Almost all startup and expansion stage technology founders build and operate their business with the hope that their fantastic product — and the hard work their people have invested in building and selling it — will eventually lead to a wildly profitable exit.
If only the exit process was simple.
When a company’s board of directors determines that it’s time to pursue an exit strategy, several decisions need to be made that will impact the company’s ongoing business and ultimate exit valuation and structure, say Michael O’Hare, Head of M&A, and Chris Hieb, Managing Director, of M&A Pacific Crest Securities LLC.
In a paper entitled “Eight Rules of Sell-Side Technology M&A,” O’Hare and Hieb suggest that, in most cases, an investment banker can provide valuable advice and support through the M&A process, resulting in a successful outcome for investors and management. Of course, that means that selecting the right process strategy and banking team is critical.
Below is a summary of the eight rules that O’Hare and Hieb cover in detail. Each one should help companies better understand the sell-side mergers and acquisitions process and the role an investment banker should play.
Rule 1: It’s best to be bought, not sold
O’Hare and Hieb say that most (but not all) technology company sales that result in a high valuation occur when a buyer is convinced that it needs your particular solution. And because most strategic buyers have sophisticated corporate development groups, they can proactively identify and partner with potential acquisition candidates. The “bought, not sold” concept applies mostly to fairly well-known companies in active markets where the buyers know most of the players.
Rule 2: Valuation means more than just purchase price
Would you accept a valuation that was entirely contingent on future performance? Would you sell your company for a very high valuation, but allow the buyer to come back and recover money up to the purchase price for any minor breach of a representation or warranty? Those are just some of the questions that O’Hare and Hieb say companies should consider. Great care needs to be taken negotiating these terms as early as possible when the seller has the highest negotiating leverage.
Rule 3: Bird in hand is better than two in the bush
It’s an old adage, but a good one that applies to M&A. O’Hare and Hieb write that investors are often biased and believe they deserve a premium valuation. And though many valuation methodologies and publicly available statistics may dictate a “market” or “above market” valuation on paper, valuation is ultimately determined by the type (e.g., big, small, acquisition experience, etc.) and number of buyers.
Just like in stock investing, it’s better to sell too early at a profit than too late with no profit at all.
Rule 4: Walking away is your “silver bullet” – use it wisely
It’s not uncommon for sellers to grow frustrated with buyers when the two parties begin negotiating business and legal terms. And while the buyer and seller may want to do a deal, there will always be points of contention, the paper states.
If, as the seller, you determine that a certain term is unacceptable after exhausting all alternatives and opportunities to explain your position to the buyer, then the ultimate strategy might be to simply walk away.
Rule 5: Bankers don’t convince buyers to do deals
Bankers are experienced at delivering articulate messages and highlighting key points about the target that a buyer should consider. However, the ultimate decision will be made by the buyer’s sophisticated corporate development, product development, strategy, and sales managers.
O’Hare and Hieb offer a few reasons why a buyer might not opt to participate in the process. For example, they may already have or be involved with a similar product or solution.
Rule 6: Time kills deals
Every seller enters a process hoping that multiple buyers will be excited about their solution, resulting in a short auction process that bids up the price and terms to “above market” levels. But the longer the process takes, the lower the probability the transaction will close, write O’Hare and Hieb. As entrepreneur and venture capitalist Mark Suster writes on his blog, overshopping your company and allowing greed to supersede a good deal can be a killer.
Rule 7: There is no such thing as perfect information
In the end, the deal team will never have the benefit of operating with perfect data on the buyer’s internal assumptions and approval process. It’s the banker’s job to get a “feel” for the buyers’ motivations and quantify how serious they are in the process, O’Hare and Hieb write. The more the banker appreciates the subtleties of communication and negotiations, the more detailed intelligence the board will have for decision making.
Rule 8: To sell is great, to run an auction is divine (and rare)
A sale process for a technology company typically results in one to three highly interested buyers. But while a full auction with more than three active bidders is possible, it’s not common, say O’Hare and Hieb. In fact, it’s very difficult to run an open auction that focuses only on maximizing value when customers and employees need to be managed carefully and buyers have many other priorities. So, while an auction is ideal, it’s also unlikely — and sellers shouldn’t count on it.
To read more detailed explanations of each rule, check out the full whitepaper here.
Michael O’Hare and Chris Hieb lead the M&A Group at Pacific Crest Securities. Michael is located in New York City and Chris resides in San Francisco. For more information go to: http://www.pacific-crest.com/Public/IB_MAAdvisory.aspx