Most successful tech companies that exit will do so by acquisition. If you are an entrepreneur or CEO considering an exit for your company at any point in the next few years, below are some of the key learnings that were shared at TechExit, the M&A Ready Conference, which took place Nov 18-19 (East) and Nov 24-25 (West). Please note that I have curated these based on my experience of having taken my growth company to an exit and subsequently heading up M&A and merger integration for a PE-backed company.
Start Preparing Early
When planning for a future exit by acquisition, a theme that was raised repeatedly was the criticality of starting early, ideally years ahead of time. Some of the top tips for doing that included:
-
Build a great business. Many of the best acquisitions are overnight success stories that are 10-25 years in the making. Don’t over-invest in financing or acquisition activities because if you build a great business, investors and acquirers will come to you. Develop and execute on your metrics; for example, Intelex had a dashboard of over 2,000 metrics that rolled up to a few key ones). Keep your financials in order. Do your best to ensure that you are on a sustainably upward trajectory and fully ready when you test the market for acquisition. Be realistic with your forecasts recognizing you want to meet or exceed them, rather than being crazy optimistic and losing credibility in the midst of the acquisition process by not meeting them.
“If you are starting a company, you have to enjoy the journey rather than focus too much or too early on the destination.” – Mark Jaine, formerly CEO, Intelex Technologies
-
Cultivate relationships. While you focus primarily on building a great business, allocate ~10% of your time to identifying and building relationships with 5-10 key partners and prospective acquirers based on your market space and growth strategy. Reach out, establish contact, stay friendly and keep them updated on your progress, both good and bad. For example, when planning trips out to visit customers that are in the same city as a prospective acquirer, make a point to schedule a check-in meeting. Ideally, form revenue-generating and product integration partnerships as these are often the source of initial acquisition inquiries. If a serious inquiry comes in, be ready to tip off other partners to initiate a competitive process.
-
Promote your company. Know your business inside out and develop a compelling story and company overview or pitch deck. Seek opportunities to speak about your company, whether at events, in webinars, in the media, or other venues; the practice will serve you well in the world-class enterprise sales process that is required for selling your company. Significant drivers of value that you will want to emphasize in your sales story include recurring revenue growth, net retention, breadth and depth of your customer base, defensibility of your offering and ultimately, the future market opportunity of your company, ideally tailored to the synergies realizable with the prospective acquirer. In the case of strategic acquirers who want to integrate your company, intellectual property, tech stack and debt, office location and company culture will also be very important.
-
Make a great impression. Maintain proper governance and documentation. Set up and maintain a data room well ahead of when it is required, always being transaction ready. Bear in mind that there will be hundreds if not thousands of documents to address all due diligence requests, and it is simply not feasible to collect that kind of material in the midst of a process without causing delays or the impression of being disorganized. Eliminate potential deal killers before you start the process. And always make a great impression: furnish significant documentation right from the start, respond effectively and promptly to requests, and keep your facilities neat and clean in the event of video calls or site visits.
“We can work through many issues but the biggest deal killers are negative customer feedback that was not clear at the outset, and things that could lead to customer churn down the line.” – Lyndsay Kerwin, VP at Silversmith Capital Partners
-
Align with stakeholders. There are multiple paths to exit and liquidity for shareholders. These include going public (initial public offerings, reverse takeovers, capital pool corporations and special purpose access vehicles), secondary financings, and minority or majority acquisitions (for clarity, the focus of the majority of the conference and of these takeaways is on exit by acquisition). When exiting by acquisition, make sure that you align with your Board and major shareholders on key terms such as timing, price, deal structure including share or asset sale, earn-outs and holdbacks, tax planning, integration expectations and leadership team roles post-acquisition.
Use External Advisors
While there was an inherent bias in the audience in that the majority of attendees were advisors, it still came through that engaging strong advisors is almost always the best course of action. Some of the key advisors you will want to engage include:
-
Legal. Experienced in M&A specifically. They will guide and protect you through the critical points in the letter of intent (LOI) and purchase and sale agreement (PSA). Key areas where they will be especially helpful include in the representations and warranties, indemnities, and hold-backs/earn-outs.
-
Tax. Seek ways to minimize tax impact for selling shareholders, employees, and/or you personally. The importance and value of a good tax advisor in what you net post-acquisition cannot be overstated.
-
Accounting. Ensure that your financials are in order and credible from an acquirer’s perspective. Depending on the size and complexity of your company, it will increase credibility to have your financials audited, review or notice to reader, from a reputable accounting firm. On the other hand, undertaking a formal valuation process prior to initiating a sale process is discouraged as it could be used as a negative anchor when inevitably uncovered in due diligence.
-
Investment Banker. Generally, highly recommended, especially for larger, faster growing and more complex companies with higher expected exit values. They are always speaking with buyers and have a good understanding of what the market is like at any given point in time. Thus, they help you see the business as an acquirer would, and to prepare and rehearse your presentations. They put the company in the best light in terms of positioning and preparation of materials. They keep you grounded with valuation comparables and by acting as an emotional outlet during the process. They will help set up, organize and maintain your data room. A good investment banker will expand the set of prospective acquirers with their outreach, and while the most likely acquirer will come from your established partnerships and relationships, every once in a while there is one that is unexpected (as was the case for Intelex, for example). They signal to prospective acquirers that you are serious and help create competitive tension, given that it is in your interest to have multiple parties to the table. Finally, they can act as a bad cop in the negotiation to free you up to be the good cop, and build a positive relationship with the prospective acquirer(s).
“Advisors can act as a bad cop in the negotiation.” – Bernie Li, formerly Co-founder of Pure Energies
Two additional thoughts on advisors:
-
Consider the ROI. All of the entrepreneurs agreed that they added value to their processes, and the only question was whether the big cheque that they wrote to them at the end was fully worth it. For your situation, consider how much their engagement will a) increase the probability of the acquisition going through; and b) add to the ultimate acquisition price. As long as the increment in the acquisition price exceeds the amount of their fees, then they will likely have been worth engaging.
-
Diligence your advisors. An acquisition may be the largest transaction you go through in your life, and deserves that level of evaluation for these critical extended team members. How much experience do they have in your domain? Watch for the bait and switch where a senior partner sells you on their firm only to hand you off to junior members of the team once you engage them; know who will be personally representing your company.
Bolster Your Negotiating Position
As with any negotiation, and especially one of this magnitude, there are numerous things you can do to maximize your potential outcome. These include:
-
Build a great business. Sound familiar? The better the fundamentals of your business in terms of revenues/ARR, growth rate, profitability and defensible position, the more that acquirers that will be attracted to you. Getting multiple interested parties to the table is a key element in creating the competitive tension that will result in more favorable terms for you.
-
Have options. If you run a great business, then you will generally have the option to continue operating it, irrespective of whether the acquisition goes through. Keep sufficient cash in the bank. Consider financing options such as debt, VC, family office, institutional or strategic, and the numerous public alternatives mentioned earlier that are increasingly accessible to growth-oriented, as-yet unprofitable companies. If you do pursue M&A, get multiple bidders to the table and don’t lose your leverage by over-committing too early.
-
Run a tight process. Address gotchas early, ideally before the LOI. Time is the enemy of the sale once the process gets started. Practice and rehearse your presentations over and over. Keep the momentum going with thorough prior population of your data room and by responding quickly to new requests. Leverage your advisors’s experience and always be prepared to step in as required to unblock and keep things moving.
-
Build trust. Be open and transparent. Build good rapport with the decision maker and key influencers at the acquirer. Acquirers do not expect perfection. Be confident and straightforward about what hasn’t worked out well, and areas that you may not have looked into as much as you might have liked. Understand the gaps in your business and thoughtfully respond to questions on them. Also understand that the buyer will always be concerned about mitigating risk in addition to capturing and creating value, and seek for ways to reduce perceived risk. Conversely, stage your disclosures based on where you are in the process, and do not at any time give away anything that would compromise your ability to succeed in the event the acquisition does not close.
-
Assert your terms. Don’t get overly excited when you receive an LOI, as it is only really a starting point. Over-invest in getting the terms right in the LOI, especially as you will lose the leverage to do so in the exclusivity period that will follow. Bear in mind that acquirers are typically more experienced at the process than sellers. To compensate, leverage your advisors and don’t aim to negotiate all of the terms yourself as CEO. Key terms to consider include price; deal structure; earn-out/holdback amount, duration and conditions; reps and warranties, and indemnities; alignment on how to treat net debt, deferred revenue and working capital adjustments, all of which may affect the purchase price; and clarity on the roles of and retention (or not) of key employees, including the CEO.
“It is critical to make sure the LOI is very tight, especially given the exclusivity period.” – Loren Rafeson, Partner at BDC Growth Equity
Adapt for COVID
COVID-19 has affected all of our lives in 2020, and the area of M&A is no exception. Somewhat surprisingly, there has been no letdown in exit activity, with a significant increase in M&A deals in Q3 in the US and over 50 IPOs taken to market. The outlook also looks promising as many owner / entrepreneurs saw the crash in March as a wake-up call to crystallize some or all of the value they have been creating in their businesses over the years. Some of the COVID-specific impact that panelists shared that they have been seeing include:
-
Valuations. Seller valuation expectations have not declined significantly, and in the case of SaaS, have actually gone up. There is a ton of capital out there for great companies, but with more back and forth on terms. Seek to understand the other side’s concerns and prepare to get creative to find the win-win outcome.
“There is a ton of capital out there for great companies.” – Lisa Melchior, Founder and Managing Partner at VERTU Capital
-
Structures. There has been an increased use and creative structuring of earn-outs, ratchets, holdbacks, and more tightness on the reps and warranties and their related indemnities to bridge valuation gaps and de-risk for the acquirer. Reps and warranties insurance has been especially useful in removing some of the friction around these items. Some good tips on earn-outs in particular include tying them to measures more easily influenced by the acquired company such as revenues; tiering them for partial payouts in the event that something less than 100% is achieved; extending the timeframe to achieve post-acquisition milestones; providing the ability to catch up if earlier milestones are not met; and protecting the earn-out in the event that the acquirer itself is acquired before the earn-out period or milestones have come to term.
-
Longer processes. Prospective acquirers universally view financials as being optimistic, and companies rarely meet forecasts post-acquisition. For strategics, integrations are tough: technology re-platforming is very challenging, and cultures can be very difficult to merge. As such, acquirers are investing more time getting to know selling businesses through their numbers in COVID, and scrutinizing to a greater degree in due diligence.
“In a study of over 200 transactions, about half did not meet their plans post acquisition.” – Kyle Feucht, Director, Growth & Transition Capital, BDC Capital
-
Human connection. Transactions have definitely been started and closed during COVID. That said, most processes have been slowed as it can be challenging to get to know management teams via web meetings, and to build up the trust for the difficult times that will inevitably occur. As such, look for or create icebreakers to show humanity and vulnerability, and accelerate relationship-building. On the positive side, as a matter of necessity there can be more peer-to-peer interaction in order to not have the process bottleneck through the CEO, thereby giving the company a head start on post-merger integration.
Pace Yourself
It was a consistent message from exited entrepreneurs and CEOs that an acquisition process takes a considerable amount of commitment, detail orientation and time on top of your regular workload. Some of their top tips included:
-
Prepare for the workload. By most estimates, expect an additional 50-100% on top of your habitual work schedule for at least 1-3 months of a typical 3-6 month sale process. And bear in mind that you will want to be meeting and ideally exceeding your plan during the sale process, and that you will want to maintain a calm, open and optimistic disposition for your team, the acquirer’s leadership team, and your and the acquirer’s advisors, all while fielding a number of incredibly detailed requests, any of which could threaten to derail the process or reduce the price if not dealt with in an effective and timely manner.
-
It’s a marathon, not a sprint. Make sure that you eat and sleep well, as the process is exhausting. As stated by Mark Jaine (Intelex) and Joel Lessem (Firmex), and experienced firsthand on more than one occasion by Vince Kadar (Telepin), many acquisitions don’t actually get to a close, and you want to mentally prepare yourself for that possibility – and be okay with it.
-
Sharing with your team. As for the topic of when to tell your team, Eric Green (formerly with Askuity, now The Home Depot) provided the metaphor of who is “in the tent” at any given point in the process. In the beginning, it may only be the CEO and possibly the CFO who are in the tent. As the process unfolds, there are additional members that you bring into the tent, such as leadership and key team members, either because you feel it is the right thing to do or out of necessity as they will help address some of the acquirer’s requests for information. Startup employees in particular may have been attracted to the company by its greater level of transparency, and want to know what is happening with the company. That said, the decision as to when to announce the acquisition to the entire company is a challenging one unique to each situation and culture given the flight risk of key personnel prior to the close. While the consensus was to only share the news with the entire company once the transaction had been completed, it was clearly an area of angst for some of the selling CEOs, including Kirk Simpson (Wave) who confessed to it being the most stressful period of the entire acquisition for him (spoiler: the Wave Accounting team gave him a standing ovation!).
-
Own the process and outcome. Never forget that as the CEO, you own the sale. The process is incredibly complex with many different parties at the table. Organize your team with each person knowing their role. As you get into the process, it is critical that you have or build a good relationship with the lead contact at the acquirer. Lawyers protecting their respective company’s interests may come to honest disagreements, and you want to be able to pick up the phone to speak with one another, take a step back, remind one another of the value you are committed to creating together, and work through any issues. Selling a company is likely the biggest enterprise sale you will ever make, and you are the lead salesperson responsible for closing the deal.
Closing Thoughts
If all of the above seems overwhelming to you as a CEO or entrepreneur, there are some parting words of encouragement to keep you motivated. Mark Jaine (Intelex) considered the sale process to be a very stressful period, but a great and unique experience than he would hope that most CEOs will get to go through at least once in their lifetimes. And Joel Lessem (Firmex) said that anytime you get to close on a sale of your business, it’s like winning a championship.
Now, go out there, build a great business, prepare early with the right team, and win your championship!
Credits
-
Entrepreneurs: Mark Jaine, Intelex; Robert Madej, PureFacts; Tarique Al-Ansari, Paystone; Kirk Simpson, Wave Accounting; Nicky Senyard, Income Access; Joel Lessem, Firmex; Miriam Tuerk, Clear Blue Technologies; Shannon Susko, Subserveo; Eric Green, Askuity; and Vince Kadar, Telepin Software.
-
Investment Bankers: Sampford Advisors; Tequity Advisors; Roynat Capital (Scotiabank); RBC Capital Markets; CIBC Innovation Banking; PwC.
-
Law Firms: Fasken Martineau DuMoulin; Osler, Hoskin & Harcourt.
-
Private Equity Firms: BDC Capital; JMI Equity; Silversmith Capital Partners.
My name is Alexander Rink. Drawing upon over 20 years of experience growing early-stage companies, my team and I help CEOs and Boards of Directors of companies from $1M to $25M in revenues identify and resolve strategic and organizational challenges to accelerate their company’s growth in a capital efficient manner.
Contact
