I’ve spent almost my entire career, going back to the 1980’s, in and around the area of tech mergers and acquisitions. I was the SVP of Corporate Development at Oracle Corporation in the late 90’s/early 2000’s, I ran the M&A function for a couple of other large companies, and I ran a boutique M&A firm for a number of years in Silicon Valley. I’ve been on both sides of M&A deals, having also been the CEO of a couple of software companies that were acquired. Few people have been around as many M&A deals as I have, over as long a period of time. And I’m puzzled.
What I’m puzzled about is how little attention people, both operators and investors, pay to what is by far the likeliest liquidity scenario for their companies: that it will be acquired by a larger company. If we look at the percentage of positive exits (meaning: we’re not counting shutting a company down, which – let’s not kid each other – is also a very likely scenario for startups) consummated by tech companies, acquisitions hover in the 95% - 98% range of those exits, year in and year out.
Of course everyone wants their company to go public. Of course. But if no thought is given to maximizing the value of their company for the far likelier scenario, the risk is that the company’s CEO will end up having this kind of conversation (a conversation which, I swear to you, happened all the time) with someone like me, a person who could help them be acquired:
CEO: Hey, Matt, I’d like you to help me sell this company.
Fantastic. That’s what I do for a living. To start with, why don’t you tell me who you think might be interested in acquiring you?
CEO: Acme Corp, Beta Corp, Company X, Company Y…
And what interactions have you had with those companies up to this point?
CEO: None at all. I’ve never spoken with anyone at those companies.
Umm, okay. And how much runway do you have before you run out of money?
CEO: Four months.
Think of the breathtaking illogic of what they are now asking someone like me to do: they are expecting that I will call the head of corporate development at Acme Corp and say something like this: “Hey, I’m going to tell you about a company that you may never have heard of in your entire life, or if you have you only know what you may have read about them or what you’ve heard second-hand. Acme Corp has no relationship with them. And I’d like you to buy them for a tremendous amount of money, ideally in the next four months. Okay?”
This is absurd, of course, and has essentially a 0% chance of bearing fruit. So we’re left with the question: what can a company do to maximize both the likelihood of being acquired and the valuation given to the company by the acquirer?
Here is where it helps to have a little understanding of the process that is happening inside of an acquiring company when they are doing a deal. If we understand that, we’ll understand the knobs and dials to turn to increase the likelihood of a strong outcome for us.
| FIRST: “GOOD COMPANIES AREN’T SOLD; THEY’RE BOUGHT”
You may have heard it said that good companies aren’t sold, they’re bought. I guess this is supposed to mean that good deals are consummated when the seller isn’t actively seeking acquisition – rather, they occur when the seller is pursued by the acquiring company.
But this maxim, while it may have the barest bit of truth in it, encourages indifference to the potential for acquisition and abrogates a basic responsibility of company management: the job is to maximize value, and every company is essentially for sale every day (for the right price, of course).
So, no. While good companies aren’t sold hastily, it’s still true that good companies are always sold. And by that I mean: actions are taken by the company’s management team to ensure an excellent result, and those actions are taken over a long period of time.
| THE ACQUIRING TEAM
Not every acquiring company will have a team of full-time M&A people, but the most common acquirers will. Others may use bankers who will act in a similar role. And there are a few things worth knowing about them:
While internal M&A people tend not to be financially compensated specifically for buying companies, nevertheless that is their job. They want to do deals. If they aren’t doing deals, there is no reason for the company to employ them. Bankers, meanwhile, get paid for closing deals. So both of them have a powerful incentive to do this deal.
"While good companies aren’t sold hastily, it’s still true that good companies are always sold. And by that I mean: actions are taken by the company’s management team to ensure an excellent result, and those actions are taken over a long period of time"
They tend to be gatekeepers, not decision-makers. They own the acquisition process, but the acquired company will belong to a business unit leader (or, perhaps, the CEO) post-acquisition. Hence, you will need buy-in from both the M&A person and the business unit leader to complete a transaction.
They will be very involved in the valuation process. In some cases, they will essentially set the valuation themselves.
Business Unit Leaders
Post-acquisition, your company will become a part of the acquirer, and typically there is some unit within the acquirer where your technology makes the most sense to reside. This is your first decision-maker. Without the express buy-in of the BU leader, you’re dead in the water. This is the person to court first as you think about an exit.
I suppose it’s possible that somewhere in the world an acquisition has occurred without the express support of the CEO of the acquiring company, but if it has I’ve never heard of it. The CEO’s buy-in is critical, and she/he is the ultimate decision maker.
| FINDING A BUYER
When the time comes for a company to find a buyer, the key principle is: the company probably already knows who the acquirer is. Over-the-transom deals do happen from time to time, but in the vast majority of cases the acquirer is exactly who the company thinks it would be. These tend to be partners, competitors, companies in adjacent spaces, and financial buyers.
Not only are these the set of companies most likely to buy the target company, they are also the most likely to pay an acceptable price. They are the companies most likely to project some synergies and therefore to experience outsized returns for their acquisition.
Care should be taken to craft a message specific to each potential buyer. How can we advance the acquirer’s strategy? What synergies could they expect to experience if we combined the companies? The message to each acquirer should resonate with them.
| THE PRE-ACQUISITION STAGE
Every acquisition process commences with rigorous due diligence. This involves an in-depth examination of the target company's financials, assets, liabilities, customers, market position, technology, and intellectual property rights. It's akin to a comprehensive health check of the company, scrutinizing its strengths, weaknesses, opportunities, and threats (SWOT).
Due diligence has four critical components: legal, HR, financial and technological.
Legal due diligence is really designed to get at one thing for the acquiring company: is there anything about this company that will come back to bite me later? Think of it: anyone who would have a potential legal complaint against the target company knew (before any acquisition) that the target company had a relatively small amount of assets against which to make a claim. Once a deal is done, the acquirer tends to see lawsuits coming out of the woodwork as latent claimants realize that the new owner is flush with assets (comparatively).
HR due diligence is critical, especially in technology deals where so much of the value of a target company resides inside of the brains of employees. The acquirer will want to determine that target company employee agreements are buttoned down and that the employees and culture of the company will be a good fit inside the acquirer.
Financial due diligence includes reviewing audited financial statements, tax returns, and other financial data. The goal is to understand the company's financial health, identify any contingent liabilities, and make revenue and profitability projections. Note that those projections are not purely for the target company, but rather for the company’s performance once it is brought inside of the acquirer (with all of the new opportunities and assets of a larger company).
Technological due diligence entails assessing the uniqueness, defensibility, and (perhaps most important) scalability of the company's technology. This includes the robustness of the tech infrastructure, quality of the code, and the soundness of the company’s intellectual property rights. It's crucial to have experts in this process to unearth any latent technological issues that could impact the company's value post-acquisition.
Following due diligence, the next step is to ascertain an equitable valuation for the company. This process involves a syzygy of art and science, necessitating comprehensive financial modeling and market comparisons, as well as an understanding of the company's strategic value. Investors often utilize methods such as discounted cash flow (DCF), comparable company analysis, and precedent transaction analysis to calculate the company's valuation.
Note that a DCF model gets a little squirrely with smaller tech companies. It is very difficult for those companies to forecast with any accuracy even two years into the future, especially if they are growing quickly. How much faith can you place, then, into a forecast that stretches out five years or more? Most companies solve for this by being extremely conservative in DCF forecasts, and they almost always include an analysis of recent comparable deals.
| THE ACQUISITION STAGE
Once the valuation is determined, negotiation ensues. This can be a complex and protracted process, as it involves not only agreeing on the price but also on myriad terms and conditions. This stage typically involves attorneys, investment bankers, and other professionals to navigate the legal complexities and ensure a smooth negotiation process.
During negotiation, investors should be discerning, balancing the desire for a good deal with the need to maintain a good relationship with the company's management. It's important to remember that the company's leadership is almost always critical to the acquirer post-acquisition, and their buy-in is critical for the success of the deal.
Closing the Deal
The culmination of the acquisition process is closing the deal. This involves signing a definitive agreement that outlines the terms and conditions agreed upon during the negotiation. The agreement typically includes clauses such as representations and warranties, conditions to closing, strong indications that critical employees will join the acquiring company, and various indemnification provisions.
The closing process often involves a simultaneous signing and closing, wherein the purchase agreement is signed and the transaction is consummated at the same time. (This tends to be preferred wherever possible. However, in some cases, there may be a delay between signing and closing to fulfill certain conditions precedent.
| THE POST-ACQUISITION STAGE
Post-acquisition, the focus shifts to integrating the acquired company into the parent organization. This includes melding different cultures, systems, and processes, which can often be a Herculean task. Probably nothing is more critical to the success of an acquisition than a smooth integration process.
| BEST PRACTICES FOR MAXIMIZING VALUE
In order to maximize the value of an acquisition, investors should consider the following best practices:
1 Start early.
The biggest mistake sellers make is starting too late to interact with potential acquirers. Smart companies will identify their potential acquirers early and develop business and personal relationships with those companies. What kind of relationship? Anything is better than nothing.
2 Clear strategic fit.
Good acquisition candidates can typically communicate a strong strategic rationale for combining with an acquiring company.
3 Develop multiple bidders.
Virtually nothing will drive the value of a deal more favorably than having multiple bidders at the table.
4 Effective negotiation.
Skilled negotiation can lead to more favorable deal terms and a higher return on investment. That said, it's important to be patient, flexible, and willing to compromise to reach an agreement that benefits both parties.
In conclusion, the acquisition process is a complex journey that requires strategic thinking, careful planning, and meticulous execution. By understanding the key stages and adhering to best practices, investors can navigate this process effectively and maximize the value of their portfolio. As technology continues to evolve and reshape the business landscape, acquisitions will remain a pivotal strategy for growth and value creation.
General Partner, Pelion Venture Partners.