What Founders Should Know Before “Selling” their companies
Summary
In corporate acquisitions, there are two types of leverage. The first is negotiation leverage, whichever side knows the opponent’s weakness will have the advantage in the agreement. The second is the leverage of knowledge, which depends on the Founder’s understanding of the needs of the market and the potential the business can achieve. It is difficult to change the negotiating leverage. But the leverage of knowledge is possible, investors can point to a multitude of weaknesses in the way the business operates in order to get the upper hand in the deal. But as long as the Founder acknowledges the value and potential of the business, they can force the Investor to spend a huge amount of money to own shares of the business.
Most Founders choose to divest through the transfer of company shares. Advice and knowledge about divestment are plentiful online, but there is very little content about the lives of Founders after divestment – while they and their associates often take years of hard work with Investors. Business acquisitions are an interesting story, but not every business owner thinks so!
Throughout my career, I have experienced over 11 different acquisitions in multiple perspectives: a founder, an investor and a member of the board of directors. Recently, I had the opportunity to listen and share with the Founders about selling the business. And here are some tips I learned from my own experience as well as from what I heard from other Founders about the startup sale.
The psychological transformation from a Founder to an employee will be very difficult and gradually tend to deteriorate in the next years of the business life cycle. You will be influenced by the thought “Founders build a business X and then sell it for $Y” – but gradually you will realize that investors will judge you through the way you work with colleagues and the benefits you bring to the company. You will also have some trouble with new colleagues who have worked hard for 10 years without making an investment. As well as the feeling that the changes coming from the Investor seem inappropriate and cause the business to go down. Get rid of negative thoughts and recall the reason for starting this. Be happy to embrace change and learn from experience, looking for ways to improve the missing elements to motivate a new goal – with a larger enterprise size.
The topic mentioned in conversations like this will often be “If only I knew what to do”. Understanding the type of leverage you have, the type of deal you have, and the factors that are important to motivate your employees will make it easier to achieve success and employee happiness.
About author:
David Jegen is Managing Partner of F-Prime Capital’s Tech Fund. He has led investments in Flywire (NASDAQ: FLYW), Toast (NYSE: TOST), Snapdocs, Kensho (acquired by S&P Global), FutureAdvisor (acquired by BlackRock), Quovo (acquired by Plaid), EVEN Financial (acquired by MoneyLion), Vendr, 1upHealth, Papaya Payments, Unison, Tradier, Guros, Axoni, Parrot and Cloudant (acquired by IBM). David was co-founder of Sensoria and VP of Product Strategy at Into Networks, an F-Prime Capital-backed company. David was also a senior executive at Cisco Systems and held early positions with J.P. Morgan and BCG.
How much can you shape the outcome?
More than you think!
For corporate acquisitions, there are two types of leverage. The first is negotiation leverage, which determines who wins on terms of compromise. The second is knowledge leverage – that is, you can anticipate what can be won without jeopardizing the deal.
It is very difficult to change the negotiating leverage or compromise with the difficult requirements of investors. But with the leverage of knowledge, it is different. Investors can point to a multitude of weaknesses in the way the business is run to get the upper hand in the deal, but as long as the Founder understands the value and potential of the business, they can force Investors to spend a huge amount of money to own shares in the company.
Understanding Investors (KYA: Know Your Accquirer)
Giving some general assessment of the Investor will help you and your associates be better prepared.
Perennial Enterprises and Startups: It is clear that the bigger and older an Investor is, the more cognitive and cultural disagreements you will encounter. You can’t change this, but you can lead the business with emotional intelligence. Investors will pay very high for this. On the other hand, being acquired by a startup will likely make you feel more comfortable from a cultural perspective and find similarities in everything from technology tools to HR policies.
Handling of post-acquisition integration activities: When we had the opportunity to work at Cisco in the early 2000s, we completed 23 acquisitions in one year. Some acquirers offer benefits; some don’t. Either way, make sure you know what’s going to happen “the next day.” Ask the buyer to detail their plan, because it will raise many important issues for you, your employees, and your customers.
Investor culture:. You may feel that the time of 2-3 years passes very quickly, but in fact it does not. That matters if your employees are entering a culture that makes them feel like home. You’ll be caught up in the buying dynamics, so ask yourself if this is a company that fully reflects your values. Talk to more people, not just acquirers and deal sponsors, you can discuss with the CEO of a start-up they bought earlier.
Understand why the business received the investment
There are five types of acquisitions, and you need to understand the model that works for you to determine the approach.
New product and new customer base: You know more than buyers, and they can ruin what you’ve built, so you should struggle to retain the autonomy of your business. The redemption failure rate is equivalent to the success rate. Good examples are Goldman Sachs and GreenSky, Facebook and Oculus, Amazon and One Medical, and Mastercard and RiskRecon.
New product or service with the same customer base: Most acquisitions fall under this model. The founder should quickly combine these two products/services to make it easier to succeed. Integrations can be a bit tricky for the earn-outs clause, you should limit these. Typical deals for this model include Adobe and Figma, Google and YouTube, Salesforce and Slack.
New customer base, but same product type: In this category, you know who the customer is, and the buyer doesn’t. Maintaining a higher level of independence in the short term is critical to the success of the acquisition. Be ready to share your knowledge and mix. Examples include PayPal and iZettle, JPMorgan and InstaMed, and Marriott and Starwood.
Same product and same customer base: Buyers want to know your customer base and are likely to become a competitor that eliminates you. Your information will be integrated into the customer base and quickly lose its independent identity. Examples include Plaid and Quovo, Vantiv and Worldpay, ICE/Ellie Mae and BlackKnight.
Recruitment (Acqui-hires): You have built such a good team that another company is willing to buy the company to get your employees. In fact, this is an interesting direction for you and an unnecessary purchase for the acquirer.
What does SB 1000 require?
Throughout the acquisition process, founders will often focus on transaction points such as valuation, working capital adjustments, escrow, and compensation. These are all essential to know, but your experience over the next two to three years will depend more on how things work after the acquisition. In hasty transactions, buyers will reassure you not to worry about these points, but you still need to consider. The following are often unnoticed points of agreement that you should consider:
Indemnity For Officers You should adjust the compensation for employees before being acquired because it will be difficult for the buyer to change them later. Your employee is paid the original salary, which is higher when the equity increase is removed. Note that contracts can still be broken, so compare compensation benchmarks and then wait for execution until you are sure the trade is complete.
Title: Staff You need to align the titles with the remuneration offered by the buyer to your employees. As a startup, you’ll probably focus on equity and interest, but buyers will often be concerned about cash compensation and other benefits. Learn the difference between titles before arranging for your employees, as large companies often rely on titles to determine bonuses and limit access to leadership meetings. Try to bring the most benefits to your employees – you have the Leverage of knowledge on them, so use it.
Maintenance Investors always want to keep the core employees of the business, and you (the business owner) have the right to decide who is retained and who must leave. However, it is a double-edged sword because almost all employees often want to stay for additional compensation. Efforts are made to retain employees who only stay for a period of two to three years as the additional compensation would be a very long and wasteful amount of time. Instead of retaining all former employees, you should negotiate with the investor for another benefit, which you can use to retain key employees who want to leave immediately after the M&A.
The budget and recruitment plan are agreed in advance: You think raising money from investors is difficult, but wait patiently for the company’s budget. Most large companies use budget and headcount as their control mechanism, so talk about it in your first year. You want the freedom to carry out your projects, so you should not take the time to plan a detailed report for each item with investors who did not appear in the initial M&A process.
Administration
Who will you report to? Seniority and investor power are the most important factors. You won’t escape company-wide budgeting processes, but it’s better to convince the right people. If you are an independent business unit, try to negotiate and convince the departments of the investor’s business to join the board. This form may seem new to investors, but it is the best way for your business to leverage the model and functionality from parts of the large business. Finally, avoid applying the matrix management model at all costs especially in case your business is earning out.
Earnouts – M&A pricing structure: investors prefer them because they are directly related to price and performance, but you should avoid them. It is easy to say, but you will never have the freedom in projects like before M&A, and unexpected “forces” will disrupt the best plans you have made. You can crush it based on revenue and ignore gross profit, or hit all your goals 12 months later. It will depend on your fundraising process, but if you have a chance to earn 25% more through earnout or settle for 10-15% more upfront, I would prefer to take the smaller amount first.
Management Board
Most acquisitions begin with a voluntary sharing of benefits, and CEOs are tasked with communicating them to the Board. Some people are easy to agree with, but others will have questions that shake up the original plan: Do you really want to do it? Don’t you want to do business for a long time? How much would you sell for?
This is when you will understand the true character of the shareholders. Everyone understands that Series B investors with a $125 million valuation will not be interested in $200 million deals. However, the real task is to find the least risk-adjusted outcome for the company, its co-founders, employees, and small shareholders. This is the time when you will be glad to have chosen suitable companions for a shareholder position on the board, and the decisions of the board will become more valuable.
If you decide to partner with an investment firm, finding a CEO who has experience in M&A can be of great help. If you are not an experienced administrator, seek help. You do not want the entire Board to engage, so convince them to appoint one or two members to the M&A board. You will avoid many small mistakes — and there are at least a few Board members who will be convinced when you return with the Letter Of Intent.
Selling your company is the tip of the iceberg, and the more you know about the post-acquisition life before starting negotiations, the happier you and your employees will be over the next two to three years. There are tremendous psychological and operational changes ahead, and you can influence many of them by using this model to consider when and where to negotiate.
Source: Havard Business Review
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