Start. Grow. Exit

Do you need an M&A advisor?

beard-2286440_640When I talk to people about our M&A process I am often asked whether or not I recommend hiring an M&A advisor. This question is especially likely when I tell people that besides a fixed monthly retainer, many M&A advisors ask for a success fee, which will be anywhere between 3% and 7% of the total transaction value. If you sell as example your company for EUR 20 million, it is likely that you would pay over EUR 1 million to your M&A advisor.

In an earlier blog post about choosing the right M&A attorney, I wrote that most start-ups have only a small team involved in the negotiations. But the corporate buyers might assign a larger team to the deal. With more members at the table, the buyer can appoint ‘bad guys’ and ‘good guys’ to the negotiating team. The ‘good guys’ explain, nicely, all the reasons why the ‘bad guys’ cannot approve what you are asking for. In this dance between your team and the buyer’s, it’s important to defend your position in the best possible way across a broad range of topics. Your M&A advisor should be able to help with difficult and contentious issues, allowing you to preserve your goodwill in the relationship. Having said that, I do think that at this late stage of a transaction, the M&A attorney is more important to you than the M&A advisor.

The real value of an M&A advisor is at the earlier stages of an M&A transaction. It starts with the aligning of expectations among the founder’s team and the shareholders about the potential outcome of an exit. This can help you to avoid unrealistic expectations, especially if you have not considered selling a company before and have no M&A experience within your team. It also helps to align everybody to implement the right process with a proper schedule and the right resources in place.

Many people who are sceptical about M&A advisors claim that contacting and meeting buyers is much easier than it was. I also think that’s right, but what is not so easy is getting through their filters as a viable acquisition target. In my view, this is where the credibility and the network of the M&A advisor can be very important for you. Typically, the advisor can also help you to understand better which are today’s logical buyer groups for your business, and enlarge the group of potential buyers for you.

For me, the most important element of all was the credibility attributed to us (as the seller) based on the advisor’s credibility. Especially if you are a small company based in a less than renowned start-up location, you need a certain international credibility if you are to optimize your exit value.

Taken together, all the aspects described above should enable you as the seller to achieve value that you might not otherwise have realized on your own, thus covering the fee of the M&A advisor.

Start. Grow. Exit

Negotiation Tip: Do not ask questions

light-bulb-1002783_640In this blog post, I’m not talking about the early stage of a sales process when you define the term sheet and structure of the acquisition. In this phase, you should ask every question that you need to qualify the offer.

But, in the last stage of selling your company, you will still get a ton of questions from the buyer and typically you will be very busy answering them. On the other hand, you might find out that you also still have some questions about the joint future. My recommendation is that, at this stage of the process, you should think twice before asking any questions. I got this advice from my M&A advisor when selling my company and I think this is some of the best advice that he gave to me.

Why is this so important? When you ask a question about the joint future at this late stage, you risk that the buyer has not thought about that question yet. Worst-case scenario, they will start thinking about your question and it will either delay the process or it will end up as a new clause in the final contract. Such scenarios are especially tricky when you are much more experienced in your market than the buyer. Maybe they are coming from a different market and want to enter your market or their focus is different than yours. In those scenarios, it’s very likely that the buyer has not thought about every aspect of the joint future and asking a “good” question can raise a lot of internal questions in the buyer’s team. This is the last thing that you want to have at the end of a selling process. Many sellers will tell you that many months, and sometimes years, after an acquisition, the buyer’s management team may still not have the full picture about the joint market or will simply see things very different than you did in the past. This is also the reason why I recommend being very careful with earn-outs, like described in my previous post. An acquisition always changes the market setup and you simply must see how customers and competitors will react to that. Therefore, it makes no sense to risk delaying your sales process by entering discussions about the joint future which have not been covered in the first phase of the M&A process. The same applies for answering questions that you will get from the buyer. Answer in the necessary detail but avoid adding something which was not explicitly asked by the buyer. It’s better to get a request to provide more detail than to hurry ahead and provide too much detail.

To summarise: The later you are in the M&A process, the more you should focus on closing the deal and avoid opening new doors by asking questions.

Start. Grow. Exit

Take it or leave it?

post-it-note-for-sale-1240322-638x457Of course, you should not be too much focused on discussing exit scenarios when you do not even have a product market fit for your start-up. On the other hand, I recommend that you start early to talk about the exit expectations each shareholder has. It can be very painful if you learn too late that the shareholders have very different expectations regarding a potential exit. Once you are successful, a typical tough discussion is if you should take the first serious offers that you get or continue to grow the business and hope that the valuation increases further.

Many of us read the stories of founders who turned down big offers from Google, Microsoft or the like and then sold the company years later for billions. Yes, these stories exist and this can happen, but I’m sure there are many more stories that do not make the news headlines, where founders turned down offers and then ended up with nothing or much less than they could have got by taking one of the first serious offers.

The issues that you should discuss in such a phase are:
• What are the risks to continue the business?
• What will the potential buyer do when I turn down his offer? Will he buy one of my competitors and what does this mean for my business?
• What’s the value to your private life to get a known amount of money now instead of an unknown amount in the future?

Founders tend to be very optimistic about the future of their own business. This is in the nature of the game and most likely you would not have started the business in the first place without that optimism. But if you get your first serious offers, it’s time to sit down in a shareholder meeting and be realistic about the risks involved with continuing the business – especially as you know now that there are buyers out in the market, which changes your market definitely. If these buyers are large companies with a lot of money and big distribution channels or very close partners of yours, then this can dramatically change your market position. Hopefully – as mentioned above – this is then not the first time that you discuss an exit amongst the shareholders and, in the best cases, you have already discussed thresholds where the shareholders agree that they are ready to sell for those amounts. I would recommend that if you are close or above those thresholds then you should not fall too much in love about the bright future of your business and you should take one of these offers. It’s nasty if you take the money now and in five years find you could have got much more – but it’s a nightmare if you do not take a serious junk of money now and in five years you are left with nothing, because your market has changed dramatically.

Note: I recommend reading the earlier blog post about Pebble. This fit nicely to this blog post.

Update May 3, 2017: Aaron Montemayor Walker posted the following article: “Where Are They Now: Startups That Declined Major Acquisitions

Start. Grow. Exit

The Minimum Viable Product

key-2114046_1280For startups it’s essential to do whatever is required to get to product/market fit, including re-designing your product or moving into a different market if necessary. Only after you know that you found a set of customers who react positively to your product can you take your startup to the growth stage. Don’t burn your money on a product no one will want to use. You have to maximize your learning for your money spent.

The Minimum Viable Product (MVP) is a product with just enough features to gather validated learning about the product/market fit. The basic idea is that gathering insights from an MVP is much less expensive than developing a product with more features and then testing it on the market. If you haven’t reached product/market fit yet, it is crucial you to keep your cash burn rate low and focus all resources on proving that people want what you’re planning to build. A MVP is the minimum you could create to find out that. This means that you are still thinking about all the elements your product could have, but you only build the things that are essential to find out that people want your product. This does NOT mean that you should build a bad product, because of course with a bad product you will get bad feedback.

Do not forget that a MVP must not necessarily mean you have to start coding a lot. For example, with Dropbox a video that explained what Dropbox does and why people should buy it worked very well in the early phase. Or you set up just a landing page to validate your value proposition, product fit, sales argumentation and even your pricing. Or, instead of providing a product, you start with a manual service. Or you launch a crowdfunding campaign on platforms such as Kickstarter or Indiegogo. Not only will you validate the product if customers want to buy it, but you will also raise money. As you can see there, are many different ways to build a MVP. You have to be smart about the right approach for your idea.

Having said that, I have to admit that it is sometimes very hard to decide which things are essential in order to find out that people want your product, especially if you don’t have any customers for your product yet. The only thing that helps here is to experiment for a pre-defined time period – e.g. 12 months – and try to learn from that. If, within that time period, you could not progress, maybe it’s time to let it go. As always in startup life, you also need a certain percentage of luck to have the right idea at the right time and find the early adopters that you need to be successful.

I strongly advise you don’t bring in marketing or sales employees to try to solve the problem of not having enough customers interested in your product. They will only add to your cash burn rate and probably won’t improve the product/market fit.

Final comment: the whole concept of MVPs doesn’t only apply to the initial phase of your startup. In my eyes it’s a methodology applicable to running your startup. For every new major feature it’s a good idea to think about starting with a MVP instead of a full-blown implementation. The nice thing is that later on when you have loyal customers it’s much easier to get feedback and input from them on how to improve the product further.

Start. Grow. Exit


pexels-photoConfidentiality is a serious issue during an M&A process and you should be prepared for breaches early on. In my opinion, it’s unlikely that you’ll keep everything confidential before the final document is signed.

The first talks are not usually a big problem. Nobody will be suspicious if you talk about selling the company. If it doesn’t take up much time, people are unlikely to suspect anything. It’s different if the talks intensify, you’re not in the office much and you start asking employees unusual questions. If you have a founding team, you might be able to answer all the questions for the buyer without involving your employees. But often this is not the case.

Many buyers will start to push you into talking to your key employees. The sooner the better for them, usually. But not for you. You want to push this back to the latest possible stage of the process. You’ll probably have to compromise, though, and start involving at least some of your key players in the talks.

When you get hundreds of questions from the buyer about due diligence, you’ll most likely need your key employees to prepare the data. Even if you’re lucky enough to be able to prepare all the answers within the founding team, your employees will realise that something is going on. The whole founding team will be out of the office and focused on time-consuming due diligence.

Even if you don’t experience all of the above, it’s very likely that someone from your founding team will either tell somebody outside or accidentally expose confidential documents to employees, or even to the public.

I can only recommend that you prepare a clear statement for when the M&A process is revealed. At least for your employees and most important business partners.

The two most important points to include for your employees are:

  1. Show clearly the benefits to them and the company after the acquisition.
  2. Make it clear that the company still has a future if the sale doesn’t go ahead. (Until you have the final signature, there’s always a chance the buyer might walk away.)

The same points apply to your most important business partners. The tricky part here is that there could be a few very important partners who will be negatively affected by an acquisition. For them, there’s no positive story. I don’t think you should lie to them. Instead, downplay the whole thing and make the sale sound much less certain than it really is.

There is no golden rule for every case. But I highly recommend that you sit down early and draft the statements for your employees, business partners and other stakeholders who might be affected. Once the sale is leaked, you might have only minutes or hours to react. Leaving it that late might deliver poor results.

Start. Grow. Exit

Deal structure matters

OLYMPUS DIGITAL CAMERAA buyer is acquiring either certain assets of your company (in an asset deal) or your company’s stock (in a stock/share deal).

Buyers often prefer asset deals over stock deals, because they pick and choose what they want to buy (good assets) and leave behind what they do not want to buy. In some cases, an asset deal might even help to shield a buyer from the past misdeeds of the seller, but that’s not always the case. However, asset sales may also present problems for buyers. Certain assets are more difficult to transfer due to issues of assignability, legal ownership, and third-party consents. Obtaining consents and refiling permit applications can slow down the whole transaction process.

You, as seller, typically prefer stock deals. In a stock deal, the owners of the company’s stock sell those shares to the buyer and this involves only one taxation. An asset deal often involves double taxation. The corporation is first taxed upon selling the assets to the buyer. The corporation’s owners are then taxed again when the proceeds transfer outside the corporation. In my home country, Austria, this means, typically, an additional 25% taxes! In addition to the double taxation, you still have your old company and have the effort required on your side to run the company and to close it after the asset transaction is finished. If you agree to an earn-out clause, this might mean that you have to continue with your company for several years, which costs you money and effort.

The decision to structure an acquisition as either an asset deal or a stock deal is an important one and should be determined on a case-by-case basis. The interests of the buyer and the seller often directly compete and effective negotiation is required to balance these interests. A higher evaluation in an asset deal compared to a stock deal might still mean less money for you as the owner of the business after taxation.

If the buyer does not offer you an all-cash deal, then this adds another layer of complexity to the deal. In an all-cash deal, the buyer uses cash to buy your company. A publicly traded company may decide to acquire your company using its own equity and not cash. In a cash deal, the roles of the two parties are clear-cut, and the exchange of money for shares or assets completes a simple transfer of ownership. But in an exchange of shares, you have to do a valuation of the buyer’s shares and it becomes far less clear who is the buyer and who is the seller. In some cases, you and the shareholders of your company can end up owning a large chunk of shares of the company that bought your shares. In many situations, of course, the buyer will be so much larger than you that you will end up owning only a negligible proportion of the combined company. But also, keep in mind that in such a case the entire risk that the expected synergy value embedded in the acquisition premium will not materialise is shared with you and the selling shareholders as you are now a shareholder of the joint company. Therefore, the choice between cash and stock should never be made without full and careful consideration of the potential consequences.

Lastly, if you foresee that you are on the right track and it is likely that you want to sell the company in the next few years, you should talk to an experienced CPA/advisor early enough to figure out what’s the best option to own shares in your company in case of an exit. If the valuation of your company is already high and/or you have an acquisition offer on the table it might be too late for such considerations. Years before that, if the valuation of the company is still low, it might be beneficial in some countries to transfer your shares to a private trust or structure that otherwise to have the optimum result in terms of taxation in case of an exit.

To summarise: Involve your advisor/tax lawyer to figure out which structure means what in terms of cash that you and your shareholders really receive at the end of the day before accepting any term-sheet from a potential buyer.

Start. Grow. Exit

Earn-outs should only be the icing on the cake

OLYMPUS DIGITAL CAMERAI must state that I’m not a big fan of earn-outs. In my eyes, they are very problematic for the seller and buyer.

In most scenarios, selling the company means handing over control to the buyer. Even if in the new setup the founders are still in a management position, they are not the owners anymore and, therefore, cannot decide things in the same manner as they were in the past. If you have the rare situation of your company still operating in exactly the same way as the past, and your decision power is almost unchanged, as the new shareholders want you to continue with the business in exactly the same way then this might be different. However, for all other scenarios you typically see one or more of the following patterns:

  • Selling your company is a process which has a lot of time pressure and a high work load, on both sides. Most likely, you will not speak with your buyer about the future of the joint business for a long time as there dozens of topics to discuss. More than that, you’ll very often have the situation that you will speak with other people during the selling process and then, afterwards, to the ones who really decide about the day-to-day operations. Therefore, you can safely assume that whatever you discuss in the selling process will not provide you with the full picture. From both sides, you will learn a lot in the months after the contracts are signed. Some of these learnings will, for sure, be different to the assumptions you had when making a forecast for the next few years. If everything is better than what you assumed then you are lucky but most of the time things are more difficult than they seem during the selling process. Then you are suddenly confronted with an earn-out target which is much harder to reach in this new setup than you assumed.
  • The buyer typically assigns members of his existing management team to run the acquired business. In many cases, one of these managers is your new boss. For them, it might be a very important career opportunity and they have to prove themselves. The last thing they want is to have to listen to you every day how they should run “their” business. They wants to run it according to their believes and this is often very different to how you did it in the past. This puts you in the position to veto everything which you believe the new management does that could harm the parameters on which your earn-out is based on. For legal reasons, you might even be forced to write formal letters vetoing against such decisions. A constant fight between you and the new management is very often the result of this.
  • Before you sold the business, you where the boss and decided everything alone. Many things will have been decided based on your gut feeling. You were fast, you where lean, and you were successful with that. In the past, you did not make everything into a PowerPoint presentation explaining why you have decided A and not B. Sometimes, you even find yourself in the position where you know that A is the right direction but you do not have a water-tight argument for it. You simply “know” it. This often ends up in either a fight between you and the new decision makers or in frustration on both ends because they simply do not share the same gut feeling.
  • If your buyer is large then there is a higher chance that you should expect a lot of rules, policies, and politics after the acquisition. Managers who have worked for many years, primarily for large establishments, are used for such behaviour but typically founders act in a very lean way and hate this kind of bureaucracy and politics. If you are one of these types of people, you should be very cautious signing a contract where the earn-out binds you to a situation for many years where you have to stay in an environment which is not made for you.

To summarise, earn-outs are a possible solution to bridge the gap between sellers and buyers if they cannot agree on a final valuation. However, I think it is very critical for the seller and the buyer if the earn-out is more than the icing on the cake for the seller. In any case, the earn-out period should be short and the decision power, during this earn-out period, has to be carefully discussed.