The Right Time to Sell

A process-driven approach takes the guesswork out of a successful startup exit.

There are a handful of options when it comes to choosing an exit strategy for a startup: friendly buy-out, controlled liquidation, IPO, merger of equals, and acquisition, among others. However, the most common options for highly successful companies are IPO and acquisition, with a heavy nod to the latter.

But when is the right time to sell? If a founder is lucky, he or she has time to ponder that question. Unfortunately, selling out of desperation and necessity is all too common. When there is time to consider the options, a process-driven approach can afford the best outcome for the founder, the acquirer, and the company.

Wanting Versus Needing to Sell the Company

There are limited reasons to sell a company: The founders decide they want to sell the company; others, such as investors or board directors, have decided it is time to sell the company; or there’s a need to sell the company before it runs out of cash. The core reason greatly influences the path taken.

Selling Due to Want

Startups that achieve sustainability and have plenty of runway with which to work are in prime positions. They are in the driver’s seat, with options. If they can’t find a desirable acquisition exit, they can keep going. If they find interested acquirers, but none that will agree on an acceptable valuation, they can keep going.

So, why sell the company if the founder doesn’t have to? There are several reasons, and some of them are obvious:

• • The founders are ready to reap financial rewards from what they’ve successfully built.

• • Without an exit, the company will need to raise their next round of funding, and the founder realizes that doing so means signing up for an extended tour of duty until he or she can deliver the future investors an acceptable investment return.

• • Something about the market being served or the product category is changing in ways that present heightened uncertainty and risk to viability in the future. Something about the market being served or the product category is changing in ways that cause big, strategic acquirer prospects to have a heightened interest in acquisitions. Selling sooner versus later presents opportunities for an oversized valuation.

• • The company has had a successful track record to date and that success isn’t expected to continue for much longer. Selling sooner versus later presents opportunities for an oversized valuation.

• • The founders and earliest employees have spent many years on the venture and are getting tired, bored, or less passionate overall about the mission.

• • The levels of stress and mental fatigue on the executive team have been high enough for long enough that selling and taking some time off is the right thing to do personally.

Founders and company executives should be honest with themselves about the reasons for wanting to sell the company. Other stakeholders, such as investors and board directors, will need to support the decision. They deserve to understand the true motivation.

Founders in this situation have an opportunity to think about the possible exit valuation. Before executing a plan, they should consider the minimum valuation they would need to sell the company versus the valuation they are hoping, or expecting, to get.

The first part of this exercise is selfish and purposely centered on the founder. How much money do they need to make to get excited about an exit? Next, they should think about the other co-founders and executives in a similar regard. Finally, it’s important that they understand whether their investors would be supportive of an exit at the valuations they are considering.

Selling Due to Need

This scenario is simple, and the most common cause is a progressively depleting bank account and low odds of raising more funding, or a low desire to do so.
Selling a company with only a couple of months of runway puts the negotiating power in the hands of the acquirer unless the startup can arrange a bidding war, but doing so takes time. So, let’s assume the startup is not that desperate and has at least six months of runway to execute a strategy.

The Best Acquirer Prospects

Founders should spend time evaluating who the most interested acquirers might be for their company. Most founders can quickly identify a number of them and might even have relationships with some of them, but usually there are more.

The evaluation of aspects beyond the ability of an acquirer to pay the desired price tag will increase the value of the sale for both the founder and the acquiring partner. When thinking about selling the company, it’s important that the founder does not spend too much time multiplying their equity ownership percentage times various exit valuations to determine if they will make enough to buy an island or just a hot sports car. At this point, there is still a long process in front of them.
Start with the synergies that would result if the two companies combined forces. With greater synergies comes a higher valuation and better overall negotiating leverage for the various acquisition terms that don’t relate to price. Higher levels of synergy also increase the odds that the acquirer will devote significant resources and funding to the 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 others 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 several things, but getting specific on likely synergies with each prospective acquirer is important. These are some common synergies that might exist for an acquisition exit.

• Deal Revenue Synergy: When the acquirer sells the newly acquired product to a customer, that sale strongly facilitates the sale of one or more of their own products.
• Sale Synergy: The acquirer has a global army of sales representatives who already know how to sell a product like the one being acquired. They can deliver expontential revenue growth versus what the startup has been able to accomplish with a smaller sales team and marketing budget.
• Customer Base Synergy: In this case, the startup’s customer base is highly attractive to the acquirer. In some cases, this means the acquirer is trying to expand into an adjacent market, and the startup already has exactly those types of customers.
• Product Modernization Synergy: The products and technologies the startup developed will breathe some life into the acquirer’s product(s) in ways that cause them to be modern versus old and legacy.
• Market Leadership or Competitive Differentiation Synergy: This synergy takes product modernization synergy to the next level. After the acquistion, the acquirer will be considered a market leader and, as a result, will be armed with a significant competitive weapon.
• Business Model Synergy: With this synergy, the way the startup acquires customers and the way they make money fits well with the acquirer’s existing business model. It’s also possible that the differences between the two business models offers the synergy. This happens when new business models are invented and later become proven and attractive to large industry incumbents.
• Operational Synergies: The processes and systems the startup uses for operating various aspects of their business either fits well with that of the acquirer or is highly desirable due to new advantages they’ll deliver to the acquirer.
• Geographic Synergies: The acquirer is looking for access to, or increased penetration in, geographic markets where the startup operates.

The greatest synergies will vary from prospective acquirer to prospective acquirer. A startup might choose to prioritize, or group, their identified acquirers based on those synergies.

In addition to potential synergies, the startup can further evaluate potential acquirers based on things like size, financial health, acquistion experience, acquistion reputation, and desirability to work for.

Acquistion Attractiveness Scorecard

After identifying the best acquirer candidates, reflect on how attractive the startup might currently be to them. This can best be done by evaluating the company along various dimensions from an acquirer’s perspective.

The founder should create a report card with categories like these:

• Existing customer base
• Customer acquistion strategy and process
• Sales pipeline
• Product functionality
• Technology
• Process and systems
• Intellectual property portfolio
• Financial results
• Team

For each category identified as relevant, a grade can be assigned similar to what an acquirer would assign. With this in consideration, the founder can view his or her company through an acquirer’s filter and understand that the acquirer doesn’t have the same emotional and biased ties as those who worked hard to build the startup.

Benefits of a Bidding War

Nothing drives up the exit valuation more than a competition between two or more interested acquirers. When there is only one acquirer, they sit in the driver’s seat for almost everything related to the acquisition. This includes the price tag, deal terms, due diligence timeline, and more. Having just two interested acquirers is all it takes to put the founder in the driver’s seat instead. Additionally, magic can happen when the interested acquirers are directly competitive with each other.

If the startup already has a relationship with one or more potential acquirers, they’ve got a jump on the entire strategic exit process. It’s more beneficial if those relationships are significant enough for the acquirer to be familiar with the startup’s product, business results, and business model, among other factors. But almost any form of partnership with a prospective acquirer is helpful because at minimum they already know who the startup is and what they do.

Expanding the List of Partnerships

Where a startup already has existing partnerships with prospective acquirers, they should evaluate possibilities to make those partnerships deeper and more strategic. Doing so should focus on exposing the additional synergies that could be realized via their acquisition. Another benefit of a deeper and broader partnership is exposure at higher levels within the partner’s organization. It is 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 with which the startup doesn’t have a relationship, it’s time to start that process. It’s basic business development. If the target company has a partner program for which the founder can apply, that is sometimes an easy and inexpensive first step. But it is rarely strategic, so that would only be a foot in the door to further expand the relationship along multiple dimensions, specifically ones that yield the desired synergies and benefits to the partner.

Using a Banker

One significant decision relates to engaging a professional mergers-and-acquisitions banker, broker, or advisor to assist with the process. These professionals come in all sizes, from solo freelancers to large Wall Street firms. The startup’s investors and board directors should be able to make some referrals.

Engaging such a professional costs money, but he or she can be worth it if he or she is experienced and if the founder has built an acquirable company.

At one extreme, the founder engages a banker right after the decision to sell the company has been made. With that, the banker can help refine the strategy from the onset.

At the other extreme,the founder waits for legitimate acquisition interest but before a letter of intent (LOI) is presented so the banker has some time to offer additional value. A banking professional will use the time to bring additional acquirers to the table, including ones with which the startup doesn’t already have a relationship. They will also serve as a front-person while soliciting, evaluating, and negotiating acquisition offers.

Some startups avoid using such a professional because they don’t want to relinquish a portion of the acquisition proceeds, but if the banker can help bring just one new acquirer to the table, negotiate a higher exit valuation, or negotiate more favorable legal terms, that is worth something.

The challenge often comes with exits smaller than $20 million. It is hard to find bankers that will do those deals because the profitability is not there for them. The amount of acquisition proceeds that go to the banker is predominantly dependent on the expected transaction size. The range varies widely, from as low as 1–2 percent for a large acquisition to as much as 8–10 percent for a small one.

Deciding to sell a company is one of the most important, and most stressful, decisions a founder can make. While it doesn’t address the emotional struggle, a process-driven approach to executing that decision can alleviate some of that stress and plot a path forward.