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 follow your thought process and related actions after being approached for acquisition. You should understand that most of the insights apply to companies that are not in distress and don’t 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, $50M or $200M price tag. Instead, try to figure out if the potential acquirer is really serious or just “sniffing around”. If so, keep reading.
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 executives of the companies I visited to get excited about a possible exit. As it turned out, over that same six years we only made 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, fill a significant void in their product line or 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 to reach that next level. But the risks mentioned above might cause you to fall short of your objectives. That leaves you with three alternatives in the future: raise even more money, reach sustainable profitability, or sell the company. Raising more money dilutes the shareholders again and causes yet another “mental contract” while selling the company could be met with investor resistance if they aren’t able to get a 3-5X return on their invested capital. Reaching sustained profitability might require a reduction, or dramatic reduction in expenses (ie – headcount).
- “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.
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.
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.
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 year’s revenue. But what if your acquirer could easily generate 12X just in 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 book ends of the narrower range might be contingent on other factors, but still this exercise can be hugely helpful. It also gives you potential narrative to use with your prospective acquirer when they ask you to suggest a price. Imagine saying something like, “We could get really excited about an offer in the $100M range and might consider something lower, depending on a variety of factors.” If they ask about that lower number, you could say something like “An offer of something like $50M probably wouldn’t cause me to inform my board of directors for a discussion.”
Two 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.
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 done to about 75% (based on my personal, non-scientific research).
Side Note: There is a rule of thumb I share with founders after they finalize an acquisition LOI. I tell them the part about the odds of successful completion being about 75% at that point in time. I also suggest that with each successful week that goes by, the odds increase by 5%. A “successful” week is one in which no showstoppers or significant issues are identified by either party. With each such negative discovery, the odds go backwards 10-25% based on severity. Most significant issues can be worked through but that might extend the acquisition close date and there’s an adage in M&A land that says “time kills deals”.
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”
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 2-3 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 “inbound interest”. In this case, you’ll probably need to push back on the 2-3 day deadline and hopefully your advisors can help you navigate this very delicate activity.
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.
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.