Selling Your Start-Up Company
September 21, 2011
The window of opportunity for IPOs seems like it is getting smaller. So many entrepreneurs are seeking to sell their companies through an acquisition. The unfortunate truth is M&A activity is directly related to the publicly traded indices, as well as the private equity market. Many entrepreneurs want to know if it’s a good time to sell their companies, but the market is sector specific. Some markets such as mobile communications and social media are doing well with acquisitions right now.
Many investment bankers and investors note that most acquisitions occur because of a previous relationship. Perhaps the acquirer and the start-up were partners or maybe the acquirer was a distribution channel for the start-up, regardless, it’s usually not a sudden move on the part of the acquirer.
If you are approaching an unfamiliar organization about a possible acquisition then a good reason is when your strength and theirs are complementary, and such a deal will allow your start-up to grow to the next level. A poor reason is just because the founders are tired and want to move on. Succession planning is positive, but abdication is never viewed in a good light.
What really makes deals close is having multiple prospects to purchase your company. There’s nothing like someone else who wants you to spur on the deal. Most start-ups should be able to identify 10 potential acquirers. Building a funnel of buyers is important with at least one highly interested party and a second credible threat. An entrepreneur needs to do so before a potential acquirer places a gag or exclusivity clause on the start-up to prevent them from seeking other buyers for a period of 45 to 90 days.
Not all acquirers are large publicly traded companies. Many private companies look to acquire smaller start-ups so they can build them up for an IPO. Often these private companies are looking for start-ups with a single product and a great team.
The reason it is recommended to hire a professional negotiator is they can be highly aggressive in getting the start-up the best possible deal from the acquirer, and the start-up can maintain a good working relationship with the acquirer. It’s no good for anyone if the deal closes and both sides are so bitter that they can’t work together.
How do acquirers value a company? A start-up’s valuation is likely to be a multiple of revenue and cash flow with technology, intellectual property, key employees and future growth opportunity being secondary. The acquirer often takes into account recent comparable M&A deals. For the most part, an acquirer wants to base the price on past performance and the start-up wants it based on future projections, and somewhere in between lays the deal.
Often the reason a deal doesn’t close is the companies couldn’t agree upon a valuation, or the price wanted by both parties is just too far apart. Of course, the obvious solution is to try an earn-out, where a bonus is paid for meeting future performance. Earn outs have many problems caused by complex terms and conditions or dysfunctional dynamics results within the organization. An earn-out is most likely to succeed if the original start-up is automatous and simple metrics are used such as revenue and milestones. An additional concern with an earn-out is the start-up competitors will target its customers and prospects in an effort to pull them away – sometimes affecting the start-up’s ability to perform against the earn-out terms. It’s not uncommon for an acquirer to hold 5 to 10 percent in escrow for 12 months to insure they are buying what they think they are. The best advice for those who sell start-ups every day is to get as much cash as possible up front.
The truth is that not many acquisitions of young start-ups yield much for the acquirer, and so acquirers have become cautious with buying the pig dressed up with lipstick – and rightly so.
Filed under: Management
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