How to get realistic about your exit options

A founders guide to selling a company

Back in January I shared my thoughts on the top 3 issues software startup leaders would have to deal with this year; finding growth from existing customers, finding efficiency in customer acquisition and getting realistic about exit options — which is the topic of this week’s newsletter.

If you believe the internet, selling your company is a doddle: “The founders weren’t looking to sell.” “There was a lot of inbound interest.” “A bidding frenzy drove up the price.” “Google swooped in and bought the company from under Microsoft’s nose”.

The reality is very different. I’ve been involved in a dozen M&A deals in my career, on both sides of the table, and can report here that trying to sell your company is an entire second job on top of your day job of running your startup.

That effortless inbound interest is always a direct result of outbound activity; building relationships with prospective buyers over a long period. Getting multiple offers is rare and getting multiple attractive offers is even rarer. And for every eager buyer that moves first, there are dozens of tire-kickers that will politely play wait-and-see.

Getting a deal done requires building and executing a plan that has a lot of similarities to an enterprise sales process, only with higher stakes, more drama and no chances to learn from your mistakes.

This post covers:

• Deciding if you should try to sell your company

• Building consensus with your internal stakeholders

• Getting realistic about price

• Identifying target buyers

• Identifying executive deal sponsors

• Running a sale process

• Negotiating terms

• Common mistakes

Deciding if you should try to sell your company

Founders usually decide to sell for one or more of the following reasons:

• You’ve been in business for a long time without a clear path to IPO. How long is a “long time”? Around 7 years is long enough to figure out if you have a shot at going public.

• You see a structural limit to your growth. There are often long term problems that can’t be overcome as a standalone company. But seeing them requires turning off your reality-distortion field.

• You’re running out of money. Raising money requires a huge effort and can come at a huge cost. As we shall see later on in this post, funding deadlines can actually make good critical events to drive M&A.

• You’re getting tired / want to do something else.

Building consensus with your internal stakeholders

Start with your cofounders. If one of you wants to sell and the other doesn’t, talk it through until you agree one way or the other. If your cofounders are actively involved in the business, they should be seeing the same issues that you do that lead you to believe it’s time to sell.

Then get your investors onboard. This can be more complicated than getting your cofounders on board as the lower your valuation, the more your investors’ incentives will diverge from your own. Here’s how to navigate this:

• Start with your largest shareholder. This will typically be one of your earliest institutional investors, who has a low weighted cost basis in your equity and stands to make more from a sale than an investor who came in on the last round.

• If the fund has not yet had any exits, you will likely run into some resistance. While experienced investors know that “lemons ripen quickly (aka the J-curve)”, they may still want to delay a small exit if they think it will impact their ability to raise their next fund. After all, if you keep going as a standalone they can use a fuzzier paper valuation until their next fund is closed.

• Focus on the structural limitation in the business. E.g. “There is a clear structural limit to our business that will cap our growth. We are going to hit that limit in X months, so we need to sell now. If we don’t, our multiple will tank.” Depending on your investors’ incentives, expect some debate about why you can’t overcome the structural limit but in the end you’ll win because you are closest to the reality of your business.

• Bring your investors into the process early by asking them for help. Here are some good questions to ask:

  • Which target companies do they think will buy you, and why?

  • Which executive(s) do they think will sponsor you and why?

  • How do they think you should approach those executives?

  • How much do they think they will pay?

Leave most of your exec team and all of your employees in the dark. Selling a company is a huge distraction from the day-to-day of running a company. Aside from your CFO and General Counsel, you need your exec team focused on executing so that you continue to hit your milestones and build trust with your prospective buyers. You can bring them into the process once you get to a term sheet.

Getting realistic about price

Prepare for emotional reactions. The instant you mention a valuation to your cofounders and investors, everyone will mentally calculate the value of their shares and have an emotional reaction to it. It’s unavoidable, since acquisition prices are usually lower than everyone is hoping for. The way to get everyone through it is to bring supporting data:

Start with overall market data. According to CB Insights’ latest report, ~95% of all tech M&A deals are under $100M. (This % hasn’t changed since I was a startup CEO over years ago).

To put this in context, there are only 80-100 deals per quarter over $100M, worldwide. If you are able to sell your company you are most likely going to sell for less than $100M.

Your current headcount is another input. The median valuation per employee for the <$100M cohort is $0.7M, so the median valuation for a startup with 50 employees is $35M.

Build a set of comparable sales (aka “comps”). Sales of companies of a similar size to yours and in the same industry as yours are important because any serious buyer will use the same set of comps to come up with their offer price. Calculate the multiple of last 12 months’ revenue for which the company was purchased and apply it to your revenue to get a comparable valuation. If you can’t get hold of a revenue multiple, use a headcount multiple. If the data isn’t public, your investors should be able to help you get it from their networks.

Identifying target buyers

As the saying goes in M&A, “One buyer and the buyer sets the price. Two buyers and the market sets the price. Three buyers and the seller sets the price.”

To find your multiple buyers you need to start by defining your target buyer profile by looking for the following attributes: