As an entrepreneur, it’s easy to get lost in the thousands of things that you have to worry about — customers, employees, strategy, finances, etc. When you add exit strategy to the mix of things to think about, it’s easy to understand how a founder’s mind can get even more cloudy. But given most entrepreneurial ventures end via acquisition (as opposed to an IPO), I often counsel entrepreneurs to be spending more time and effort now to prepare for their eventual exit. While an exit seems pretty simple in theory — someone is paying you money (hopefully a lot) in order to buy your business — it can be a grueling effort with a ton of small, yet meaningful, points in the process. Often, these small points make the difference between getting a deal done and watching one slip away.
As a 3x founder, I’ve been fortunate to have been through 3 acquisitions to public companies and I can tell you that there were tons of small things I would have never assumed would come up during the deal process. With each subsequent company, you try to get smarter and more prepared.
But why do I recommend focusing on these items well in-advance of an acquisition? So you can enjoy the fruits of your labor. I recently sold a house, and when the house originally went on the market, the first few people to visit didn’t make an offer. When we asked for feedback on the house, they were eager to provide a short list of things that should be updated, fixed, corrected, or replaced. For example, everyone thought the downstairs floors needed new carpet. So what did we do? We replaced the carpet. And the house sold within a few weeks.
I often tell entrepreneurs not to wait until they move out to replace the carpet. The process of preparing your business for an acquisition can be incredibly valuable to the everyday operation of your business. My advice is to do that work now, be prepared, and enjoy the benefits that come from this process. Ultimately, it will help make your business stronger.
At High Alpha, we work to prepare all of our companies to be in the best position possible for capitalizing their business, regardless if that is being ready for an investment from a top tier investor or an exit opportunity (acquisition/IPO). I thought it might be helpful to share some of the things I’ve personally faltered on in the past or that I’ve seen other companies falter on.
In my personal experience, I’ve seen plenty of M&A deals that cave based on the fact that customer agreements or terms and conditions are so vastly different that they cannot be bridged. It seems like something that could be easily altered, but when dealing with customers, they often become accustomed to certain methods of transacting with businesses. For example, if the selling company invoices their customers month-to-month and the acquiring company invoices their customers annually, this can be challenging for integrating the go-to-market functions of the businesses. The acquirer may find the differences to be more of a hassle to change than it’s worth or they may worry they won’t be able to move the customers to their way of doing business. I suggest studying the contractual terms of companies that could be potential acquirers. If you are in enterprise SaaS, getting a hold of Salesforce’s standard terms and conditions is a good idea. The more you can mold yourself to these terms, the better.
Regular financial audits usually start to take place for most VC-backed businesses after they reach a certain size (typically around $5M in revenue), but can be overlooked for businesses that don’t have institutional backing. Having audited financial statements makes the process of selling a company much easier, and it provides a level of legitimacy to the company being acquired. Even outside the context of an acquisition, audits can verify if the controls and processes of a company are in good standing. Private companies fall under much less scrutiny from a financial documentation standpoint, which third-party audits can often rectify in the situation that the acquirer has a different standard or is a public company.
Alignment of pricing models can also be an important factor in a possible acquisition. As the old saying goes, it’s easier to sell additional products to existing customers than it is to sell new products to new customers. As such, acquirers are often looking at acquisitions as a way to add additional products for their existing sales teams to sell to their existing customers. When the new company’s pricing model is in alignment, it makes the potential for this much more plausible to the acquiring company.
When pricing models aren’t aligned it can also cause significant headache. If a customer is used to a permanent license, convincing them to adopt a new subscription-based system may be very difficult. When pricing and billing structures are very different, it can be tough for an acquirer to reconcile the differences and meaningfully integrate a product into its larger ecosystem.
Customer’s Right to Approve Change in Control
This is fairly rare, but something to consider nonetheless. Often when a very small or young company is selling a big customer, the customer will ask for a fair amount of control when signing a deal in order to de-risk the proposition. As a startup, it can be easy to be hasty to sign the big deal and get revenue in the door, but during times of acquisition this can be an incredibly costly and frustrating move. I personally had a contract like this during my time at iGoDigital and it caused a fair amount of tension during the life of the contract.
Go To Market
This has a lot to do with streamlining internal operations of the two companies. A great example of this is in sales — when acquired, do your sales reps start selling a brand new product, or do they stay with the current product? Additionally, when customers are duplicated across the two companies, the interactions have to be shifted in order to work on both sides of the equation — the customer doesn’t want multiple sales streams and the company wants to make sure that its cost of sales (commissions, compensation, etc.) doesn’t balloon because of duplicate work on a customer. This can be an incredibly complicated negotiation between companies as often companies are tied to existing systems and struggle to deal with consolidation of the systems.
This is likely the most important part of an acquisition that is easily overlooked. It’s also likely the most difficult part of the whole process. If you, the entrepreneur, are joining the acquirer as a part of the deal, it’s important to know how you (and the rest of your team) are going to fit in. This ranges from the very observable aspects of culture like meetings, structure, and organization to company values and autonomy. When ExactTarget acquired iGoDigital, our team’s cultures aligned really well. I think this was in part to our similar core values, a similar org structure, and both being based in the Midwest.
This is very tactical, but I strongly recommend maintaining an updated data room. If you’ve raised venture capital, you are aware of the due diligence process and the corresponding level of documentation that is required. The requests can be varied and often include your articles of incorporation, financial statements, board meeting minutes, product roadmap, employee files, customer contracts, and more. Organizing all of this can be very time consuming and often a large distraction to the business, requiring multiple resources throughout the company to pull all of it together. If you also have a desire to keep the acquisition confidential, the data room requests make it very difficult.
The bigger issue may be how the acquirer views the organization of the company it’s trying to acquire. A well-maintained data room signals an operationally efficient company.
You never know when an unsolicited offer may come in. My advice to founders is to constantly maintain a data room. You’ll be ready when the day comes and it’s a great forcing function as you try to organize the business operationally.
An acquisition is never perfect, but these small things can add up — and when there is a fair amount of dissonance between the two companies, things can easily fall apart. A good rule of thumb is that 1 or 2 differences can be overcome but as you have more differences (like 3 or 4), these may add up into a deal-breaker. For high-growth companies, change is ever-present. If it isn’t, you aren’t committed to growth. Mergers and acquisitions is all about change and managing expectations that people — on all sides — have about the change.
It’s a great idea to always have deep intelligence about the big players in your space. As an example, if you’re in the CRM space, you should try to get your hands on Salesforce’s customer agreement, pricing and other information about them. Study the companies they’ve acquired and how those companies aligned with them across these key areas. I have found doing this level of preparation not only prepares you for the potential acquisition process, but more importantly, it provides a deep framework for scaling a successful business — a win-win in most senses.
It’s important to note that selling a company is very similar to selling a product to a customer — there needs to be a need, an alignment of philosophy between the organizations, and great timing on both sides. The devil is always in the details or else the deal won’t get done. Considering the small things up-front can mean all the difference in a customer sale, and similarly can mean the difference between an acquisition getting done or a missed opportunity.
It was fun to collaborate with Mike Fitzgerald, a fellow partner at High Alpha, for elements of this post. Mike ran Corp Dev at ExactTarget and Salesforce and led the deal team that acquired my last company, iGoDigital.