A next-gen nutritional startup received a low-ball offer for a majority stake in their company. I spoke with the founders earlier this week, and the conversation brought to mind many similar situations.
I’ve encountered this often: Entrepreneurs have their head down for years, working hard to build their business, when all of a sudden they receive an acquisition offer.
Oftentimes, they don’t know what to do with it. They don’t know how to evaluate the offer.
But this doesn’t have to be the case. Below are five things founders should consider when assessing inbound interest.
1. Don’t Jump at the First Offer
When an entrepreneur sees their first acquisition offer, it may be the most money they have ever seen. The founders are likely excited and eager to sign on the dotted line.
This brings to mind a famous saying: Sometimes, the trades are the ones you don’t make.
In other words, now might not be the right time to sell.
Consider the following: In 1999, an investor convinced Google founders Larry Page and Sergey Brin to sell their company to Excite for $1 million. After Excite CEO George Bell rejected the $1 million price tag, the investor talked the duo down to $750,000—but Bell rejected that figure as well.
The $750,000 in consideration? Today it would be worth over $200 billion. Excite has since been sold to AskJeeves, which is now a small part of IAC Corp.
One of my clients had an experience not unlike this one. Once he started building a solid client base and partner network for his digital security company, potential acquirors came sniffing around. This was his first venture, mind you, so my client was very excited about what some would consider lowball offers. He was eager to set up a trust, put money aside for his kids, etc.
Ultimately, we talked him out of the deal and encouraged him to continue building his business. If he went about it right, more acquirors would come knocking with checks many times the size of what he was offered initially.
About a year later, my client sold a good chunk of his ownership in a bad deal. He was excited to liquidate some of his holdings in exchange for upfront cash—but much of the “capital raise” was a secondary offering that left only about $10 million in new capital for the business. Further, because the new investors owned a considerable stake and needed a certain hurdle rate, this complicated future sale discussions and limited the company’s ability to take the next best offer that came along.
Sometimes, building the business is what’s most important. No matter how tempting it may be, don’t jump at the first offer. If you’ve put the work into building a viable, successful company, this is will only open up more doors and bring along better offers in the future.
2. Note that Inbound Interest Trumps a Formal Sale Process
Building on the above point, receiving acquisition offers beats going out and shopping a young company to potential acquirors. I advise a number of companies that are eager to sell, and cannot emphasize enough that founders are hungry to realize the payday they’ve been dreaming of since before the company’s inception.
What does this mean? It means that some founders will look to run a sale process and start chasing potential acquirors. And while a marketed process may bring the highest certainty of sale, waiting for an unsolicited approach is more likely to maximize value.
The best thing young companies can do is continue building their pipeline. Find new clients and customers, seek out new partners, and become entrenched with all of them. The more traction—and the longer history—you build with all the parties in your ecosystem, the more you will appeal to potential acquirors. This is more appealing than running a sale process because you haven’t actively sought out an interested party—they came looking for you.
In simple terms, the ball is in your court, and you can leverage your position to receive a higher purchase price and more favorable acquisition terms.
3. Remember that Strategic Value Garners the Highest Acquisition Price
As a young company, you’re most valuable not for your current revenue stream or immediate product portfolio. No, your value lies in the fact that a potential acquirer cannot afford not to own you.
Unilever, for instance, acquired Dollar Shave Club for $1 billion. Walmart paid $310 million for Bonobos and $3.3 billion for Jet.com. The acquirors needed these companies—Dollar Shave Club because they were eating the bottom out from underneath the personal grooming industry. They couldn’t afford to see DSC acquired by Gillette. Walmart needed to pay a high premium to acquire Bonobos and Jet in order to catch up with Amazon in the eCommerce race.
In these situations, the targets commanded premium valuations by maintaining their leverage.
Among the transactions I’ve worked on over the past few years, the companies that commanded the highest premiums were those that focused on growing their business. They were acquired because of their strategic value, because they were strategically important to their acquirors.
While marketed sale processes sometimes garner desired valuations, potential buyers usually see right through this approach. They wonder why these businesses are for sale in the first place, and question why a founder would give up the opportunity to ride out the eventual upside of such a promising young company.
The takeaway here? If you build it right, they will come. Be patient, and be sure to leverage the strategic value of your company.
4. Consider Dis-Synergies and Competitive Consequences
If there’s anything young companies should keep in mind, it’s this: Partners and customers are also potential acquirors. This presents both challenges and opportunities.
Let’s talk challenges. In a sale process, marketing and outreach can be potentially damaging to the business, which may hurt the pipeline.
Customers and partners want to see stability. To this end, the neutrality in a young company’s ecosystem is what allows customers and partners to trust the company with data, purchases, and more. Once a company is acquired, it tends to forfeit that neutrality—and this means valuable, big-ticket customers may leave when they find out their biggest competitor has bought that young company.
An eCommerce company I recently advised dealt with this same issue. They sat at a neutral focal point in their ecosystem. Customers and partners bought from them, shared their data with them, and actively partnered with them. Once the young company announced a sale process, these same partners decided to pursue other avenues. The company was still in the early stages of building those partnerships, and the much-bigger partners wanted a company that was in it for the long haul.
Simply put, they wanted a young company with stability. Their customers felt the same way. Eventually, the company sold in a successful process, but the post-acquisition pipeline was no longer as robust.
In many sale processes, young companies and prospective buyers are eager to talk about synergies. Dis-synergies are often overlooked, and yet they are equally important when evaluating a potential acquisition.
5. Examine Dis-Synergies When Evaluating Transaction Structures
An earn-out is a provision written into an acquisition offer. It indicates the seller of a company will receive additional payments based on the future performance of the business being sold. For example, if a young company is acquired for $300 million, $250 million of this consideration may be received upfront, with the remaining $50 million structured into an earn-out that is only received if the selling company hits specific sales targets.
Earn-outs are common among young companies with limited historical revenues, but significant future growth projections. A buyer may want the target to put its money where its mouth is, so to speak—especially if it is promising hockey stick-type growth.
I’ve sold many companies that have tried to navigate the earn-out discussion, and I can say with confidence that the abovementioned dis-synergies should be a real consideration. In particular, your growth projections are likely assuming that everything goes as planned—that none of your customers or partners jump ship. If you’re in an ecosystem or industry where neutrality matters, then others may leave your pipeline if you sell out to a major competitor.
Basically, partners may no longer be as eager to work with you, and large customers may not want to buy from their competitors. Both parties will seek other paths, which can hurt you three-fold: 1) Your pipeline will suffer, 2) Your competitors may benefit, and 3) In an acquisition scenario, your consideration will be tied to growth projections that did not take any of this into account.
What young companies really ought to consider is that in evaluating dis-synergies, they should aim to avoid potential earn-out structures—especially if neutrality and competitive dynamics are a major concern.