By Mark Peter Davis, Managing Partner at Interplay.
The M&A process is unlike any other part of the startup lifecycle. To date, I have sold five companies that I cofounded, and through these exits, I learned a lot. Here are the biggest takeaways that founders need to know:
#1 Don’t Skip The Bank
When I sell a company I “buy” higher valuations by paying a banker. Good bankers make the sales dynamic super competitive. They bring more buyers to the table and they drive them to pay top dollar for the company, so it is safe to say that they typically pay for themselves... and then some. If you are debating about hiring a banker, my advice is to stop thinking about it and get one.
Bankers tend to try to add fees to everything so it is important to know that they are negotiable. Here is what to consider when negotiating:
Monthly Retainer: In some cases this can be negotiated out entirely.
Percentage of Exit Proceeds: This is a variable – you can aim to negotiate that down.
Performance Fee: There is also typically a minimum performance fee. You can often negotiate that down as well.
Performance Fee Structure: Maybe more interestingly, you can structure the performance fee to align incentives. I suggest creating a progressive fee structure where they get paid a higher performance fee for achieving larger valuation outcomes. I would think about what you could sell the company for without their help and ensure that most of their comp is achieved above that threshold.
#2 Prepare For A Time Intensive Process
It typically takes about six months (or more) to sell a company. Here are the phases of the process:
Material Preparation: The bankers will want to create marketing collateral, a model and a data room. This tends to take four to eight weeks.
Outreach: Once the materials are ready, the bankers will reach out to the list of target buyers. That takes a few weeks.
First Round Bids: The bankers will set a deadline for interested parties to submit their first round bids.
Second Round Bids: If there are a healthy number of first round bids, a subset of the bidders are typically selected to participate in the second round of bids. At this stage the bidders are given more information about the company and they are expected to come back with a more accurate bid. Bankers tend to allow the bidders two to six weeks to prepare their second round bids.
Going Exclusive: After the second round of bids are received, the company typically negotiates the offers of the top bidders to make sure the deal is more fully baked. Once it is, the company will sign a Letter of Intent (“LOI”) with the buyer they have selected to do the acquisition. The LOI generally includes an exclusivity period where the company cannot engage other prospective acquirers. During the exclusivity period, the buyer is expected to complete their diligence and both parties work through the legal agreements. This can last up to a few months.
Sign & Close: At some point the agreements get signed, but signing does not mean that the deal is closed. Sometimes the money moves at a later date, adding time to the duration of the process.
Remember, the M&A process is an endurance game. Brace yourself for a long haul so you do not become a broken founder after hundreds of meetings and calls with lawyers and team members. I would suggest that you mentally and physically prepare. Exercise. Meditate. Do whatever it takes to survive the journey.
#3 Incorporate Legal
You might not be able to know every point in the contract that is going to be negotiated, but you can try to predict them. One trick is to have the buyers redline a template acquisition agreement as part of their second bid so you can get a sense of what types of other legal terms they are expecting if you take their offer. Also, this can illustrate which companies are not as serious; if a buyer does not follow-through, or does a subpar job with the redlines, that is a signal.
Buyers that are offering worse terms have an incentive to hide some of their deal conditions until after they have you locked up in exclusivity.
When they are the only other counterparty at the table they can try to bully you with the hope that your other bidders lose interest after they think they lost the deal. One way to combat this is to negotiate more upfront. Try to work through every major deal term in the LOI phase to ensure that you have a stronger alignment on what the final deal will look like.
#4 Negotiating The Deal Terms
In my opinion, you should not pop champagne when the LOI gets signed. M&As are never simple. Culturally, it appears buyers expect to be able to negotiate and renegotiate every detail until the final paperwork is signed. Buyers have little incentive to stop negotiating early and they often hide behind their lawyers so they can save face while the deal gets haggled. To safeguard yourself against a soured negotiation, you will want to keep your second and third choice buyers in the wings in case the deal falls apart after the LOI. You should also work with your partners to figure out your negotiating strategy and walk away before you sign the LOI.
Selling a company has a rather large scope and requires a web of deals to be made. It is not just the process of negotiating one enormous deal with the buyer, it is the process of negotiating new deals with all of the key stakeholders. It is like the process of breaking every bone in the corporate body so they reset properly. Prepare yourself.
#5 Beware of Misaligned Incentives
Some founders will want to maximize the value of the company while others may be more concerned about who their new boss will be. I suggest having an open conversation about what everyone wants at the beginning of the process. Get it all on the table. Operating as a team will help keep blood pressure levels low when individual founders face hard negotiations and tough choices.
As discussed in Point #1, bankers are pretty focused on their performance fee and that means that they want you to consummate the highest value transaction. This means they will be motivated to push you to take the highest valuation, which I have not found to be too big of an issue with good bankers as they know that the founders are sufficiently aligned in that motivation. But there is another, more nuanced issue to keep in mind. If a banker is going to go out and run a process for you, they really really really want you to do a deal. This means that in the final hours of a negotiation they may encourage you to accept non-economic deal terms that you should not accept. The best way to combat this is with an experienced M&A lawyer. They serve as the natural counterbalance to the bankers and buyers when you are working through the final agreements. Be sure to keep them close and listen to them.
There are a lot of moving parts during the M&A process. And what is intense and exhausting during normal times can be even more brutal in economic downturns, like what is happening now. The sharks will be out looking for deals so be prepared. Use these warnings to help you navigate with caution and hold your ground. But at the end of the day, do what you do best. Trust those same instincts that helped you get your company to the point of a M&A in the first place.
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