Through TechStars, my other investments or just at random, I’m often approached by entrepreneurs who want advice on what to do when a potential acquirer first brings up the idea of buying their company. Often, the company being targeted for acquisition is “up and coming” and is very early stage. For that reason, the entrepreneurs are often rightfully concerned that the “acquirer” is really just digging for information. That’s a valid concern for many early stage companies. Here’s the advice I usually give concerning this situation.
Step 1. Assess the acquirer. First and foremost, you should assess the potential acquirer. Can you really see yourselves working with them? Do you like them? Are you willing to be an employee of that company? Do you trust that their interest is genuine? If the answer is no, recognize that it’s either a non-starter or that it’s going to take one heck of an offer to pique your interest.
Step 2. Notify the board. Notify your board and/or key investors. If you have a board of directors, you should promptly notify them (email is fine). You might also notify key trusted advisors and mentors. Make sure to mention that the interest is very early, and that you’re exploring it. As always, getting mentorship can be key.
Step 3. Set your number. Next, if you haven’t already done it, you should have an honest discussion with your co-founders and key management about the minimum number it would take for you to sell the company. When doing this exercise, it’s useful to think about the following issues:
Recognize that it’s very easy to trick yourself at this stage. It’s really important to define the minimum number without padding. In other words, you’re effectively deciding that if the offer clears this hurdle, then as a team you want to work towards taking it.
Step 4. Engage the acquirer. When you first enter into discussions with the potential acquirer, you should expect them to ask you all sorts of questions before they make any sort of offer. You can expect questions about revenues, expenses, headcount, conversion rates, attrition rates, and all sorts of detailed stuff.
At this point, it will be your natural reaction to ask for an NDA with the acquirer. While this is a good instinct, delay doing it up front. Don’t worry – you will use it as leverage shortly. Without mentioning an NDA, provide a few high level answers that you’re comfortable with them knowing and when the questions get into the “zone of discomfort” ask them to provide a detailed list of their questions via email so that you can work on them.
Step 5. Ask for the ballpark offer. Now that you’ve answered just a few high level questions and have a more detailed list of what they’re after, it’s important to go for the “ballpark” offer before proceeding. Explain that you’ve received their email, you’re obviously flattered with their interest, and that you’re happy to answer all of their questions under two conditions. The first condition is that you’d like all of the information that they requested to be covered by an NDA. The second condition is that before proceeding, you would like for them to provide the likely “ballpark” paramaters of the acquisition via a simple email, including the likely cash/stock split.
Most acquirers will happily accept the first condition (not doing so is a serious red flag) but will avoid the second condition. It’s important to stand firm on both conditions before proceeding. The acquirer will likely claim that they don’t have enough information to make an offer, and that they need their questions answered. Assuming that you’ve given them basic revenue and expense figures, this is bullshit. Hold firm. Explain that you’re very busy working with customers and improving your product, and that you can’t afford to distract the company without having at least a ballpark understanding of the offer. Explain that it’s obviously non-binding and that you won’t hold them to it, but that you’re just trying to get a sense of it. Sometimes there is a little dance at this stage, where they will look for a couple more tidbits of information in order to give this ballpark offer. That’s fine – use your best judgement. Just avoid dropping your pants completely until you get the ballpark offer. Note that this does not mean sign the NDA and give them all the answers that they’re seeking! This is your leverage to get the ballpark offer, so don’t give it away. Recognize that the NDA won’t protect you from giving the “fake acquirer” exactly what they wanted.
If the acquirer resists the NDA or the ballpark offer, they’re probably just fishing. You’re not being difficult. You’re asking a perfectly reasonable question about ballpark deal terms before wasting your time.
People who are not high up enough in the acquiring company to actually be making this offer will be scared off at this point. That’s a good thing. Perhaps they never had permission to be pursuing an acquisition in the first place. This technique weeds those people out since they have to provide the non-binding ballpark offer in writing via email.
Don’t proceed without the ballpark offer.
Step 6. Identify mentors. Now that you have a ballpark offer, you have what I would consider serious interest. Now make sure that you’re working with someone who has been involved in multiple acquisitions, ideally on both sides of the table. Perhaps one of your existing investors or advisors can fill this role. It’s critical to have someone on your team that can help you negotiate terms, and to help you understand their impacts. I can tell you from experience that when I had my first exit from a company I founded, I left millions of dollars on the table before I learned this lesson. Do not underestimate the ability of experienced mentors to greatly increase your ultimate outcome. If you don’t have an advisor, contact someone that you trust that has done this before and ask them to help. It’s fine to pay for this help if you don’t have other options, but you should only pay in a success case and you should recognize the dynamic that this creates: 1) This person loses nothing if there is no exit other than time and 2) they’re motivated to help you maximize the exit at the expense of everything else.
Step 7. Assess the ballpark offer. Take the floor value of any “range” that they gave you for both the total comp and the cash percentage of the stock/cash split. This is all you should “hear” – ignore the rest of the range. The actual offer is very likely to end up being very close to the low end of the range unless there are multiple competing offers. You should now compare this to what you discussed in Step 3. If the offer isn’t high enough to be interesting, then your best bet is to simply tell them that and politely decline to provide any other information.
Step 8. Get to know them and answer their questions. At this point, the offer is “interesting.” Your goal now should shift to getting some face time with the acquirer and getting to know them on a personal level. It’s fine to do this by phone, but find ways to spend time with them physically. This will help you figure out if they are “for real” or not. Ideally, if practical you’ll start to this before fully “dropping your pants” and answering all of their questions. It’s a fine line between being coy and stalling. You can’t stall too long, but you can offer to meet with them personally to go through their questions. Basically, the more time you spend with the potential acquirer, the more you can develop trust and build from there. Provide the requested information under NDA to continue the process. Be sure to mark all information provided as confidential under the NDA. Keep a copy of everything that you provide.
Step 9. Push for a term sheet. Even at this stage, many acquirers will go silent for a long period of time. Sometimes this is normal – these things just take time. Internal fires that have nothing to do with you come up. People go on vacation. Things always move slowly. Do not assume this is going to happen. Keep building your business in the meantime. Continually push for a term sheet fully describing the acquisition. At every meeting, ask what information you can provide to work towards getting a definitive term sheet describing the acquisition.
Step 10. Decide. If at any point in the discussion you decide that something is not right, just stop. Ask for the return of confidential information, and politely bow out. If the deal happens – congratulations! Assume it won’t until it actually has.
Good luck! I’d love to hear your thoughts and experiences in the comments.
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great post david.
and timely.
Great post dude, thanks for sharing!
I’ve had a few friends in this position come to me for advice (crazy, i know) because there’s such a dearth of information on this topic out there on the web. This is truly useful and scarce information. Awesome.
Awesome post, David. From personal experience, I want to reinforce points 3) and 6).
Setting your number is vital because the overwhelming odds are that the acquisition will not be a success — the body is going to reject the organ. I’ve heard that something like 90% of all acquisitions result in a net loss for the acquirer. And during this time, the experience is likely going to suck for the entrepreneurs.
Even if you like the people making the offer or think that the company is great, there are wayyyyy too many uncontrollable variables to predicate your decision to sell on who’s buying you. Executives and strategies change, and you’re newly acquired company is likely just one very small part of the overall picture. The odds are that once acquired, you’ll never materially improve your product and you’ll end up working on something else entirely.
So the best thing to do is ask yourself “how much money do I need to never improve the product again.” If that’s in the lower end of their ballpark, move forward. If you want more than they’re offering, then politely disengage.
As a corollary, if the offer isn’t up front cash, then you need to seriously assess where you think stock is going and the value of two or three years of your life. “Resting and vesting” is mental torture for an entrepreneur.
As for finding a mentor to help navigate the process, when my company was acquired, our mentor was personally responsible for raising the overall acquisition price somewhere between 25-and-33% with just a few hours of effort.
This is hands-down the best post I’ve seen on the topic, as applies to small tech companies. Kudos, David.
One note on the NDA: don’t get hung up on the form of it. In particular, if the acquirer offers a two-way NDA in their own form, that’s probably quite sufficient (have your lawyer scan it, of course). The key thing here is, as David points out, making sure you’ve got 1. some kind of bona fides on their part (i.e. not a fishing expedition), and 2. someone high enough in the org to bind the company with at least an NDA.
One thing to consider are earn outs. This can cut a big chunk of your net gain out. If the earn out takes 2 or 3 years a lot can happen in a big company – reorgs, new bosses, changing business models, the economy, firings etc. that can keep you from getting the rest of your money. My advice, Never accept an earn out.
@eric it was 50% and it took him a whole week.
Great post David. Can relate to it in a +vely, looking back at our series A experience. Many of the points you make here are applicable to “funding interest” too. You should do another post on those lines.
There is a “formal” name for the ballpark offer. It’s called a Letter of Intent. If they’re serious, they will send you one of those.
Phenomenal post! Expertly written, and very informative.
I have bookmarked your site.
This is awesome– nice, simple, and really clear list. Well done!
Depending on your particular situation, I would add one more key ingredient– call it “Step 7.5″– and that is to get some other parties interested in the deal. In other words, if there is only one company interested in acquiring you, then you are a “price taker”– you can accept their offer, or not. If you have multiple companies interested, then it becomes a “market” (or sometimes even an auction) type of environment.
This is a delicate thing, and you don’t want to piss off Acquirer #1 by shopping yourself. But, getting Acquirers #2 and 3 to come to the table gives you negotiating leverage to help get the price you want. Even the possibility/perception of other interested parties can help keep Acquirer #1 honest, and help keep some heat on the deal.
I would also emphasize #6, Identify Mentors. Keep in mind most large acquiring firms have a corporate development group (often ex-Ibankers) who do this professionally, and they are rewarded by buying you as as cheaply as possible. So mentors are a great way to level the playing field a bit.
PS: I’m fanatical about this topic…I’m currently advising a mobile company that is “in play” so it’s very timely for me. I recently built a deck on the subject called “Exit Strategy for Startups” which I put up on slideshare: www.slideshare.net/VentureArchetypes/startup-exit-strategy-thought-piece-v76 (It’s still a work in progress…would love your feedback.)
Again, nice article! This one is tweet-worthy. Nathan Beckord
Great advice. Simple and lucid. I am in the middle of such a process for one of my firms. Thanks.
David, this is a great collection of advice and guidance. Thanks much for sharing it.
The one addition I have is to write a rejection letter to the acquirer. A mentor of mine recommended it to me when I was going through a potential acquisition and it helped a ton.
The letter is only hypothetical and you don’t have to send it to the potential acquirer. But it provides a balance to Step 3: Set your number because this tends to get you excited about the potential exit.
The rejection letter forces you to consider the alternative and forces you to analyze the reasons the deal might not work.
At least, that’s what it did for me.
This looks like appeared a day after I published this story of Apple’s interest in my semantic technology kandarpmadhav.wordpress.com/2010/06/17/itunes-semantic-search-project-derailed-by-apple/
Interesting points to keep in mind for future reference.
Ray’s comment about earn outs is very good. Things always change once you are inside the acquirer. Don’t assume anything that you don’t control personally will happen, unless it’s contractually stipulated. Marketing funds, engineers, etc – never take an earn out that depends on acquirer behavior if you can help it, and certainly not without contractual support.
Also, any milestone farther out than 6 months is chancy, and 12 months is fiction. Some acquirers are sincere about paying all of the milestones (Google was absolutely great to us in this regard), and others use them as a sneaky way to take ‘negotiate’ the price of the deal down on the back end.