Startup: An Insider's Guide to Launching and Running a Business (26 page)

In addition to dealing with tough issues in the proper way, your preparation for an acquisition maps very closely to the good execution of the operational principles discussed throughout this book. Primary among these are

• Having identified a clear niche in the market and subsequently taking ownership of it through effective positioning and communications.
  
• Having built your organization to be self-directing, or self-managing (staffed with employees that are trained and empowered to run the business without the principal owers).
  

_________________

Common Reasons for a Sale

Even if you want to operate, build your company to sell. Keep your options open. You never know what can happen to change your needs or outlook. Here are some events that can trigger an exit (planned or otherwise):

• A plan to build and sell from the very beginning
  
• A belief that the future of the niche or market is not good, and you need to get out while you can
  
• Health issues
  
• Relationship issues between founders
  
• Financial weakness (perhaps leading to a bargain-basement acquisition)
  
• An unsolicited offer that’s too attractive to pass up
  
• Investor fatigue (you are not yet wildly successful, and your investors or principals decide they want to move on)
  

_________________

What Makes a Business Attractive for a Sale?

Simply wanting to sell is not nearly enough to get you bought. In my case, when challenged with the task of getting a business acquired, the thought process for positioning and building to accomplish that end iterates repeatedly over the question of what our strengths are, and what the market has and does not have.

What would make us attractive (or irresistible) in the market?

Here are some common answers to that question:

• A developed product that would be too much effort to duplicate
  
• Intellectual property that an acquirer could not obtain any other way
  
• Strong brand recognition
  
• Physical assets
  
• A significant customer base
  
• Industry-leading talent on your team
  
• A larger rival in your space looking for greater market share
  
• Weakness (an acquirer may believe that they can buy your company cheap for resale, or that they can fix and operate your company)
  

_________________

Relationships Count

Relationships with the right people at the right time account for a great deal of the opportunity that you will need to be successful in your business. The same goes for your exit. Your chances of finding a good exit are enhanced significantly if you have a robust network. So long as you have a good reputation and a good story to tell, the more people you know, and the more people who know you, the better.

An individual’s personal network is usually a very slowly evolving structure—so get ahead of the curve and shore up your network before you need it. Make it a point to be involved in trade groups, investor forums, CEO meetings, and the like from early on in your business. Two of my transactions came about because of attending an industry event and rubbing elbows with fellow executives over a cold beer.

_________________

Choose the Front Man Well

Once you decide to sell, or once you are approached, consider carefully who the front man (or front woman) should be for your business. It may not be the smartest person on the team, the most experienced, or even one of the founders, but a good front man is a person that can open doors for you. Pick someone with the right look, the right words, the right swagger.

For the sale of our real estate dot-com project, we had this in our CEO. He was invaluable in that he looked the part and could play the role expected by the acquiring company. We would not have had a deal if it were not for the CEO’s ability to win over the investors early on with “old-boy network” charm. It also didn’t hurt that he was smart and had a lot of experience in transactions from his previous work. Our company was a good purchase for the acquirer, but this connection and networking was what made the sale possible.

A sale has to be a mix of the right numbers and the right emotions. The numbers have to add up to a good value for the acquirer. But numbers alone are not enough—you also have to set the right feeling and emotional tone with your potential suitors. Some say that emotion does not have a part in business, but I assert that it is frequently at the heart of transactions when businesses are sold. Part of that emotion on behalf of the acquirer is their feeling about the organizational risks involved in buying your company. This category of risk includes whether or not the people, processes, and hidden aspects of the business are really as good as you portray them. The organizational risks are framed and communicated by your front man—and this is a critical process. A good front man can open doors and help you to close deals that you would otherwise never have had.

_________________

Getting the Right People on Your Side

If you are looking to sell your business, you need to get your organization’s financial IQ developed and working toward the right ends quickly. If your
principal founders are not experienced with negotiating and structuring financial deals, you need to find somebody that is, and start working with them months ahead of any negotiations to sell or take on serious capital investment.

A lot of irrevocable decisions can happen very quickly in this kind of transition, and a lot of value can be won or lost in the small details. The investors that you will likely be dealing with in these scenarios are (probably) going to be savvy, sophisticated, and more experienced than you in terms of the business of buying equity and structuring deals. In the process of selling a business, it is typical for the entrepreneur to have significantly less experience. In my case, I have been in three major transactions over 18 years or so. That means I have had some very specific experiences and a reasonably diverse track record as an entrepreneur, but compared to a venture capitalist (VC) or private equity group that might do five or six transactions per year, three is not a very impressive number in terms of negotiations. I think about it this way: if I had played baseball three times in my life, I would have a lot to say compared to somebody who had never played the game before, but would be at a disadvantage against an professional competitor in the sport. Professional negotiators and VCs are (usually) good at what they do, and they benefit from the fact that a significant gap between their knowledge and yours can cost you a lot. Make sure your team has an experienced deal-maker engaged on your behalf. Jeff Olson, a publishing pro who helped me extensively in the production of this book, experienced this in his career when he sold part of his business to a larger competitor several years ago. The situation was typical in that he felt utterly and completely outgunned when dealing with the guys on the other side of the table during the negotiation. He wishes that he had had more support and experience representing his interests during that process, and will always have some lingering doubts about whether or not he got the best deal possible.

Knowing this, you should make sure that you have your own gunslingers at the table with you during any acquisition.

• Hire an attorney that specializes in venture capital and acquisitions.
  
• Bring in an experienced businessperson to help you negotiate. Look for people like this well before you need them, and build their context in your business over months and years—you will benefit in many ways from doing this, in addition to having them there to advise you in a buyout.
  
• Setting up a formal (or informal) board of directors for your business early on can be another way to have experienced businesspeople on your side to help guide you. Being a board member is a minor status symbol for businesspeople, and it need not cost you anything to get them to agree to serve as one.
  

_________________

Due Diligence

Any sale will include a period of investigation called
due diligence
, in which an acquirer will attempt to get inside your closet and look for any skeletons. Make sure you don’t have any. Or, if you do, consider framing them constructively and proactively sharing them with your potential acquirer.

To get through due diligence

• Be free of lawsuits and legal entanglements. The uncertainty of pending lawsuits will scare away most potential acquirers.
  
• Ensure that you have maintained full and proper bookkeeping and financials.
  
• Provide all contracts and current legal obligations.
  
• Show that you have used intellectual property properly. In a recent acquisition, we went through two months of intense due diligence. Neither the principals on our side nor our attorneys had ever seen anything like it before—we were presented with a long list of disclosure requirements that dove deep into core software, servers, every agreement with every vendor, and even to the level of providing lists of every software program on every computer and laptop in the organization. It must have been good karma paying off for us, because we had meticulously licensed every relevant piece of software across our infrastructure.
  
• List reasonably well-documented operational assets (software, product production, and processes). Any acquiring company will send in its crew of experts and managers to interview your team with the purpose of making sure that they will be able to successfully utilize your assets according to their plan. This is where having documentation and well-designed systems can really pay off. If you are holding together your operation with layers of duct tape and bailing wire, you might not get the nod to go ahead during due diligence.
  

One fond memory of mine from when we were selling the Meridian company involved a comment from the investors. They said they “had never seen such a well-prepared due diligence package.” Sterling had printed and bound all of the contracts and financials into a phone book–sized package that served as the centerpiece of due diligence. The full and well-documented disclosure set the tone for what was to become a relatively quick and easy sale.

_________________

Earn-Out Agreements

Investors like to hedge their bets. Many recent deals that I have seen, especially with smaller companies, have involved earn-out clauses in the acquisition contract. In this scenario, the buyer pays a percentage of the purchase price up front, but withholds the remaining money contingent upon you staying in the business for a couple of years post-deal and driving a prescribed level of performance. In essence, they are telling you this:

If you believe your own sales pitch about where your business is going, prove it by doing it.

They will pay you a percentage of your asking price to acquire your company, and hold out the remainder as “safety money.” The remaining money will never be paid unless you can prove that your sales pitch was not simply hot air: You hit your multi-year business metrics and grow the company value to where you said it could go. This is usually 2 years in term. It is good to know
ahead of time that your options on exit may involve this kind of time-intensive scenario.

_________________

Giving Up Your Baby

Every aspect of running a business can be imbued with emotional content for an entrepreneur. There had to be a serious case of fire in the belly for you to commit to building a business in the first place. It is a sure thing that there will be a significant emotional component in selling your company. In the case of Meridian World Data, our decision to sell was definitely an emotional one. My business partner told me, “If I have to do this one more day, I am going to shoot myself.” If that is not an emotional decision, I don’t know what is. So we sold it. Luckily, I was on the same page as my partner, and I agreed to do it. This is a significant point where controlling interest and management control can come into importance.

One very likely result of your emotional investment in a company (and your close-up perspective) is that you may tend to overvalue your business due to your proximity to it. Your potential acquirers will likely see things differently. They are going to lowball you—just try not to take it personally! In one case, we actually lost an early acquisition deal because we had momentary second thoughts about the sale price. We were near to a deal, and we were feeling the pain of impending separation from our baby (company). We mishandled the situation by pushing too hard for too much. That potential deal fell through at least in part because we had not worked out for ourselves what our pricing requirements were—and we let it get the better of us. We sold the company to another party within a few months, but at a lower price than had been offered in the deal we lost. Tough lesson. One useful way to keep this type of problem at bay is to decide early on how to answer this question, “How much is enough?”

Think about what an exit needs to look like for you to be satisfied. Set a minimum price that you would accept, and then anchor your negotiations well above that level. Also think in advance about other characteristics of the deal that will be important:

• Do you want to stay on and earn a salary as an employee?
  
• Do you want to get out and move on to other things? (Watch out for earn-out conditions in this case.)
  
• How will your employees be taken care of?
  
• Do you want your brand to survive, or is it OK for it to be subsumed by another company or taken apart?
  

_________________

Getting and Evaluating an Offer

The most primal of human emotions come into play when you finally get an offer to sell your business: fear, excitement, anger, uncertainty, greed, relief. It will trigger a significant emotional response. As Darwin would tell you if he were part of this conversation, emotions evolved in humans in support of our survival, which, when it comes to behavior, is often concerned with the acquisition and defense of resources. From a biological standpoint, selling your business is a major event. Short of being attacked by a bear or otherwise having your life threatened, few situations will be more personal or emotionally intense.