Leave the Ice or Skate On?: To Sell or Not to Sell
I was struck by an article by David Fleming in ESPN Magazine in which he describes how many hockey players used to make their own sticks. He quotes Washington Capitals star Alex Ovechkin as saying, “To a hockey player sticks aren’t equipment.… They are a piece of your body.”136
Fleming also shares the story of Canadian Bruce Boudreau, who was a star junior player in the 1970s. “Before games, the 20-year-old Boudreau would sit in his kitchen and customize the fiberglass curve of his weapon by carefully steaming it over a teakettle. Then he’d wedge it under a door hinge and bend it until it was perfect, race outside and plunge it into the snow to set the blade.”137
For many founders, their start-ups also feel like part of their very beings. They have shed a lot of blood, sweat, and tears to build the company, and everything about it is a reflection of themselves. This makes the process of deciding whether to sell the company when potential buyers come calling extremely difficult, even if an irresistible offer has been made. For some founders, the decision to sell feels like the right thing to do or can sometimes even be a huge relief. They may be burned out from the daily grind, or they may be itching to get back to the scrappier process of initial creation and want start building a new company again. For other founders, selling is completely out of the question; they are determined to keep control of the firm and grow it according to their own vision. And for yet others still, they’re left with no real option but to sell or to bring the company through an IPO because they have transferred so much equity to outside investors whose primary aim is to cash out.
When making this decision, only one thing is for sure: You will be barraged with all sorts of advice about what’s the right thing to do, and much of it will be from experts who are highly persuasive and have a great deal of experience with the ins and outs of selling a company that most founders know very little about.
Hockey Stick Principle #87: Carefully consider whether or not you would like to sell your company well in advance of needing to know whether you have to.
Many founders have not thought through the pluses and minuses of selling before they find themselves in the thick of the process. That can make it extremely challenging to get a firm footing in negotiations and to keep your focus on what your own objectives are. All founders should start thinking about these options well in advance of becoming a viable acquisition target and at the very least establish a set of guidelines about the types of offers they would seriously consider and the terms they want to make part of a deal. As was said earlier about negotiating with VCs, in mergers and acquisitions, all terms are negotiable, but good negotiation requires a cool head and a clear understanding of your interests and goals. Too many founders find themselves swept up in the heat of the moment and all the emotions that come with it and later regret the decisions they made.
As Ben Horowitz wrote in The Hard Thing About Hard Things, “One of the most difficult decisions that a CEO ever makes is whether to sell her company. Logically, determining whether selling a company will be better in the long term than continuing to run it stand-alone involves a huge number of factors, most of which are speculative or unknown. And if you are the founder, the logical part is the easy part.” So let’s begin to think of some of the issues to be aware of when navigating this emotional terrain.
Expect to Have Some Seller’s Remorse
The words of one founder who made a great sale for his start-up especially resonate for me. Roger Bryan, who started Enfusen Digital Marketing, eloquently told mashable.com in an interview about his thoughts on the transaction, “I spent six years building the first company I sold. The day that I sold it was one of the greatest accomplishments of my life.… Then as each month went by, and the money sat in my bank account as I tried to figure out what to do next, the regret started to set in. I hadn’t sold my company, I had sold my passion.”138 Many founders feel a deep sense of remorse once a sale is complete, even if they have made a truly great deal and even if as time passes they still feel that they made the right choice.
Hockey Stick Principle #88: When selling your business, you’re selling your passion.
With all the hype around technology start-ups that founders design primarily with the hope of being bought by Google, Facebook, or Amazon, the emotional difficulty of giving up your baby has been underreported. Certainly this will be a passing phase for many founders as they move on to a new challenge or they eventually realize that with the earnings from the proceeds they made they’re now in a wonderful position to plot out their next adventure. But for many others, regret builds because of the way the acquisition ends up playing out or because with hindsight, they believe they could have achieved even more success if they had kept the company independent. Even with some of the sales that are seen as great triumphs, founders later express some regret.
Take the case of Waze, the real-time, social network traffic alert and map service, which was bought by Google in a $1.15 billion deal and which has now been folded into Google successfully. Cofounder and CEO Noam Bardin wrote in a reflection about the sale that “one of Waze’s mistakes was the valuation of its A round which significantly diluted the founders. Perhaps, had we held control of the company, as the founders of Facebook, Google, Oracle or Microsoft had, Waze might still be an independent company today.”139 The acquisition made good sense, but the question clearly lingers whether the founders might not have been happier if they’d kept it independent.
In other cases, the remorse comes from the difficulties that arise during the merger of your firm with the acquiring company. Some mergers go fairly smoothly, but many are full of friction and are horribly frustrating for founders, even when they’ll be staying on to keep running operations. One extreme outcome is that the acquirer isn’t able to figure out a way to integrate your company’s business into its own and simply dissolves your operations.
Such was the case with the acquisition by Google of Dodgeball, which was one of a hot new type of business at the time—location-based mobile social network programs—which seemed in good synergy with Google’s plans for development. Google acquired the company in 2005 but shut it down in 2009. The cofounders, Dennis Crowley and Alex Rainert, made no secret about how they felt about the outcome, writing in a social network post at the time, “It’s no real secret that Google wasn’t supporting Dodgeball the way we expected. The whole experience was incredibly frustrating for us—especially as we couldn’t convince them that Dodgeball was worth engineering resources, leaving us to watch as other startups got to innovate in the mobile plus social space.”140 Crowley, who went on to found Foursquare, the geolocation-based local search app, later reflected on the core strategic disconnect between what he came to understand was Google’s motivation for the purchase and what he and Rainert had thought it was. He said, “We thought it was a product acquisition, and they knew it was an ‘acqui-hire.’”141 The concept behind an acqui-hire is that the acquiring firm is really most interested in bringing in personnel from the start-up rather than continuing the business.
This might seem a good problem to have; better for the acquiring firm to want to bring you and your team in because they value the skills and business savvy that allowed you to build your company so successfully than for them to want to cast you out, especially if the acquirer is a market leader like Google. For many founders, that would in fact be true. But for Crowley and Rainert, it was a great disappointment, and it might also be for you.
Hockey Stick Principle #89: The strategic fit of two companies cannot truly be known until they’re put together.
Rainert and Crowley’s experience highlights one of the most important things founders should be prepared for should an acquisition be proposed: understanding the purchaser’s strategy behind buying your company is not nearly as simple as it might seem, even when the synergies in your businesses are obvious.
Do Not Accept the Buyer’s Plans for Your Company at Face Value
There are basically three major outcomes for your company when you sell:
1) Your company remains intact and separately run. Either a private equity firm purchases your company with the intent of either later taking it public or reselling it, or you are bought as a wholly owned subsidiary by a larger company. In this case, founders and key employees may well be asked to stay on to continue running operations, but this is never to be assumed, and significant changes in operations may be part of the terms of the deal.
2) Your company becomes a division of the parent company. While some of your operations may remain entirely under your team’s management, other functions are taken over by the buyer to realize efficiencies, such as payroll, payments and receipts, marketing, HR, product maintenance, manufacturing, distribution, and warehousing. Becoming a division is the typical common outcome after a strategic merger, with the purchaser buying you with a plan for improving their company’s products, services, and profits.
3) The company is dissolved, and your product is folded into the buyer’s product line. In this case, even if you and a skeleton crew of key employees are retained, most employees will lose their jobs.
Knowing which of these scenarios you’re getting into is only the beginning of probing into the buyer’s intentions and the thinking behind the strategy. You must drill deep into their motivations, their expectations, and their analyses of why your firm is a good fit for their goals. You cannot take their pitch to you at face value, and you cannot assume that just because they’re a big firm with so much more experience and with specialists in corporate acquisitions that they have a fundamentally good strategy for making the deal or one that you’ll ultimately be happy with. You’ve got to challenge their arguments and vision.
Business author and Inc. magazine editor Bo Burlingham, who has researched and interviewed hundreds of founders of privately held firms who have sold their companies, warns that acquiring companies are intent on selling you on the advantages of the deal—basically telling you what you want to hear. “When you are in a situation where you weren’t looking for a buyer, you seem to overlook the fact that [buyers] are actually giving you a sales pitch. In order to get you to agree to a sale, they’ve got to convince you that this is a great deal for you, and a great deal for everyone you care about. But once the deal is signed, you’ve lost all your leverage.”
It’s vital to keep in mind that some mergers work out much better than others, even when they’re spearheaded by the same acquirer. Take the divergent cases of two high-profile acquisitions by online marketplace eBay. Since its founding in 1995, the company has made forty-nine acquisitions,142 many of which have worked out as planned. One of these was its 2002 acquisition of PayPal for $1.5 billion, making the firm a subsidiary. PayPal’s business fit so squarely with that of eBay’s that eBay became extremely aggressive about the purchase. As PayPal cofounder Max Levchin recounts, “They would say, ‘You need to sell to us because it’s a natural synergy—and if you don’t we will compete you out of the way and kill you.’”143 In fact, according to Eric M. Jackson, at the time PayPal’s chief marketing officer, 70 percent of eBay’s auctions accepted PayPal payments.144 Many pundits have argued that PayPal sold too early, leaving lots of money on the table. But as Levchin assesses the outcome, he stresses that the fight with eBay was getting “really, really bloody” and also that “eBay has been a fantastic steward of what we built.”145 Making the deal freed up the PayPal founders to move on and start a host of exciting new companies. Cofounder Elon Musk started the hugely successful companies Tesla and SpaceX, Peter Thiel has become a successful investor in start-ups, Reid Hoffman went on to found LinkedIn, and Jeremy Stoppelman founded Yelp.
In the end, PayPal’s business was kept so well intact and developed so successfully that eBay announced in the fall of 2014 that it would spin the firm off into an independent company again.
However, eBay’s judgment in making another premier acquisition proved less shrewd in September 2005 when they purchased online VoIP (Voice over IP) firm Skype for $2.6 billion, plus incentives that increased the deal to $3.1 billion.146 The basic idea was that integrating Skype capabilities into its service would allow eBay buyers and sellers to consult face-to-face with each other, which would enhance the trust in one another when agreeing on sales. But the deal didn’t work out as planned. “When we bought Skype, we thought it had synergies with our other two businesses, and it turns out it did not,” recalled John Donahoe, eBay’s CEO in 2009.147 It turned out that not many eBay buyers and sellers in fact want to chat; they prefer as smooth and simple a transaction as possible. eBay ended up selling 65 percent of its stake in Skype to investors in 2009 for $1.9 billion. This divestiture worked out just fine for both companies, as Skype thrived so much back out on its own that Microsoft bought the company in 2011 for a whopping $8.5 billion, in which eBay earned a $1.4 billion return on its investment.
There are a few key lessons here to keep in mind when companies are courting you. One is that the strategic thinking behind making the acquisition may be fundamentally flawed. eBay did not truly appreciate an aspect of the nature of the relationship that its buyers and sellers wanted to have, even though understanding that relationship is at the very core of its business. Another is that if the firm that wants to buy you has the ability to compete so effectively with you that you might well be put out of business by it before too long, a sale may be your best option. And a third is that it’s extremely important to evaluate the timing of the sale and how long you might want to hold out on selling by doing a tough, rigorous assessment of your future prospects. This involves taking into account in particular the total potential size of your market and what share of it you might be able to claim, how much money you’ll be required to invest into your product and how much marketing you’ll have to do to remain competitive, and whether or not you can continue to grow or achieve profitability in the foreseeable future.
Some say PayPal sold too soon, but it fended eBay off for at least a year. Now consider that in 1999, roughly six months after founding Google, Larry Page and Sergey Brin almost sold out for $750,000 when a purchase offer was made by the Excite Web portal and search engine. Unbelievable. Now that’s what you would call too soon.
The offer was spearheaded by Vinod Khosla, an investor in Excite as well as in Google. He thought the two companies would both be stronger if they were combined, and he had talked Page and Brin down to selling the company for $750,000. But the CEO of Excite, George Bell, who was a media executive and had been CEO since 1996, ended up rejecting the deal.148
The better way to think about the decision of the PayPal founders to sell to eBay is that they got the timing right for one key reason: They were still in a very strong negotiating position. The Google founders considered selling way before they were in a strong position to negotiate a reasonable amount for the firm, and they were totally unaware as of yet of the true magnitude of the company’s potential.
Never, Under Any Circumstances, Be Afraid to Be a Tough Negotiator
When potential buyers are waving millions of dollars before your eyes, it is thrilling. Do not underestimate the power of this effect. However, on the flip side, the fear that if you don’t take the money now you’ll never have a chance to make such a good deal again can be terrifying. This is why it’s crucial to keep in mind that it is almost always the case that no one understands the value of your company and has a more realistic assessment of its future potential than you. Mergers and acquisitions experts have elaborate formulas, and they have a great deal of wisdom from their experience, but the ultimate truth is that there is no one “right” valuation of a company. And the correct valuation for you can be quite different from the correct valuation for a potential buyer.
Your valuation should include not only the more pro forma considerations of revenue, profitability, market potential, degree of competition, current and future value of your intellectual property, and strategic value to the prospective acquirer but also your interest in continuing to control the direction of the company. Only you, of all the negotiating parties, can make this assessment, and doing so may put you at odds not only with the prospective buyers and their legion of M&A experts but with your cofounders and management team. You therefore must anticipate that you will have to negotiate not only with the buyers but with your partners, as well, when selling.
A great story of a founder who ended up realizing that continuing to run the company was much more valuable to him than he had understood when negotiations commenced is Gary Erickson, cofounder of energy bar company Clif Bar. His story of almost selling out to Quaker Oats is told in detail in Bo Burlingham’s book Small Giants: Companies That Choose to Be Great Instead of Big.
The deal was worth $120 million, and Erickson would get half the money, but just minutes before closing, he had a change of heart. He started crying over what he was about to do. He changed his mind and called off the deal. Everyone—venture capitalists, lawyers, and other advisors—told him he was making the biggest mistake of his life by refusing to sign the closing papers. Clif Bar competitors PowerBar and Kraft had already been sold to larger competitors, and surely because of their size they’d crush Clif Bar. Erickson’s partner, Lisa Thomas, the then CEO, quit and demanded to be paid out. Erickson agreed to pay her $65 million over five years. He stayed on as CEO and has since increased Clif Bar’s sales from $39 million the year he almost sold out to nearly more than $500 million in 2013.149 In a demonstration of why it mattered so much to Erickson to stay in charge and that he had a particular vision for growing the company, in 2010, he sold 20 percent of the company to 239 of his employees through an employee stock ownership plan.150 That is not a move that a corporate acquirer would be at all likely to support.
Another founder who considered a big deal but ultimately looks back with no regret that he instead ended up staying in charge—and who built the firm up impressively—is Jeremy Stoppelman, cofounder and CEO of review site Yelp. The first offer Yelp received, two years after launch, was for an impressive $100 million from an undisclosed would-be buyer. When three years later, Google came calling and offered $500 million, the deal was even more tantalizing, and so they entered into negotiations, but those fell through. Stoppelman highlights that this can be a disorienting experience. “It ends up feeling a bit like brain damage to everyone involved,” he told The New York Times. “People start dreaming about paying off mortgages. Everyone had to shake off all those fantasies and get back to work, including myself.” He accepted the challenge, dug in, and built the company very successfully, taking it through an IPO in 2012 that brought it a $5 billion valuation, a great deal higher than the $500 million Google offered. Despite a host of press that admonished Yelp for failing to make the Google deal work, the result has been stellar.151
No Regrets Are Necessary
Of course, one way to avoid any buyer’s remorse is to be resolute about not selling and committing to developing your company for the long term.
Hockey Stick Principle #90: The value of the satisfaction of guiding the long-term success of your company cannot be quantified.
A number of the founders I interviewed expressed a deep conviction never to sell, and the satisfaction that they feel from having stayed in charge of their firms and being able to drive the car on how fast to grow and in what ways is impressive and a factor that every founder should weigh heavily.
Schedulefly founder Wes Aiken makes a strong case for the pleasures of enjoying the controlled growth of a company whose model he has honed:
I don’t know why anybody would start a business that they wanted to sell, or for any other reason except to create a great life. Why would I ever say, “I want to sell my company?” I never want to sell this. I never want to have a different life. But my identity is not Schedulefly.
We have an incredible business and life. The business is very profitable and has grown every month for eight years. The five of us work very well together—and know each other well and we are each great at specific things. For that reason, we rarely need to talk. I speak to Tyler a few times per year. We don’t have meetings. We don’t work in an office. We don’t travel. This keeps everything extremely simple and low cost and free from things that don’t really matter. I guess most go-getter business types enjoy the travel and the rat race and the meetings and the things that make up “doing business” because they feel like business is getting done. I don’t. I never did well in an office setting—reporting to an office at 9am. I never liked team building events and doing expense reports and performance reviews. I hated conference calls.
Instead, I now work only when I need to work and after eight years it’s still fun and rewarding work because it matters to people. Staying simple and not overdoing it matters to people. It matters to my customers and to my family. And I never dread work. Monday mornings to me are every bit as great as Friday evenings. I spend more time with my family than anyone I know and our company still grows. Every morning I see my kids and every evening we play and I give them baths and read with them.
Why mess with that kind of life? Why not do everything in my power to protect that along with protecting why people love what we do and want to do business with us? That’s what I am doing. By saying no and by passing on the countless opportunities that I could pursue and focusing as hard as we can on those who think we matter, I am relentlessly protecting a life and a company that I had never dreamed could exist.
Another founder who speaks powerfully about the great satisfaction of continuing to run his company is Dude Solutions’s CEO Kent Hudson. When I asked him what he thought the chances were that he would sell the company in the future, he answered, “Zero. We had ten or eleven offers to be acquired along the way and turned them all down. It’s our belief system about a year ago when we reassessed the business that the golden era of the Internet was just starting. We think that era was just beginning. We’ve done the hard part. Now comes the fun part.” The way he describes his vision for the years ahead offers a powerful antidote to the mythology that to sell and move on is the ideal. “My goal is to come each day and build something so special that I can’t give it up,” he says. “I’m proud of it. The customers love it. They tout the customer service. They love the product. I’m going to build something that’s so good I don’t want to give it up.”
If you are getting a good deal of satisfaction from running your company and feel that your results are providing you and your stakeholders with sufficiently rich rewards and that you can fend off competition and face the demands of the future, then making the determination not to sell, even when quite alluring offers are made, may well be the most logical thing to do, in addition to being the most emotionally rewarding.
You Likely Won’t Have a Choice
All of the press coverage of acquisitions seems to suggest that they’re quite common, but the fact is that successful sales of start-ups are much less common than the intense press coverage of sales suggests.
According to financial research firm FactSet, there were 11,994 mergers or acquisitions in the United States for twelve months ending February 28, 2015. This may sound like a lot, but considering there were three million high-growth-potential start-ups in the United States at the time, that number is actually quite small.152 Moreover, many of the mergers are in mature industries, such as when one large utility or bank buys another, so the number of innovative start-ups acquired is even less than 11,994.
Even for VC-backed firms that are often trying to be acquired with professional investment behind them, acquisitions are rare. According to a study by Dow Jones VentureSource, “Of the 6,613 U.S.-based companies initially funded by venture capital between 2006 and 2011, only 11% were acquired or made initial public offerings of stock.”153 The hugely successful Y Combinator, which has helped launch some of the most recent successful start-ups, such as Dropbox, Reddit, and Airbnb, has also not made much headway against this basic math. By December 2015, only fifty-five of the 699 Y Combinator–backed start-ups had been acquired.154
Selling Is Not Always Selling Out
If you are one of the founders who does have to grapple with the decision to sell, another important step to take is to make a detached assessment of the opportunity costs of not selling your business.
Your vision and ambitions for the company may, in fact, be the best reason for selling, because by doing so, better capitalized players with greater scale than you will be able to take the company to a whole new level. A good example of this kind of sale is of Boogie Wipes. By 2012, five years after starting their venture, cofounder Julie Pickens had grown the company to $10 million in revenue, and the product was being stocked in fifty thousand stores. Recall from chapter 3 that when starting out, Julie and Mindee had shared their idea about their saline nose wipes online and face-to-face and weren’t worried about a huge company like P&G stealing it. As we discussed, large businesses often don’t take notice of such good ideas; but they do start to take notice when they see lots of customers buying another product and the serious revenue growth that comes with it.
Many big companies are constantly on the lookout for firms with such results. Jeff Weedman, P&G’s VP for global business development, had Boogie Wipes on his radar for more than a year through its “Connect and Develop” program, which helps P&G generate revenue through its vendor relationships.155
P&G didn’t want to buy the company itself, but Weedman referred Julie and Mindee to Dan Meyer, CEO of Nehemiah Manufacturing, which P&G had licensed the rights to market some of its products to, such as Febreze and Downy Wrinkle Releaser. Weedman thought Nehemiah might be a good manufacturer for Boogie Wipes. As things turned out, Nehemiah made Julie and Mindee an offer to buy the company.
“We had put a new concept on the market, and they were very interested in that technology,” Julie recalls. “We went down the road to talk to them about doing it, putting it on an adult wipe, and ended up working with them for a short period of time on developing a wipe. In order to do it, they really wanted the company closer, in Cincinnati.”
In 2012, Nehemiah partnered with Boogie Wipes and purchased a portion of key investors’ shares. Julie still held her shares and moved the company to Cincinnati to help run the company. She sold her stock in August of 2014 and resigned to go work at another start-up. This was a win-win outcome, as it allowed the founders to not only preserve their creation, assuring it was managed by a major firm with good expertise, but also gave one of the founders a whole new adventure to pursue.
Doug Lebda is another person who made the decision to sell and is confident that he made the right call. In his case, doing so allowed him to put the company under more focused, aligned management. In February 2000, LendingTree completed a public offering, selling 21 percent of its stock for $43.8 million. That was a great result in terms of cash raised, but it also led to a very complex management situation in which Doug struggled to reconcile the competing demands of many stakeholders.
When in August 2003, IAC/InterActiveCorp, a $6.3 billion revenue media empire run by the famous business icon Barry Diller, made an offer, the sweetness of the deal brought the interests of all stakeholders into alignment, and IAC acquired LendingTree for $726 million ($21.67 per share) through a stock-swap transaction. The transaction cleaned up LendingTree’s balance sheet and reconciled the complications related to having many different stakeholders with different objectives, allowing Doug and the management team to focus exclusively on the business rather than spending an inordinate amount of time on shareholder relations. The move also worked out well for Doug personally. He clearly made a good judgment call about the fit between his management style and that of IAC’s, as shortly after the sale he was promoted to president of IAC.
If you do think that you would want to seriously entertain an acquisition offer, or if you’ve determined that all things considered, a sale is your goal, then there are a number of best practices for making sure you end up with a deal you don’t later regret and helping you to keep your sanity during the process.
The Hockey Stick Rules for Good Mergers and Acquisitions
1. Don’t Rush Into Discussions with Just One Party
Ideally, you want to be able to stoke competition and consider multiple offers. You should be proactive about identifying possible buyers and learning about their businesses so that if one company does come calling, you not only have a good basic knowledge of the businesses you think are the best strategic fits with your firm and how this potential suitor stacks up, but you can also readily put out feelers to competing firms.
As Manu Kumar, founder of seed start-up venture firm K9 Ventures, observed in one of his blog posts, “Most potential acquirers follow start-ups, and it’s important to stay in touch with them. You want to have them know what you’re doing and have those channels open. This should be well before the start-ups get to any acquisition stage.”
You don’t want to just be reactive or running as fast as you can to get up to speed on possible purchasers once a company tests the waters of your interest. As Bo Burlingham highlights in his book Finish Big: How Great Entrepreneurs Exit Their Companies on Top, one of the hallmarks of founders who made the best exits is that they planned well in advance the kind of deal they would want to make and with whom.
When I sold First Research, there were several businesses operating in our market—sales and marketing intelligence. Any number of them could have been suitable candidates to buy us, but instead of soliciting offers and discussions with them, I opted to negotiate directly with Dun & Bradstreet. I did this for a few reasons. I didn’t want to invest the time to hire a broker and create a pitch book—a detailed information packet about our financial performance, business model, and operating plan. Putting one together is a great deal of work. I also didn’t want to be distracted from the day-to-day business, which usually happens when founders are considering a sale or merger because so many meetings with potential acquirers are involved. In addition, I knew that D&B was acquiring sales-and-marketing Internet firms as part of a larger strategy, so they were probably the most motivated buyer. I didn’t think I’d be able to get a better offer from anyone else. And finally, I enjoyed owning First Research, so if D&B didn’t make an offer I liked, I would be happy turning it down.
The one problem with my process, looking back on it now, was that I really wasn’t looking to sell First Research. Because I negotiated with only one party, the process went relatively quickly. If I had been negotiating with several other places, I would have had more time and spoken with more experts to better understand the broader implications of selling my company. And as I look back on the deal now, I think I might have decided not to sell.
2. Hire M&A Expertise to Work with You
Zappos CEO Tony Hsieh said wisely in a magazine interview, “Poker is very similar to business. Don’t play if you don’t understand it.” Just as with negotiating term sheets with VCs, acquisitions deals are extremely complex, and founders are vulnerable to many pitfalls. The company that is negotiating with you may be extremely experienced at acquisitions, so you need experience on your side in the form of an experienced M&A advisor, accountant, and lawyer. Otherwise, it’s like playing Texas Hold ’em in Vegas with millions of dollars. You’re likely to lose—and maybe lose Texan big.
If you’re thinking about selling your business, it’s best to begin conversations with pros well in advance so you can take your time learning about the process. But be wary of hiring Wall Street investment banks that often put their youngest staff on deals that aren’t huge in size. Furthermore, their incentives are not always matched well with yours. Instead, I advise that you hire experienced former business owners who successfully managed the sales of their own firms.
As Alan Smith, the founder of Advanced Medical Devices—which he sold to behemoth Johnson & Johnson for $22 million in 1998—attested in an entrepreneurship.org article about the value of an expert team, “Johnson & Johnson’s initial offers were significantly less than the final offer. I attribute that to one factor: my decision to retain an expert in mergers and acquisitions to represent my interests. The leveling of the playing field between the two parties—J&J’s sophisticated financiers were now dealing with a peer who they could assume was knowledgeable and credible—made all the difference in securing the higher price.”156
This may seem glaringly obvious, but one of the things that comes up on list after list of big mistakes made by founders is that they try to take charge of the process themselves or get too far along in discussions before they bring in the pros. Professional M&A advisors know what acquiring firms will be requesting from you, such as financial statements audited by a top-five national CPA firm.
As outsiders, advisors can act as a neutral party to help you better understand the value of your business and how to market it best to a number of potential qualified buyers. They can also get you a much better deal. For example, when Pacinian, a keyboard technologies firm, was acquired by publicly traded firm Synaptics for $30 million, the advisor to the chairman of Pacinian, Basil Peters, helped drive up the price considerably. He recounts in exits.com, “You don’t really want to negotiate one-on-one with someone and end up in a bear hug, with them telling you how much they love you … and how cheap they can buy your company.”157
3. Expect Intense Competition for Your Time and Lots of Stress
From start to finish, including organizing information, having informational discussions, negotiating term sheets, helping with the buyer’s due diligence process, and aiding lawyers with the sale documents, the sale of your company generally takes between eight and ten months, or sometimes longer. And during that time, you still have to run your company while you are going through all the elaborate and often very time-consuming processes of negotiation. You will also have to respond to seemingly countless questions and requests for information during the rigorous due-diligence process.
It’s important not to underestimate how much time this will take. You may think you have a good idea of what to expect from talking to founders who’ve gone through the process—which you absolutely should do—and from reading about it, but trust me, until you’re actually in the throes of it, you can’t really appreciate just how many unexpected issues may come up and how much time responding to the requests from the buyer’s attorneys and bankers will require.
I like the analogy used by Thomas Metz in his book Selling the Intangible Company, in which he writes, “Many CEOs think selling a company is easy. The process seems quite straightforward.… A founder typically enjoys a good challenge; that is why he or she started a business in the first place.… What they fail to consider is the tremendous amount of time and effort required to do the job right.… The situation is analogous to taking on your own home remodeling project … halfway through the project you uncover some unforeseen problems that are beyond your expertise.”
Also know that the process is nerve-racking and often crazy making. People you don’t know well and still aren’t 100 percent sure you can trust to come through with an offer you can feel good about accepting are peering into every detail of your operations, your finances, and the quality of your management and staff.
Former investment banker Scott Moeller has written three books about mergers and acquisitions. In Surviving M&A: Make the Most of Your Company Being Acquired, he says, “Anything seems better than living through the hell of a merger or acquisition.” From my experience, the process is indeed incredibly stressful. For a period of months, I had to shift dozens of hours each week to managing the sale. Here is how I spent my time:
• Explaining how the business worked to the buyer
• Reviewing legal documents hundreds of pages long
• Discussing the ongoing negotiations with shareholders and advisors
• Worrying about the implications of selling the business
Merger documents are complex, and because I’d never been through the process before, I had a lot to learn. I committed myself to understanding the basic meaning of each and every provision, and I was fortunate because I hired an experienced attorney who has a knack for explaining things very clearly—and providing just the right amount of detail and context to make all the implications of terms and conditions totally understandable. If the advisors you’re working with aren’t adept at this, you must look for someone who is. Understanding all the details and the possibilities about how the agreed terms might play out is crucial.
4. Expect Dissension among Stakeholders
If you have retained a majority share in your company, you normally have the authority to push forward with a deal, but even so, you will have to contend with the competing views and interests of various stakeholders. For example, you may find yourself in a very uncomfortable tug-of-war between you and your investors, who want to sell, and some members of your management team, who may object to the enterprise of working for the buyer or be rightfully concerned about their job security.
If you have awarded your management team stock options, they may well be incentivized to support the deal and to assist in making it happen. But sometimes when start-ups have raised substantial financing, particularly through venture funding, those outside funders will be entitled to so much of the cash from the deal that your management team stands to gain little from the transaction.
One very important thing you must do before selling your firm is you must gain an understanding of the impact of the sale on all stakeholders or those vested in your company. Basically, you have to make sure each group involved is treated as fairly as possible. This is your responsibility as a leader.
Fordham University professor Michael Pirson and Harvard professor Deepak Malhotra wrote a paper titled, “Unconventional Insights for Managing Stakeholder Trust,” which says that most organizations don’t do a good job of managing the disparate needs of stakeholders because “trust is multi-dimensional—and it is not obvious which dimension you need to focus on when dealing with any particular stakeholder group.”158 This is the core of the problem during mergers for the founder and CEO: trust to some people is “kind-hearted benevolence”; to others it is “fair-minded integrity.” An incredibly important takeaway from Pirson and Malhotra’s research is that they say during mergers, building trust with one group can destroy trust with another.
From my own experience selling First Research, I know just how difficult a balancing act this is. Pirson and Malhotra point out that each stakeholder has different needs, and therefore, when you build trust with, for example, suppliers, you can totally lose trust with your shareholders in the process or vice versa. An especially difficult period of time for me was the weeks leading up to the closing of the deal when I was obligated by the buyer to not discuss my possible merger with anyone outside of counsel, yet I was obviously very busy and distracted, so my employees knew something important was going on. I had always been transparent with the entire team, and keeping secrets wasn’t how we did business with one another. So by keeping trust with the acquiring firm, I felt as if I was destroying it with my employees. This is just one example because when your firm is acquired, you’re constantly facing this challenge with regard to operational decisions and communicating with customers as to what type of changes they can expect.
Shareholders, employees, customers, suppliers, and partners all have skin in the game, and how each group responds to the sale will inevitably be different. Your lawyers and CPAs will say you should pay attention to new regulations that are gray and unclear, but your suppliers will persuade you to ignore the regulations. Your employees will say that they want more benefits negotiated as part of the deal, but your most important shareholders will say that your staff expenses are too high as compared to other similar companies.
Furthermore, subgroups within a main group may have different objectives, as well. For example, one group of shareholders might desire to sell the company as soon as possible because they need the cash, whatever the price, while another group doesn’t want to sell for any price. These disparate objections require that you balance out each subgroup’s needs as best you can and try to see everyone’s viewpoint clearly. Skills with regard to communication, listening, and understanding are at the core of helping form consensus.
5. Negotiate Every Point as Forcefully and in as Much Detail as You Can before Signing a Letter of Intent, and Don’t Be Afraid to Say No
An important step in the process is signing a formal letter of intent, which spells out the terms that both the buyer and seller are agreeing to. After you’ve signed this, the balance of power shifts decidedly to the buyer, and you will also be excluded from continuing discussions with other buyers during the period of due diligence that will follow, which is usually between sixty and ninety days. You do not want to leave any substantive issues to be negotiated thereafter, so you should be a persistent pit bull regarding any big issues before you sign. This is one part of the process in which your team of M&A experts will prove of great assistance.
Too many founders feel overly pressured to sign the letter of intent. That is particularly true when venture capitalists and other investors have invested heavily in this exit. As M&A law expert and Forbes contributor Scott Edward Walker wisely counsels, “Entrepreneurs must understand that their strongest leverage as a seller is prior to the execution of the letter of intent (LOI).… Not negotiating the material terms of the deal in the LOI is the most common mistake I see from the sell-side. Once the LOI is executed, all the entrepreneur’s leverage is gone because he generally won’t be able to shop his company around to any other potential buyers … due to what’s called a ‘no-shop provision.’”159
6. Prepare for a Rocky Road in Integrating after You’ve Sold
Make no mistake: integrating your organization into another one is messy work. As the founder and leader of your company, you’re constantly speculating as to what your new owner intends to do with your company. Will they fire employees? Will they change their pay scales? When will they implement their changes? How will mutual customers be handled? Will your product be integrated into the acquiring firm’s product? Who’s in charge of that process? I could list a hundred questions like these, and each one will weigh on you heavily. Employees and managers also want answers since their jobs could be in jeopardy. But during the first several months, no one has the answers about what will happen to most of their jobs because that will be decided as you go through the integration process. Communication often flows only awkwardly during this stage, with many parties being guarded about their next move.
Things became so tough for me during integration that I ended up suffering chest pain. There I was with a dozen red, black, and white wires attached to my bare chest and back as I ran on my doctor’s treadmill. Though my heart was perfectly healthy, thankfully, I was in a good deal of pain. I like to say that the integration process just about broke my heart. Unless you’ve been through it several times and know just what to expect, you should expect it to be more painful than you’re hoping for.
7. You’ll Be Going through a Life Change
If you sell, just as with a divorce, the loss of a loved one, or losing anything you care about deeply, you’ll go through something of a mourning process. This can become quite intense, and some founders fall into a deep depression. If you feel yourself sinking that way, I strongly recommend getting counseling. Don’t assume you are the problem if you feel lonely or lost after the sale of your business. It’s normal and in many cases should be treated.
Cashing Out through an IPO
While landing VC investment is rare, taking your company public through an initial public offering is much rarer. In 2014, there were 288 IPOs in the United States, and that was a banner year, up 27 percent from 2013. Health care was the largest sector, having captured 111 of the deals. The fact that 63 percent of the deals in 2014 were sponsored by VC or private equity firms underscores how driven to achieve a sale of their portion of a start-up’s stock these firms are.160
For the most part, you have to be a relatively large firm to absorb the costs of regulatory filings and complex reporting required of public firms. Bronto Software, which had $27.4 million in revenue in 2013 and grew 40 percent in 2014, seemed like a good candidate for an IPO down the road, so I asked founder Joe Colopy what he thought of the prospect. His answer was insightful:
“It’s not something we’ll race to do because there are a lot of challenges. It’s very hard to do any long-term planning and make trade-offs when, at the end of the day, you’re living and dying based on that quarterly number above all else. It would be a wonderful financing event, but we don’t need to [do it] because we don’t have outside investors. If we were to do that, most likely, we would probably … take funding in there anyways because it would be like going from kindergarten to graduate school just like that. We don’t really even have a board.”
Going public requires managing a great deal of complexity. But the complexity can be well worth the effort, not only because you generally raise a good deal of capital but also because an IPO can help build credibility with customers. When Red Hat went public in 1999, its revenue increased from $33 million in 1999 to $84 million in 2001 in part for this reason.161 Founder Bob Young recalls, “[Buyers from large corporations] genuinely fought this open-source thing all the way through the nineties. Not until Red Hat went public did Linux become safe for corporate managers to invest in.”
Hockey Stick Principle #91: A founder should be the star player of an IPO, not sit on the sidelines.
Some founders are naturals for the IPO process because they don’t mind being in the public eye, and they’re intent on greatly expanding their brand awareness. One of those is founder and CEO of GoPro, Nick Woodman, who in an interview with Forbes says this about going public:
A lot of people who advised me asked, “Why would you complicate your life and your business this way?” I thought more about it and decided that as long as we had a strong vision—as long as we execute—everything’s going to be ok. The team is only getting stronger every year.… I’m in my 12th year of [GoPro.] We’re not suddenly going to start sucking at this.162
That’s a good summation of the way I think founders should feel about the IPO process if they’re going to take their companies through it. Founders are always following the lead from the firm’s investors and investment bankers in an IPO, but their role is still vital. If you’re not confident about playing the part, then I strongly advise that you work with your board to appoint a replacement CEO with good experience.
More Than One Kind of Great Adventure
When I’ve given speeches about entrepreneurship, I’ve often been asked, “Are you glad you sold First Research?” and “If you could do it all over again, would you sell?” Though I have moved on to an exciting and fulfilling new venture, as I have reflected on this question repeatedly through the years since the sale, I’ve realized that the answer is no. The reason is not that I think I should have held out for a better deal, though that might be true. Instead, it’s that I enjoyed working at First Research so much. What I had was already great—much greater than having money and options. Moreover, because the business was already performing well financially, I already had more than enough money to be happy and have options. This is not to say that I regret the sale so much that I’m crying myself to sleep at night—not by a long shot. But given the opportunity again, I would think the decision through more carefully.
So why did I sell? The answer is probably best explained by J. M. Barrie’s Peter Pan when he said, “To die would be an awfully big adventure.”163 I’m always looking for adventure and building First Research had provided that. When Dun & Bradstreet made its offer, I figured I was ready for a new undertaking, and the offer was a good one. All my partners wanted to take it, and I felt that the employees would be getting a good deal and would be mostly unaffected. I miscalculated, and that didn’t turn out to be the case. Many were affected in the end, and that was difficult for both them and for me. I now realize that the greater adventure might well have been to keep building First Research into every bit the company it had the potential to be, and those employees were part of the reason why it was so successful in the first place. We were a happy business family, and I think it might have been best all in all if I’d kept us intact.
With that said, being with First Research prepared a number of the team members to go on and launch their own successful start-ups. So far, five successful firms have sprung up from employees of the First Research team.
I think the most important factor you have to weigh in making this decision is whether or not you are at heart a serial entrepreneur, one who finds the process of coming up with an idea and developing it into a successful start-up to be the most satisfying experience, or whether you’re the kind of person who wants to bring your company through to maturity, continuing to grow it and guide it according to your vision and values—which, for some, is the greatest adventure.
Hockey Stick Principle #92: Founders grow companies better than outsiders.
It’s interesting to note that founders who do stay on may well be a generally more effective group of corporate leaders than the average. A series of studies have shown that founder CEOs of Fortune 500 companies that have gone on to take their companies public have led their firms to stronger overall results than those run by CEOs brought in from outside. A 2006 study showed that the average return on stocks of the twenty-six Fortune 500 firms run by founders was 18.5 percent annually from 1995 to 2005, which was seven percentage points better than the Fortune 500 average in those years. A 2010 study reported that “founding CEOs consistently beat the professional CEOs on a broad range of metrics ranging from capital efficiency (amount of funding raised), time to exit, exit valuations, and return on investment.”164
So while it’s certainly true for some entrepreneurs that running a large, mature company is neither their desire nor their strength, for others, making the transition to corporate management seems to be in their bones. Making a strong sale to a company with a good strategic plan for incorporating your firm into its own mission and staying on to keep building your company can both be great choices. You must decide which is the right one for you. Only you can do this.