I’m willing to bet that 95% or more of startup exits are via acquisition rather than IPO. But when is the right time to sell? Actually, you’re a lucky founder if you’re actually able to ponder that question. Many startups are sold out of desperation and necessity. This article is a guide for founders that have decided it’s time to sell the company, but aren’t in a desperate state. This article is not for founders that just received an unsolicited approach for acquisition (for that, read my article titled “Approached for Acquisition – Now What?”).
Wanting versus Needing to Sell Your Company
You’re likely reading this article for one of three reasons. You’ve decided you want to sell the company, others (ie – investors or board directors) have decided they want you to sell the company, or there’s some reason you need to sell the company.
Selling Due to Want
If you’ve achieved sustainability, have plenty of runway to work with, or could pretty easily raise more funding when needed, you’re in a very fortunate position. You’re in the driver’s seat and with lots of options. If you can’t find a desirable acquisition exit, you can keep going. If you find some interested acquirers, but they won’t reward you with an acceptable valuation, you can keep going.
This brings up the question of why to sell the company if you don’t have to? Well, there are plenty of reasons, some of them being pretty obvious:
- You’re ready to reap financial rewards from what you’ve successfully built.
- You project that without an exit, you’ll need to raise your next round of funding within a year or so and realize doing that means signing up for an extended tour of duty (easily 2-3 years and possibly 5 years), until you can deliver those future investors an acceptable investment return (think 5-10X).
- Something about the market you serve or the technology category you’re in is changing in ways that present heightened uncertainty and risk to your viability in the future.
- Something about the market you serve or the technology category you’re in is changing in ways that have big, strategic acquirer prospects super interested in companies like yours. Selling sooner versus later presents opportunities for an oversized valuation. As the big companies start making acquisitions, a game of musical chairs could ensue and you don’t want to be left without a chair to sit in.
- You’ve had a crazy successful track record to this point and don’t see that continuing for a lot longer. The shapes of your KPI graphs are likely to change and you predict an opportunity for an oversized valuation sooner versus later.
- You, and possibly other co-founders and early employees, have already spent many years on your venture and are getting tired, bored, or just less passionate about the mission.
- The levels of stress and mental fatigue on the founding/executive team have been high enough for long enough that selling and taking some time off is the right personal thing to do.
I strongly recommend you and your founders/executives be honest with yourselves about the reasons for wanting to sell the company. Other stakeholders (investors, board directors) will likely need to support the decision and you don’t want to bullshit them on this.
Since you’re in the driver’s seat with regards to exit timing, you also have an opportunity to think about your possible exit valuation. Before executing the plans you’ll see later in this article, do some serious thinking about the minimum valuation you’d need to sell the company versus the valuation you’re hoping/expecting you can get. The first part of this exercise is selfish and just centered on you. How much money do you need to make in order to get excited about an exit? Next, think about your other co-founders and executives in a similar regard. Finally, but very importantly, predict if your investors would be supportive of an exit at the valuations you’re thinking.
Selling Due to Need
There’s not near as much to say about the situation in which you need to sell. The most common cause for this is facing a forecasted cash fume date and low odds (or low desire) for raising more funding. Selling a company with only a couple of months of runway puts all the negotiating power in the hands of the acquirer, unless you can setup a bidding war. But doing that also takes some time. So, for the purposes of this article, I’m going to assume that you’re not that desperate and have at least 8 months of runway to execute the strategies you’ll see later. Or perhaps you have investors that will inject just enough capital to give you that desired runway.
Your Best Acquirer Prospects
It’s really important to spend time evaluating who would be most likely to acquire you, if they knew you were available for acquisition. You’ve surely already got some number of them in mind and might even have relationships with some. But I’m willing to bet there are more.
I also recommend that you evaluate some things beyond just the ability to pay your desired price tag. In fact, when thinking about selling your company, it’s important not to spend most of your time multiplying your current equity percentage times various exit valuations to determine if you’d make enough to buy an island or just a hot sports car.
I always start with the synergies that would result if you combined forces with a given prospective acquirer. With greater synergies comes a higher valuation and better overall negotiating leverage (other acquisition terms beyond price). Higher levels of synergy also increase the odds of the acquirer devoting significant resources and funding to your venture post-acquisition. Some founders might not care what their acquirer does with their products, technology, customers and employees after the acquisition check clears the bank. But most founders really care about those things, even if they don’t go to work for the acquirer post-acquisition.
The word “synergies” is often overused and thrown around during acquisition discussions. It can mean a lot of things, but getting specific on likely synergies with each prospective acquirer is really important. Following are some common synergies that might exist for your acquisition exit.
When your acquirer sells your product, it facilitates the sale of one or more of their own products. This particular synergy is strongest when the ratio of revenue from your product versus theirs leans strongly in their favor. In other words, the sale of $100K from your product drags along $1M from their existing products.
Your acquirer has an army of sales reps that already know how to sell your category of product (or could easily be trained to do so). They can deliver exponential revenue versus what you’ve been able to accomplish with a much, much smaller sales team and marketing budget.
Customer Base Synergy
Is your current customer base attractive to your acquirer? In some cases, that means the exact same type of customers they already target. In other cases, the acquirer is trying to expand into an adjacent market and you already have exactly those types of customers.
Product Modernization Synergy
The products and technologies you’ve developed will breathe some life into your acquirer’s product(s) in ways that cause them to be (or at least seem) modern versus old/legacy.
Market Leadership or Competitive Differentiation Synergy
This synergy takes product modernization synergy to the next level. Your acquirer will be considered a market leader and, as a result, will be armed with a significant competitive weapon.
Business Model Synergy
The way you acquire customers and the way you make money fit well with your acquirer’s existing business model. It’s also possible that the differences between your business model and your acquirer’s presents the synergy. This happens when new business models are invented and later become proven and attractive to large industry incumbents.
Tech Stack Synergy
The tech stack you’ve used to build and deploy your solution fits well with your acquirer’s existing tech stack. It’s also possible that the differences between your tech stack and your acquirer’s presents the synergy. This happens when new programming languages, technical architectures, and technical interfaces are invented and later become proven and attractive to large industry incumbents.
The processes and systems you use for operating various aspect of your business either fits well with your acquirer’s or is highly-desirable due to advantages they’ll deliver to your acquirer.
Your acquirer is looking for access to, or increased penetration in, geographic markets where you operate.
As you evaluate the synergies that could result from an acquisition, you might find that some of the ones listed above exist with certain prospective acquirers but not others. If so, consider grouping the acquirers in some way that allows you to visualize this. Later you’ll have some decisions to make on actions to take to be most acquirable and boost your exit valuation. You might choose to prioritize those actions based on desirable synergies for a particular group of acquirers over other groups.
Below is a checklist of additional things to consider when evaluating and ranking your best potential acquirers:
Usually, the bigger the better due to suggesting their ability to pay your desired exit valuation
- Financial Health
Even big companies fall on hard financial times. Also, some are sitting on piles of cash and others aren’t.
- Acquisition History
Experienced, prolific acquirers offer a double-edged sword. On the one hand, they can move quickly and efficiently through the process, and should also be more effective with post-acquisition integration. On the other hand, they surely got burned on some mistakes in the past and will perform more aggressive due diligence and not be a pushover on things that an inexperienced acquirer might be.
- Acquisition Reputation
Most of this relates to post-acquisition execution, starting with integration. Some acquirers are accommodating, respectful and just overall good at folding a new company into theirs. Others are the opposite. You might not find press articles on this, but if you look back through their acquisition history, you probably can do some back-channel reference checks with acquired employees, executives or founders.
- Desirable to Work For
How excited would you and your team be to work for a given acquirer? Much of this relates to the company’s culture and status in the industry.
Acquisition Attractiveness Scorecard
Now that you have a sense for your best acquirer candidates, it’s time to reflect how attractive you currently are to them. But you’ve likely got so many biases about your company that you might have to work really hard to put yourself on the other side of the table for this assessment.
Evaluate your company along various dimensions, as would be evaluated from an acquirer’s perspective. Create a report card with categories like the ones listed below:
- Existing customer base
- Customer acquisition strategy and process
- Sales pipeline
- Product functionality
- Tech stack
- Processes and systems
- Intellectual property portfolio
- Financial results
You’ll probably identify additional categories and some that are listed above could possibly be further split into sub-categories to get a more granular assessment. For each category, assign yourself the grade you think an acquirer would assign. And remember, they don’t care about how long the co-founders bootstrapped the venture or the number of pivots it took to get something right. Basically, they don’t have the selfish emotions that you do about the company you’ve built over time.
Which categories do your likely acquirers care most about? If they care a lot about it, it’s also more of a valuation driver than the others. And like with the synergies evaluation, you might also need to segment this evaluation by acquirer group.
For categories you scored yourself lower than you’d like (especially those the acquirers most care about), what can you do over the available period of time to improve? If you’re serious about pursuing an acquisition exit, that list of things becomes pretty important. Just don’t shift your priorities so much as to screw up your performance in other areas.
Benefits of a Bidding War
Nothing drives up the exit valuation more than a competition between two or more interested acquirers. When there’s only one acquirer, they sit in the driver’s seat for just about everything related to the acquisition (price tag, deal terms, due diligence timeline, etc). Having just two interested acquirers is all it takes to eliminate a lot of games and put you in the driver’s seat instead. And magic can really happen when the interested acquirers are directly competitive with each other.
If you already have a relationship with one or more potential acquirers, you’ve got a leg up on the whole strategic exit process. It’s great if those relationships are significant enough for the partner to really know your product, business results, business model, and the like. But almost any form of partnership with a prospective acquirer is helpful because at least they know who you are and what you do.
Expanding Your Partnerships
Where you have existing partnerships with prospective acquirers, you want to evaluate possibilities to make them deeper and more strategic. Doing so exposes the additional synergies that could be realized via their acquisition of you. In fact, you can look at the list of possible synergies to determine how to best expand and deepen these partnerships. The other benefit of a deeper/broader partnership is exposure at higher levels within your partner’s organization. It’s hugely beneficial to have a relationship with a division general manager or corporate executive that would be directly involved in any decision to acquire.
For prospective acquirers that you don’t have a relationship with, it’s time to start that process. It’s basic business development. And if you don’t have someone in that function, it might be time to hire one. If the target company has a partner program that you can apply to be a part of, that’s sometimes an easy and inexpensive first step. But it’s rarely strategic, so if you decide to start with that, don’t stop there. Rather, use it as your foot in the door to further expand the relationship along multiple dimensions. Specifically, ones that yield desired synergies and benefits to your partner.
Below are some common options for expanding an existing partnership:
- Technical integrations between your product and theirs
- Joint marketing activities
- Reseller relationship, in either direction
- Technology licensing deal, in either direction
Don’t Become a Seller
Possibly the biggest difficulty in executing this whole strategy is establishing and expanding partnerships in such a way that doesn’t also reveal that you’ve decided to sell the company in the relatively near future. You want one or these companies to be the one to utter the “acquisition” word to you, rather than the other way around. In fact, you want to initially resist the temptation to show excitement in front of an acquirer that utters that word.
Great companies are bought, not sold. This involves as much art as science, and you can learn more about that from my article titled “Are You Selling Your Company or is Someone Buying It?”.
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
- I talked to a startup that expected to sell their company for something in the $10-15M range. The offer they got from a 2-person M&A advisory firm was as follows: 6% on first $2M, 5% on next $2M, 4% on next $2M, 3% on next $2M, 2% on next $2M and 1% on any amount above $10M.
- 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 1.5-2% range above about $50M.
Deciding to sell the company you’ve built is one of the most important and most stressful decisions a founder can make. This article describes an analytical and process-driven approach to executing that decision, but doesn’t cover the emotional difficulty involved. If you’re a founder that’s on the fence with this important decision, I hope seeing how the next steps of the process could play out somehow helps you with the decision.
And since you have some time to dial in your desired scenario, read my article titled “Don’t Accidentally Kill Your Future Acquisition Exit” to learn about the most common deal killers, or valuation subtractors, that are discovered during acquisition due diligence.