Sold Not Bought: Valuation, Psychology and Closing the M&A Deal
Editor’s note: This is adapted from a talk given by Geoff Lewis, a venture capitalist at Founders Fund, about how to plan ahead to sell a company. He previously cofounded startup TopGuest. This is the third of three posts.
In Part 1, Geoff discussed folding M&A into the fabric of a startup’s roadmap–the terminal plan–and mapped out how to begin creating this plan; in Part 2 he covered strategy for appearing more attractive to acquirers by controlling the narrative. Here, in Part 3, he concludes his own narrative, discussing valuation, motivation, and the human element at the heart of any deal.
To most, price is the most interesting thing about M&A; as an entrepreneur and founding team, it’s of course the most important aspect of selling your company. You want to get the best price possible. At the same time it’s the most detached from reality. There’s really no way to objectively value a startup. There are comps, revenue multiples, and the prices the companies you’re talking to have paid in previous acquisitions. But fundamentally every startup is unique, and there’s no truly objective price. This means that price is a figment of your imagination, and a function of your sales skills. If you can dream up a great price and do an amazing job of selling, you just may get it.
There’s another way M&A is detached from reality: the higher the price, the more potential appeal it has to the acquirer. On a psychological level, a high-priced company can seem more important. A hundred million dollars? A billion? It must really be worth that much.
Still, there are limits, and you’ll need to understand your acquirer’s capacity to pay. And while valuation is a fluid thing, this capacity is one aspect where there is quite a bit of data. Through discussions with a potential acquirer, through company annual reports (if they’re publicly traded), and through disclosures from past acquisitions, you can get a pretty informed sense of the acquirer’s capacity to pay. You will also have your minimum viable exit–the rock-bottom price you and your co-founders have agreed on.
Optimally, the opening price in a negotiation is slightly below the buyer’s capacity to pay and in front of your minimum viable exit price.
THE HUMAN FACTOR
Companies don’t buy companies–people buy companies. It’s easy to forget this in an acquisition, to develop an antagonistic view of the people you’re negotiating against. It’s easy to fall into “us versus them.” Of course, there are going to be times when you feel like you truly hate the person across the table. But you need to always remember that people–individual, subjective people–buy companies, and they generally buy companies run by people they like.
That said, don’t be fake and don’t overlook something obvious. If you don’t like the people you’re talking to, if your people aren’t getting along with theirs in negotiations, this may not be the right buyer. Conversely, if they don’t like you or you turn them off in the negotiation process, it’s far less likely that your talks will end in a closed sale.
INCENTIVES & MOTIVATION
Not only are the people across the table swayed by feelings and connection (just like you), they can also have really warped incentives. It could be argued that every decision at a big company is motivated by a need to impress the boss. Whether it’s a manager wanting to impress a VP or a new CEO wanting to shake things up, this fact remains. The derivative of this is that having little traction from a product standpoint may not be a deal-breaker. For example, other incentives could be: if there are great investors on your cap table (and the acquiring execs want those investors on their cap table), or the buyers want to build personal networks and you’re a really well-networked person.
There are psychological motivators in M&A that may have nothing to do with your product. You need to tease these motivations out in your discussions, and try to leverage them as much as possible. In TopGuest’s case, two of our term sheets were motivated by new CEO’s in new companies, wanting to make a splash. That really helped our negotiations.
THE POKER FACE
While you’re looking for hints on the buyer’s motivations, he or she will be looking for yours; it’s really important that you conceal your own psychology. Here, on stage, I’m revealing that I’m hungover, delivering a somewhat unrehearsed presentation. But when negotiating with a potential acquirer you must not reveal your stress-level, how distracted you are with everything you’re juggling.
This is really hard, of course, and this is where having people you can confide in is so important. Ideally this is your co-founders, but at this point you’re probably going to be at each other’s throats. So find a close friend, a counselor, something. Flushing those emotions in private means you’re less likely to reveal them at the negotiating table.
When I was negotiating the acquisition for TopGuest I was super cool in all of the meetings–I held my poker face. At home I would rant to my partner, cry, punch the punching bag. But I never revealed my psychology outside the house.
Now consider that actions reveal psychology, not just words or emotions. One specific action to avoid: In most cases you should not have bankers involved in your deal. If there are multiple term sheets–if it’s obvious that one company or another will buy you and you’re just in a bidding war to optimize price–then sure, bring in a banker. But in the vast majority of early-stage startup acquisitions, a banker is an overt sign that you’re too eager to sell.
Speaking of psychology, the same goes for legal counsel. There are a ton of wonderful lawyers in the Silicon Valley, lawyers experienced in M&A. But there are also some bad ones, and it’s possible that the lawyers on the acquiring side are simply looking to run up billable hours. If the diligence seems like overkill, this may be the culprit. But time kills all deals, so you need to keep the buyer’s lawyers honest. Use your counsel to call them out if they’re stalling the process.
Lastly, it could happen that the negotiators and legal are aligned with you and you still see slowdowns. Maybe a board member on the buyer side is also on the board of a company competing with yours, and is pulling for them. This is just one example. The point is to nurture champions at all different levels of the acquiring company, to push your vision and your psychology by proxy.
With luck you’ll get a signed term sheet, and you’ll want to pop the champagne. But in fact you’re only halfway there. Term sheets aren’t legally binding, and the deal could fall apart at any time. At this point it becomes critical to manage your team’s psychology: Everyone must be on the same page and must continue executing. You’re going to have to tell your team (most likely they already know because you’ve been out of the office a lot or there’ve been strangers visiting the office), and you need to be both positive and insist they keep the secret.
Strangely, the point of the term sheet is the point of greatest risk. Employ everything we’ve talked about to keep it alive: control the narrative, and keep that poker face.
AFTER THE TERM SHEET
After signing the term sheet you enter the full diligence process, and you’ll need to stay both organized and driven. Push all of your acquisition documents to a Dropbox folder, and then push your team to continue executing the original vision. Launch new features, publish press releases, show that you’re scaling and growing. This creates the illusion of normalcy, and creates a sense of urgency with the acquirer.
How do you manage business-as-usual and this incredibly complex deal? Embrace your inner sociopath. You’re going to be so frustrated with this company you’re talking to–you’ll never want to talk to them again. But be extra nice, super friendly, serenely calm. All you want in this world is to have this deal go through and to work with this company. You love them all so much, you want to take your dogs for walks together…
Keep forward momentum, and remember the poker face.
THE DEFINITIVE AGREEMENT
Now you’re in the home stretch. Call up all of your reserve energy and focus, and analyze every last detail. Here are is a short list of things to watch out for:
Employment agreements: Obviously your lawyers will help here, but with any talent acquisition employment agreements will be an appendix to the definitive agreement. Make sure terms and causes for termination are tightly defined.
Reps and warranties: Be sure that these are true as listed and that you, as a founder, feel comfortable with them. You’re personally on the line here, so be sure that everything you’re representing and everything you’ve said is actually true.
The fire alarm: There will be a last-minute fire alarm. Count on it, anticipate it, prepare for it. Take my earlier example, my impromptu dinner that was my hail-mary pass–there will be something that will happen that will almost kill the acquisition. So it’s better to expect that this will happen, find your Zen place, and proactively be ready for it.
Once you’ve signed the definitive agreement you’ve basically closed the deal. The worst will be over for you and the team, and (poetic justice!) the worst has just begun for the acquirer–now they have to deal with integrations and ensuring that the deal delivers on the hopes they’ve sold to their board. You’ll want to bask in the afterglow.
But we all know that most acquisitions end in failure, and even after the ink is dried this is your problem as much as theirs. Whether as an acquihire or an advisor, your reputation is still on the line–do whatever you can to deal with the complexities of post-acquisition integration. Pop the champagne and celebrate the end, but remember that the road of being part of the acquiring company has only just begun.
THE REAL CHAMPAGNE MOMENT
The great part about selling a company is that all of the horrible things, the end-of-the-world things, that you had been dealing with simply disappear. Tension between cofounders will turn into a narrative of success, of partnership, a wonderful story about how you worked together. Savor this moment, and enjoy it for all it’s worth.