Company?
There’s an adage that every company is for sale at the right price. But what does “right price” mean? I give some insights in another section below but want to make a different point here. Are there reasons other than a super high price tag to consider selling your company? Of course there are. I describe several such reasons below, but realize they might just be contributing factors and not the sole driver of your decision.
- Fading Performance – Continuing to perform at very high levels of growth for a sustained period of time (ie – years) is extremely difficult. Almost all high growth companies experience periods of reduced growth or worse. When this happens, it is rare that the company ever reaches the previous high rates of growth, on a percentage basis.
- Market Risks – At each phase of a company’s evolution new risks are presented. Some are market risks like new competitors, completely new approaches to solving the problem you solve, shifting marketing dynamics or trends that somehow force you to react.
- Execution Risks – As you grow, the way you do things needs to change to accommodate (ie – tools, processes, management system) and the talent/skills you need on your team also likely needs to change over time. Even your own position as a top executive in the company might need to change. As complexities are added, so are the risks that you will poorly execute in at least some aspects of your business and start performing worse than in the past.
- Fundraising – If you need more funding to reach the next level, you are basically signing a mental contract with yourself and your investors for a new multi-year “tour of duty”. And remember that any new investors will want you to keep growing until they can realize a 10X or greater return. How long might that take?
- “Tired” Founders – Running a startup is challenging and mentally exhausting. After several years or longer, the founders can start getting burned out, less passionate, or just ready to move on to their next challenge.
If contemplating the above-listed issues leaves you still considering the possibility, you might want to do a quick gut check on the required price tag for the acquirer to pay. This step isn’t intended for you to start negotiating valuation with the prospective acquirer, that comes later. Instead, I’m talking about a sanity check to help you decide if you would consider selling the company. Here are some questions to help bookend the issue and determine if there’s a possible good deal to get done:
- What is a number that would certainly cause you to sell the company now?
- Reducing from your answer to #1, what is a number that would at least cause you to consider selling the company now?
- What is a number that is definitely too low to even consider selling the company now?
- Increasing from your answer to #3, what is a number that would at least cause you to consider selling the company now?
Hopefully you see the benefit of the exercise. You might end up with a wide range between #2 and #4 and a really wide range between #1 and #4, but I still find this to be a valuable exercise. Additional value comes from having each founder or significant company executive go through the exercise individually and then compare the results to facilitate a discussion.
When you conduct this exercise, you might find conflicting thoughts inside your head. That’s likely due to the three different stakeholders you’re thinking about that stand to make money from an acquisition. I’ve listed the three stakeholders below, but recommend you first isolate your thoughts just on yourself. After that, re-run the exercise by thinking about your investors and employees.
- You
- Your investors
- Your employees
Please don’t take this exercise to suggest that price (valuation) is the only important term when being acquired. In fact, read my article titled “Tell Me Your Price and I’ll Tell You My Terms” to learn more on that topic.
Don’t Turn Into a Seller
If you decide to consider the sale of the company, don’t become the Seller but instead let your interested pursuer remain the Buyer. It leaves you in a commanding position for the next key steps and throughout the merger agreement negotiation, should it go that far. Of course, that assumes you don’t actually need to sell the company.
Here is an abbreviated example narrative to give you an idea of what I’m talking about: “We weren’t considering selling the company until you approached us and expressed interest. In fact, we are hugely focused on continuing to build a great company with a substantial role in this market. We have very high expectations for our company’s potential and have strong support from our investors and our board. In order to decide if we would consider selling the company, I would need to know what your key interests are, what synergies you see, and how you feel we can better achieve our vision as part of your company rather than independent.”
Just be careful not to get so cocky in your response that the acquirer decides you’re going to be a royal pain in the ass to deal with during the acquisition process and later as part of their company.
For additional important information on this topic, read my related article titled “Are You Selling Your Company or is Someone Buying It? ”
Get Outside Advice
If you determine the acquirer is serious and decide there are reasons to consider a sale of the company, immediately seek outside advice. Before an LOI is presented to you with a 48 hour response window and a “no shop” clause, you want to make sure your head is on straight. An experienced outside advisor can be a sounding board for your decisions and a trusted resource during the rest of the acquisition process. If selected carefully, they will not only help you negotiate the best price tag but also make sure you don’t get taken advantage of by an experienced acquirer. A great acquisition includes a combination of high price and fair terms.
Where can you find such an advisor? First, look to your other company advisors, consultants and board members. Investors can also possibly serve in such a role but just realize they could be conflicted due to their financial interest and potential to focus excessively on things that affect their return on investment. You want someone that will also help look out for the interest of your employees, your co-founders and your going-forward vision once a part of the acquirer’s company.
Using a Banker
A big decision you’ll need to make is whether to engage a professional M&A banker/broker/advisor to assist you with the process. They come in all sizes, from solo freelancers to Wall Street firms. Your investors and board directors should be able to make some referrals.
Engaging a banker certainly costs money. But they can be worth their weight in gold if they’re experienced and if you’ve built an acquirable company. At one extreme is engaging them starting right after you and your board decide to sell the company. With that, the banker can help expand your strategy, starting with the things that are described in this article. At the other extreme is waiting for legitimate acquisition interest, but ideally before an LOI is presented so they have some time. With that time, they will attempt to bring additional acquirers to the table (ones you don’t already have a relationship with) and they’ll serve as a front-person while soliciting, evaluating and negotiating acquisition offers.
Many startups avoid using a banker because they don’t want to give up a portion of the acquisition proceeds (varies widely based on deal size). But if the banker can help bring just one new acquirer to the table or otherwise help you negotiate a higher exit valuation, that is definitely worth something. And that’s not the only value they bring. The challenge often comes with exists smaller than about $20M. It’s hard to find bankers that will do those deals because there isn’t much money to be made.
How much of the acquisition proceeds typically goes to the banker? Well, it depends on the type of banker you choose to use. Actually, there are different types that are most commonly used based on the expected transaction size. I’ve just been using the word “banker” for simplicity. Here’s a way to think about it, assuming the banker is engaged before signing an acquisition LOI:
- Transactions less than $2M: An M&A advisor will charge in the range of 8-10% of the acquisition proceeds
- Transactions in the $2M – 20M range: An M&A advisor or broker will charge on a staggered basis in the range of 8-10% for the first $2M, 4-6% for the next $3M, and 2-3% on the remainder above $5M
- Transactions in the $20M – $100M: This is when legit M&A firms get involved. They also often charge on a staggered basis but starting at 3-4% and reducing to the 1-2% range above about $50M.
Determining The “Right” Price
How much is your company worth anyway? If there were a magic formula we could all use, it would make things easy. But there are way too many factors at play to come up with a formula. It is true that multiples of revenue or EBITDA are often used as a starting point. But the point I want to make here is different. You might think that a fair price is one that recognizes and rewards the work you’ve done in the past and the accomplishments you’ve achieved along the way. It is true that such a price could be a very exciting number. Unfortunately, it misses a very important thing – the future potential of what you’ve built once in the hands of your prospective acquirer.
You might get excited about a price tag that is 5X your prior twelve month’s of revenue. But what if your acquirer could easily generate 12X just in just their first year because of their size, scale and brand reputation while also using your technology to gain a strategic advantage against their own chief competitor? Now ask yourself if a 5X revenue multiple seems like a fair price?
Here’s an exercise to try. It involves narrowing an infinite range of prices to something more narrow by establishing “book ends”. At what price would you definitely sell? At what price would you definitely not? Now, narrow that range by replacing the word “definitely” with “strongly consider” for the high side and “might consider” for the low side.
The exercise I described above that involves identifying prices you would definitely (and definitely not) sell the company for can be somewhat helpful, but that’s more of an emotional approach versus an analytical or market-based one.
If you’re currently raising a round of funding, or recently closed a round of funding, your acquirer might point to the valuation that was used as an anchor point. “You say you recently raised your Series B at a $25M valuation, so our $30M acquisition offer values you more than what investors are valuing you at right now!” Nice try. When you value your company for fundraising purposes, you’re planning to use the funding to further grow and eventually exit at a much higher number. When you sell your company, you’re mostly closing the door on future valuation growth potential. I say “mostly” because some acquisition offers include some upside earnings element (usually tied to future performance).
The right price for acquisition is one that recognizes what you’ve built, what the acquirer will be able to do with what you’ve built, and is sufficient to cause you to close the chapter on seeking your continued growth on your own.
Three final comments about trying to determine the right price.
- Terms Matter – Price is just one key factor in such an important transaction. Terms matter greatly and you can read more about that in my article titled “Tell Me Your Price and I’ll Tell You My Terms“
- Future Execution Risk – Remember the going-forward risks mentioned above? Selling your company relieves you and your team of those risks and passes them on to your acquirer.
- Performance Earnouts – It’s possible your acquirer can only reach an acceptable exit valuation by tying some of the proceeds to your future performance post-acquisition. This isn’t necessarily a showstopper, but definitely comes with nuances to consider. Read more about that in my article titled “Golden Rules for Acquisition Earnouts“.
Get to a “No” Quickly
Since most acquisition approaches never reach the LOI phase, you want to get to a “no” as quickly as possible. I’m not talking about your soul searching on whether to even consider the sale of the company but rather the potential acquirer’s decision to make an offer and your reaction to their offer (price and terms). Just dancing the dance to get to this point takes time and can be distracting. Push your potential acquirer in ways that optimize your efficiency and gets to a “no” as quickly as possible.
The Importance of the LOI
Everything that leads up to getting a Letter of Intent (LOI) is non-binding and should be considered exploratory (I used the phrase “sniffing around” earlier). Even the LOI itself is non-binding, but it clearly demonstrates the acquirer’s seriousness and includes high-level specifics about their offer. But it might surprise you when I say that executing an acquisition LOI only increases the odds of getting the deal all the way across the goal line to about 60% (based on my personal, non-scientific research). If a more detailed, and legally-worded, term sheet gets signed, the odds following its execution are about 70%.
Side Note: There is a rule of thumb I share with founders regarding the odds of getting a deal completely done, at various points throughout the process. The process is obviously not this analytical, but I’ve found it to be a pretty good mental guide.
- Once the LOI is signed, assume the odds of getting all the way across the goal line are 60%, and go up by 5% for each week of due diligence that goes by successfully
- If a more detailed term sheet ends up getting signed instead of an LOI, then the starting point is 70%
- Each slightly concerning item discovered during due diligence causes the odds to go backwards 5% and each moderately concerning item is -10%. Any significant concerns put you in unknown territory, until hopefully back on track.
- Once the odds get to 90%, they continue to rise in small step functions towards 95%, according to key merger agreement negotiation issues getting resolved and the deal gets signed.
- Once the deal is signed, there are more step function rises to 100% as various closing conditions are completed and the deal is finally closed
When you really want to be careful is before getting an LOI. The potential acquirer needs to get certain information from you in order to confirm they want to pursue an acquisition and to determine the key economic terms (mostly price). But they will continue to ask for more information as long as you’re willing to give it to them. What you need to figure out is the minimal amount of information they need in order to confirm their intentions and structure an LOI.
For additional important information on this topic, read my related article titled “Revealing Company Info Before Getting an Acquisition LOI”
Term Sheet or No Term Sheet
Whereas the LOI is fairly high-level and non-binding, a term sheet is worded much more legally and has much more detail to inform the eventual merger agreement that gets executed. It’s still somewhat non-binding, but allows the parties to move forward into due diligence in good faith and with fairly good knowledge of what the merger agreement should look like, if due diligence doesn’t reveal issues.
Some startups move straight from LOI into due diligence, thereby skipping the term sheet phase. Negotiating a term sheet takes more time and incurs more legal cost, but there’s easily an argument that at least that same amount of time and cost would be incurred to negotiate those same items during due diligence. So a key benefit of a term sheet is knowing more specifically what you’re signing up for before you enter due diligence and the required “no shop” period (described next). It’s also likely that your key investors will require a term sheet so they know what they’re signing up for.
The “No Shop” Clause
You must realize that the LOI will include what’s called a “no shop” clause, which essentially prevents you from talking to other prospective acquirers or entertaining other offers after signing the LOI. The duration of this term varies but is usually 60-90 days. Also realize that LOI’s are usually only valid for a few days. This is to put pressure on you to make a decision quickly. But what this also means is that if you don’t already have other potential acquirers available to approach before your deadline to sign the LOI, you won’t be able to create a competitive bidding process.
There isn’t much you can do about it at the last minute but this also points to the value of having strategic partnerships with other companies that truly understand your value and might be in a position to quickly engage if you tell them you’re considering acquisition due to “unsolicited acquisition interest”. In this case, you’ll either need to drag out the verbal discussions & negotiations that precede getting a term sheet or push back on the short deadline for signing the LOI. Hopefully your advisors can help you navigate this very delicate activity.
Soliciting Other Acquirers
The best way to get a higher acquisition price is competition amongst multiple interested acquirers. But if you are approached with unsolicited acquisition interest, how to you notify other potential acquirers without appearing like a “seller”? It’s not easy, but can be done. And it works much better if you have existing partnerships or business relationships with the companies you want to reach out to. Below is some template language to consider as a starting point:
- “I am writing because we recently received an unsolicited interest in acquiring our company. And while we weren’t even thinking about selling the company at this time, the verbal offer is just interesting enough to cause us to have a discussion with our key stakeholders. I wanted to let you know this in case we do decide it is in the best interest of the company to gauge additional acquisition interest. In that case, I would be happy to notify you and provide additional information. I haven’t been through an acquisition process before, but I understand the early part of the process can move really quickly.”
You probably recognize that the template language attempts to give a notification without becoming a “seller”. It’s almost as if you’re doing the partner a favor by giving a confidential heads-up.
There is a definite risk with notifying the other potential acquirers too early in the process. They might conclude that even if you don’t sell the company now, you might do so in the near future. It could cause them to be nervous about devoting more resources to a partnership that later comes to a crashing halt due to an acquisition by one of their competitors. For this reason, you might decide to wait until you get enough additional information from the current acquirer to become serious in your consideration. Again, hopefully your advisors can help you navigate this.
Prepare for a Massive Time Suck
Assuming you’ve agreed on a price and signed an attractive LOI. Congratulations, now prepare for the chaos and massive time suck associated with what’s called “due diligence”. Your acquirer gets to ask for every piece of information you can imagine and then some. They do this initially to double-confirm their acquisition intentions and price tag while then moving to a phase that supports the negotiation of the merger agreement and preparation for company integration.
Only after successful due diligence and merger agreement negotiations do your odds of getting the deal done increase from 75% to 100%. So pace yourself and prepare for elevated stress that lasts at least several weeks and probably longer.
Maintaining Your Negotiating Leverage
Even though a term sheet might have been negotiated, there are plenty of nuances to get worked out and sometimes certain items get punted from the term sheet so that due diligence can get started. For those reasons, and more, it’s important to try and maintain your negotiating leverage. Or if you didn’t have much at the time the term sheet was signed, you should try to gain some as due diligence occurs and the 85 page merger agreement is negotiated. Below are a few suggestions to pursue in this regard:
Amazing Responsiveness to Due Diligence Requests
Blow the acquirer’s mind by how well managed your business is, partly as evidenced by how quickly and reliably you’re able to fill their data room. If you talk to an advisor, investor, or your M&A attorney, you can discover at least 80% of the things they’re going to ask for, so make sure you’re ready for it. A good chunk of the acquirer’s requests will overlap with Series A/B/C due diligence you might have recently gone through, but there will be plenty more that you’ve never previously been asked for.
Clean Due Diligence
If your acquirer doesn’t discover any major concerns, that’s great but is already baked into the price and terms described in the term sheet that you signed. But if can you do better than that by being especially “clean” as compared to most other acquisitions they’ve made, you gain some negotiating ammunition. This is mostly out of your control at this point, since you can’t rewind and redo much of anything related to your processes, technology, systems, and contractual agreements.
Unexpected Positive Discoveries
This could relate to your technology, new customer wins, an advancing strategic partnership, or a variety of things your acquirer will be impressed with. If your team has been working on something amazing that your acquirer doesn’t know about (or doesn’t know much about), blow their mind by unveiling it as early as possible during due diligence. In fact, try to “manufacture” a few such unveilings over the first few weeks of diligence.
Not all of it needs to be super-huge accomplishments. Instead, cause your acquirer to conclude “Holy crap, these guys keep accomplishing interesting and amazing new things at a fast pace! Why can’t we seem to do the same?”
Some New Dynamic Occurs in the Market
This is out of your control, but certain announcements by your acquirer’s competitors or your competitors could cause your acquirer to get more anxious/desperate to get the deal done. Of course, there could be announcements that cause them major concern and that could swing the negotiating pendulum in the wrong direction.
In a previous life, I led an acquisition of my company to a Fortune 500 and I was fortunate to have all of the above play in my favor. We used it with amazing power to negotiate a deal that would put a huge smile on the most M&A attorneys’ faces.
Summary
Getting approached by a potential acquirer is both validating and flattering. If you’ve built a great company, it will happen on a somewhat regular basis and you’ll become a professional at “doing the dance”. And someday you’ll possibly decide it’s time to sell the company. If so, I hope you are handsomely rewarded for your accomplishments.
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