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The big story out of Silicon Valley in 2016 was that venture capital investments were slowing down, marking an end to the free flow of startup cash. But that doesn’t mean big money has left the Bay Area. In fact, some insiders predict a new wave of tech mergers and acquisitions, according to Business Insider.
History doesn’t repeat itself, but it does rhyme. Merger mania often signals the last phase of an economic cycle (typically occurring during the last eight interest rate cycles) before a recession. The latest Fed tightening cycle began recently, according to CNBC, so merger mania will likely peak within the next 12 months.
This is a great time to be a seller as valuations top out. But the path is fraught with potential dangers for companies that overacquire or take on too much debt. Merger mania usually ends with a reversal of the tide, which can be painful for those running tech businesses that aren’t profitable or growing. During a recession, higher carrying costs in the form of spiked rates and lower earnings can instigate a painful right-sizing of valuations.
To sell or not to sell?
Entrepreneurs who receive acquisition offers face a tough decision and many hours of sober discussions. In a true boom time, acquirers ask few questions because they fear missing out on opportunities to snap up startups whose valuations will only shoot higher tomorrow.
But entrepreneurs should be asking questions and positioning their businesses against market and business realities. They should also be assessing issues such as how they’ll weather periods when acquirers have less money to spend — and whether their valuations are realistic based on their growth and revenue forecasts.
Startup founders need contingency plans for times of economic difficulty so their businesses can thrive when others turn fearful. But asking challenging questions (and accepting the answers) is crucial, no matter what the economic climate is. Before agreeing to an acquisition, entrepreneurs must look long and hard at the acquiring companies.
Is the buyer a good fit for the startup and its team? Is the acquirer likely to be successful in the long term? What’s the game plan if the acquisition isn’t as successful as the buying company had hoped? Unsuccessful buyers will sometimes renege on stock or earn-out agreements to claw back their losses if a transaction is less profitable than they’d hoped.
Entrepreneurs must stick to their principles and never let potential buyers coerce them into something that doesn’t sit right. The word “no” is a powerful tool, and sellers seeking clean sheet deals should exercise that power liberally.
Most importantly, entrepreneurs should ask themselves why they’re selling in the first place. Do they need the liquidity, or should they hold out for a better partnership opportunity? A substantial acquisition offer may seem tempting, but startups should resist the urge to cave based on the promise of fast money or short-term benefits.
Successful deals lead to more opportunities in the future, so it’s critical that entrepreneurs think long and hard before participating in an acquisition. I’ve met more than one person whose greatest regret was selling too soon or to the wrong buyer.
Feeling the deal.
There’s no one-size-fits-all formula for deciding whether a sale is the right move. Every company is different, and every entrepreneur has unique circumstances to consider. Some have partners who force their sales, while some want to retire or explore another field; others are under too much financial strain to continue leading the business.
Then, there are considerations to make about the company itself. The biological age of the team, the company’s cash flow trajectory and its potential for future revenue are ultimately the greatest arbiters of whether a company is sold — and at what price. Each entrepreneur’s situation will vary depending on these and other factors.
However, the following strategies will guide entrepreneurs as they weigh the pragmatic benefits of acquisition against their own priorities:
1. Do a gut check.
Tech founders who build successful businesses become incredibly in tune with the organization’s subtleties and the rhythms that make it work. They should use that intuitive knowledge to “feel the deal” before agreeing to an acquisition. Something that looks good on paper won’t necessarily bear out in the real world, and smart entrepreneurs should trust their instincts when they don’t align with the numbers.
Potential buyers approached me five times in four years in pursuit of my business, Uniregistry, as I told DN Journal in 2007. Several offered nine-figure deals, and they were willing to go higher at each point in our negotiations. I met with each one and seriously considered their propositions. In the end, selling didn’t feel right. I may sell eventually, but not until I find a situation that suits my goals and represents what I believe is best for the company.
2. Size up the buyer.
Learn everything there is to know about potential buyers. Why are they interested in your company? What’s motivating them to make this deal? What are their long-term intentions for the business?
Skift founder Rafat Ali admits that he sold paidContent to Guardian Media Group without understanding the buyer’s history in regard to its acquired properties. Guardian Media Group sold paidContent to a competitor, who then closed the startup, much to Ali’s chagrin. “I should have done more due diligence on their history of supporting other companies,” he told the Press Gazette.
3. Dig into the details.
Most contracts to purchase a company begin with a Letter of Intent, followed by the “definitive docs” that define the minutiae of the deal. Read these carefully. If the contract is full of draconian stipulations, clawbacks and provisions that would force you to give up the company in the event of poor buyer stewardship, run for the hills. Contracts should be balanced and clean. If your buyer has a dark heart or is likely to fail, you’ll find out in the LOI and definitive docs.
4. Distinguish between failures and opportunities.
If you can’t come to agreeable terms, walk away. Take the opportunity to restructure the business, or hire a CEO so you can take time away and gain perspective. A failed deal does not equate to personal failure. There are more buyers in the world than there are companies to buy, so hold out for the right one. At the end of the day, you want to feel proud of yourself for building something great and leading with integrity.
The best deals are the ones that need the least negotiation and coaxing. Onerous deals that require months of tense back-and-forth discussions usually end in heartbreak — or the courtroom. The best deal is sometimes none at all, and entrepreneurs should acclimate themselves to that idea.
The M&A wave will create many opportunities for tech founders to sell in the next two years. Those who lead with their instincts — instead of numbers — will have no trouble attracting buyers when they’re ready.