Grow

Selling a channel-based business

Startup Stock PhotosBuilding a software vendor in the enterprise space that uses resellers and VARs as a distribution channel can be a very good way to scale a business fast. Especially in the on-premise enterprise software market, it’s sometimes the only way to succeed, because as a startup you don’t have the resources to sell directly and you can’t provide local support without a partner.

If you later decide to sell your business, potential buyers will look closely into your channel business and reseller contracts. Buyers’ concerns will be that successful resellers might walk away after the acquisition or claim goodwill compensation if fundamental changes are made to their contracts. Some European countries have laws in place to protect resellers’ businesses. What this means is that if your buyer cancels a reseller contract or fundamentally changes it, the reseller might have rights to a share of your buyer’s future business for some years to come. Naturally, this isn’t what future buyers want when acquiring your company; typically it either decreases your company’s valuation or requires escrow provisions to address these concerns.

I can only recommend engaging an experienced lawyer early in the process when you decide to start a channel-based business, to draft contracts in the right way and discuss how to manage your reseller relationships accordingly to mitigate that risk.

Exit

Choosing the right M&A attorney

pexels-photoThe Mergers and Acquisitions (M&A) attorney is a very important team member during your transaction. If you have an M&A advisor, then I would say the attorney and the M&A advisor are the most important external team members. You need also a good CPA, but the attorney and the M&A advisor are more involved in the negotiation stage.

Some of the most important questions you need to answer in order to help choose the right attorney for your situation are:

  • How’s the relationship between you and the attorney? If you have an M&A advisor be sure to involve them in selecting the right attorney.
  • Has your attorney done deals of similar complexity and size? Ask for references and do follow them up.
  • Does the law firm also have experienced in-house patent, tax, international law and labour relations professionals? This is important, because when it’s time to draft and review a sale agreement you don’t want to be introducing an additional law firm.

In my experience one additional question is very important: do you trust your attorney’s negotiating skills?

Typically start-ups have only a very small team involved in the negotiations. On the other hand, corporate buyers might assign larger teams to the deal. With more members on the table the buyer can appoint ‘bad guys’ and ‘good guys’ to the negotiating team: the ‘good guys’ explain, in a nice way, the reasons why the ‘bad guys’ cannot approve what you asked for. In this dance between your team and the buyer’s it’s very important that your attorney is able to defend your position in the best possible way across a broad range of topics. Your M&A advisor can be a great help in bringing the discussion to a fair and reasonable level too. Be aware, however, that as most discussions end up as clauses in the contract it’s always the lawyer who helps to nail down the final details.

There is one very important additional element in this dance: if you are not ready to walk away from the negotiations you may end up not signing the best possible deal. I’ll write a separate post about that topic in the future.

Exit

Selling Tip: Can you organise a bidding war?

the-strategy-win-champion-the-championship

Buyers and sellers try to determine the right valuation of the company based on revenue, free cash flow and profits. Most of these transactions are supported by Excel calculations.

However, from time to time there are deals that stand out. Companies where it seems that their market has no significant barriers to entry and who only have a few team members get very high valuations.

According to Corum’s president, Net Burgess, the reasons for such high valuations are typically:

  1. A robust IP portfolio protecting critical ground in an emerging market
  2. High-value software that gives the buyer a time-to-market advantage in a high-value market
  3. A rock star team

If you are already in the selling process and do not have (1) or (3), you should think about what you can you do to establish a situation where two or more buyers are so interested in your time-to-market advantage that they make increasingly higher offers above what they would normally be willing to pay:

  • Try to engage competitors to bid for your company.
  • Try to generate a climate that gives each potential buyer the feeling that they are not alone and that there are other buyers that could hurt them if they buy your company. (Note: Be careful about what you say as typically you will have to sign NDAs.)
  • Try to generate a sense of urgency, even if not all buyers are that active.
  • Seek support from a M&A advisor with a good reputation. This gives buyers the impression that there are most likely other potential buyers on the table as well.
Start

You should not take out loans too early

money-finance-bills-500Although the start-up ecosystem in Europe has improved in the last few years, it’s generally still harder to obtain funding in Europe than in Silicon Valley, that is unless you live in London, Berlin or Paris. Therefore, some funders might instead consider a more traditional European way to finance their business.

For instance, trying to obtain a loan to start a franchise business or real estate development is usually a good idea, whereas trying to obtain a loan to start an unproven business, is in most cases, a very bad idea. Anyhow, many European banks will not grant loans to start-ups anymore as they are highly risk averse, but there are exceptions, as some countries have start-up programmes that, in reality, grant you loans. My home country, Austria, is one example of this. As a start-up, you obtain a bank loan that is guaranteed by a government-owned agency (once they approve your business plan). I once made the mistake and took out one of these loans. At the beginning, I was very exited to get the loan approved and to get the money. But at the end of the day, I learnt the hard way that the whole system works just the same way as a traditional loan and one day you will have to start paying back the loan. And if you cannot pay it back, you are typically done, no matter how much potential your business has. In such scenarios, the bank even has a big interest in declaring your business bankrupt. Only in that way will they get back their loan from the government agency and if they miss that and grant you further loans, they risk the local law calling those loans equity. Which they are very careful to avoid.

It is always true, of course, that it is better to have enough cash to survive, even with debts, than to have no business and no debt at all. But be very careful with loans! And, at least for my part, I would never again take out a loan in the early stage of a start-up. In the later stages, when you are highly profitable, well that’s a different story, but at the beginning, believe me, it’s poison!

Start

Start executing – do not look for investors too early!

Ideas are worthless!

As of June 2016, there were over 4.2 million apps between the Apple & Google app stores. Many of the developers behind those apps probably think they have a great idea and will earn a load of money. But in reality, only 25% of iOS developers will earn over EUR 5,000 per month from their apps. And on Android, it’s significantly less. In fact, many developers, if not most, earn close to nothing.

Perhaps you have a great idea too; one which you believe could make you a lot of money. But the real value is not the idea itself, it’s the combination of the idea and the execution. You have to build your product, market it, hire employees, search for customers, care about bookkeeping and find an office, and then there are also many external factors to consider. Nearly always, there will be competitors with the same idea going after your market. Or typically, in a later stage, the big guys like Google or Microsoft or large investment firms throwing their weight around and splashing their war chest of funds at your market to take you and everybody else down.

So even having a great idea and being the first person on earth to think of it will not necessarily bring you success. Apple was not first to launch an MP3 player, while Google was not the first to develop a search engine and Facebook was not the first social network. But they took all these products to another level. And they are all examples of how it’s all about the execution and doing what you do better than others.

Start executing

pexels-photoTherefore start executing, but do not immediately rush into looking for investors in the first place. I highly recommend to only pitching to investors when you have an existing company with paying customers; especially in Europe. You will learn a lot by waiting and operating the company; you will be forced to operate lean and very likely you will experience that you have to change some assumptions and adjust your idea. You’ll be infinitely better placed to land an investor after you have had some success in the market; you will also have much more shares in your company and in a best case scenario, you might even discover that you don’t need an external investor after all.

Start. Grow. Exit

Build a platform, not a feature

pexels-photo-218443Many of us use software products every day. Therefore, it’s not unusual that we might find a lot of features that are missing in certain products that we still regularly use. Sometimes it’s very hard to understand why a certain feature is missing as you know that a lot of people would find it useful and it would undoubtedly improve the product.

Now some people might think that this is the perfect starting point for a start-up and so they might try to build this feature set inside the ecosystem of another company (e.g. YouTube, Google, Microsoft, Facebook, …). Their product will add certain functionalities to that ecosystem, and their monetisation strategy is based on charging for the use of the new and improved tools.

I consider this a very dangerous approach: one that rarely works well in the long run. If you build an awesome set of tools and they work, there is a high likelihood that the owner of the ecosystem is going to copy them and make them free. And you can’t really blame the owner of the ecosystem for doing that, as they probably had this feature set on their development roadmap as well.

You might even have an exit strategy in which the owner of the ecosystem will buy your company. This might happen, but negotiating with someone who can build or even just rebuild your product better than you can and who can easily distribute it to their large user base puts you in a really bad negotiating position. They might only want to pay you a price that’s close to what their costs for building that feature set themselves would have been. It’s therefore much better for you to build your own platform instead.