For most founders, selling a company is a life-changing event, leading up to which you get little training. Like raising money, the best time to sell your startup is when you don’t need to or want to. Paradoxically, many founders look to sell their startup as a plan C, when there is a lack of traction, tough competition, or difficulty fundraising. The result of that is likely a small set of bidders and less leverage on demands for the ones who do come to the table.
The best time to sell your startup is when you have options. These options don’t all have to be acquisition offers; they can also be venture term sheets for your next round. You might even be operating profitably and find yourself in the enviable position of confidently being able to turn down an offer. Usually, you will have these options because your startup is actually gaining traction; counterintuitively, the best way to build to flip is actually the same as building a successful company.
Here's how you value your company, garner interest in it, and navigate through the acquisition process.
Starting acquisition talks
Do not enter acquisition talks unless you are ready to sell your company. Negotiating an acquisition is the most distracting thing you can do in a startup: going through a merger and acquisition is an order of magnitude more work than raising money. During that time, your ability to run the day-to-day operations of your company will be impacted. You should only enter an acquisition process if 1) you are certain you want to sell the company and 2) you are likely to get a price you will accept. Don’t go down this path just out of curiosity.
Valuing your startup
Investors value companies based on either their financial value or their strategic value. A company’s financial value hinges on its profits and model of its future cash flows. For many tech startups, it is much more likely that your company will be valued based on where it fits with the acquiring company’s strategy. Here are some surprisingly common reasons your startup has strategic value to an acquirer:
The CEO finds it interesting or wants to keep it away from a competitor
Your company unlocks access to an audience or market share of value to the acquirer
A competitor to the acquirer is out-executing and you can help the acquirer become better
The acquirer doesn’t have the talent in an area where you have employees
Your businesses have synergies and combining them is theoretically value-accretive
The acquirer is running a similar business but you are executing much better. They are afraid of you
When it comes to setting a price, there is no right price for a company, there is only the price that you can negotiate. Management teams, investment bankers, and corporate development people will use an array of metrics — like cost per user — to justify a number. Ultimately, though, the clearing price for a startup depends on what can be justified to the market (previous comparable acquisitions, for instance) and the sale price that you and your investors agree to.
A potential acquirer’s first offer is rarely its best offer. Don’t be afraid to say no. There are many negotiation strategies, but in order to extract the most value you need to be willing to walk away and to initiate a competitive bidding process.
The best way to solicit acquisition offers is to have ongoing conversations with potential acquirers about ways you can work together. Within a big company, these conversations usually involve many different people; you’ll only get an offer once a sufficiently high-up decision maker is convinced that buying you is a better idea than partnering with you. When you have an offer, the next thing to do is determine your alternative options. You can do this by letting other potential acquirers (including larger companies you have partnered with and/or competitors to the acquirer) know that you have received a term sheet from an acquirer and you are considering selling yourself, but would prefer a longer-term future with their company (find a reason). Now would also be a good time to call up venture capitalists you have been talking to and ask for a term sheet for your next round. Sometimes, a company you are doing a critical business development partnership with will insist on a cool-down period in an agreement. This is a period of time during which you have to wait once you’ve received an acquisition offer before you can sign (for your partner to theoretically prepare a better counter offer). Cool-down clauses can actually work in your favor as a way to acquire additional offers once you’ve received a first term sheet.
Weeding out the bad offers
Most of the offers you will receive to buy your startup will not be real. It costs a company exactly zero dollars to tell you it wants to buy your startup. These offers are dangerous because they can lull you into a false sense of security.
How do you sniff these out? One big tell: it doesn't come with an expiration date and/or a promise of a term sheet delivery within a day or two. When a sufficiently high-up decision maker decides they want to buy your startup, they will attempt to meet with you constantly and put time pressure on you, so as to prevent you from shopping the deal and getting a better offer. The absence of this behavior indicates the other company is not serious about acquiring your business.
Often the expectations of the founders and corporate development people diverge. Before proceeding far into conversations with big acquirers, try to clarify valuation expectations (and other important consideration details, like retention packages) as quickly as possible. This strategy should help prevent you from having half a dozen meetings, only to find out the potential acquirer expects to pay $10 million for your rapidly growing startup that already has a term sheet for a $15 million Series A round.
Hiring a banker
Like the world of venture capital, investment banking is a field with a small number of extremely well-connected, analytical, and experienced people. Investment bankers typically charge one to two percent of the total value of the deal. But you may not need an investment banker at all unless your selling price is in the mid-millions or higher, and maybe not then either.
However, the right ones can help you get a thorough understanding of the competitive landscape, navigate decision makers at every potential acquirer, and know what buttons to push to maximize your deal value.
Also, keep in mind that the people you are negotiating with in corporate development are professional negotiators. Their job is to get the best deal for their company. Having a professional negotiator on your side can be extremely valuable.
Pre-term sheet diligence
If you are committed to going through an acquisition process, you should be fairly free with your company data (under an nondisclosure agreement), as it is better that the acquirer uncover any red flags before you’ve signed a term sheet and entered the closing process.
However, if the potential acquirer asks to interview your team you should not give into this (unless you are going through an acqui-hire and have no other options). Letting a potential acquirer interview your team is extremely distracting for the team, and signals to the acquirer that you are willing to yield to its terms.
Signing a term sheet
Once you have collected all your term sheets, get ready to sign. But before you do, to negotiate the business and legal points in as much detail as possible. Feel free to push back on exploding offer deadlines and other pressure to sign immediately. After you sign, you can expect any points that weren’t previously negotiated will end up with language in favor of the acquirer.
As the startup, you have all the leverage before you sign a term sheet. Once you sign, a lot of that evaporates as you have committed to selling the deal to yourself, your employees and investors.
Once you get negotiation fatigue — and maybe even before — you will start to agree quickly to things you wouldn’t have considered at the term-sheet stage. Also, once you’ve signed a term sheet you can no longer shop your company to other acquirers. If your deal falls apart, other acquirers may have cooled off or think that the deal fell through for other reasons.
When negotiating a term sheet, push for the shortest possible closing period (target 30 days) to avoid getting deal fatigue and to put pressure on the acquirer (although, be aware that sometimes a regulatory issue will dictate the timing of the closing and that is outside of everyone’s control). A short closing period will also help you somewhat limit the distraction from your main job: running your startup.
Keep in mind that just because you signed a term sheet does not mean your deal is done. In fact, it is a possibility that it will not go through. Despite a commitment to trying to close, companies can change their minds during the diligence process.
The most dangerous stretch during the acquisition process is the time between when you decide you are going to sell, and when the sale actually occurs. But be prepared to ask yourself:
What happens if the acquirer comes back and changes the total deal value?
What happens if the acquirer changes its mind, and you have to go back to the grind?
What happens if the acquirer has talked to your senior management, and then decided your team isn’t good enough?
What happens if you run out of cash before the deal closes, because negotiating the deal documents took twice as long as you expected?
These things happen. You should be prepared to walk away from any deal up until the point where you are watching your bank account, waiting for the wire transfer from the acquirer to hit.
Getting to closing is a process largely driven by lawyers. The items to be negotiated are typically divided into legal points and business points — the lawyers will resolve the legal points, but you are expected to figure out the business issues. The outcome is ultimately your responsibility, so be prepared for the time and effort this process will take.
Disclaimer: LTSE is neither a law firm nor provides legal advice. Before making decisions on matters covered by this post, readers should consult their legal adviser.