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Any number of factors can trigger a tech company’s exit: worn-out founders, anxious investors, industry consolidation or wild, Instagram-like success. As tech founders and executives contemplate potential exits, they inevitably encounter questions about the approach, process and strategy. If you are thinking about an exit, consider these five tips.
Related: You’ve Sold Your Business. Now What?
1. Set realistic pricing expectations.
Everyone on the company side should understand and accept an honest valuation. Setting these expectations early, with as much industry due diligence as possible, will help avoid morale issues and keep all parties united. This does not mean telegraphing a price in early discussions with the potential acquirer(s) – it means sharing best- and worst-case pricing with all stakeholders, including management and investors. This is particularly important at a time when prices on many tech deals are not based on financial metrics such as a multiple of earnings before interest and taxes (ebit) or even gross revenue.
Pricing expectations should be based on the following: recent acquisition and valuation activity in the space; the perceived value of the team, especially engineers; and the potential for outsized demand. On the latter point, look at whether there is existing latent interest from behemoths, such as Google, Cisco or Amazon, or if you can create this interest.
2. Stage your company — and yourself.
Your company should be presentable before you show it to prospective buyers and the due-diligence requests start pouring in. Financial statements must be current and often, if you are venture-backed, audited to ensure all transactions have been recorded correctly and standard Generally Accepted Accounting Principles (GAAP) have been followed.
It is also important to develop and verify all documents regarding employee onboarding. That means at-will work agreements, prior-inventions intellectual property contracts, confidentiality and non-compete agreement, and equity, options and vesting agreements.
In addition, consider whether you have any deals in place that are wildly favorable to customers or strategic partners. These could include the assigning or sharing of all IP rights to customers or partners, or exclusivity in a vertical or geographically locked-in “most favored nation” pricing.
Founders should also ensure their own interests are protected in company vesting and equity contracts. This includes locking down elements like double-trigger acceleration vesting as well as change-of control incentives and severance. It’s also important to double-check personal and estate planning issues.
3. Understand the impact of your funding choices.
Many types of investors are available to startups: accelerators, crowdsourcing, angels, traditional venture capital, corporate venture capital and, for later stage companies, even private equity funds and other larger institutional investors. All have varying goals and requirements. This tsunami of capital has fueled a large crop of startups, dozens of so-called “unicorns” and in the end, plenty of exits.
Traditional growth-capital investors often have a longer horizon when weighing exiting now versus holding out for a larger deal or even, in the rare case, an initial public offering (IPO). Growth capitalists answer to limited partners, many of whom are institutional investors who expect capital to be locked up for a long time.
Smaller investors, from angels to funds comprised of lower net-worth individuals, more often associated these days with crowdsourced deals, often have more constrained timelines. Traditional venture investors have a typical seven- to 10-year exit timeline when they invest in early rounds (series A) and shorter timelines when they invest in later rounds. Those managers are under constant pressure to raise their next funds — and they need to show returns. Their demands for liquidity can accelerate exit paths and create dynamic sets of influences on founders.
Corporate venture investors can have just as dramatic an effect on exit timing, either because they are hoping to delay a sale in order to prolong the benefits of a well-negotiated strategic deal, or because they exercise a right of negotiation to buy the company itself.
Related: To Sell or Not to Sell? 6 Steps to Take to Answer This Question.
4. Leverage the larger pool of potential acquirers.
The profile of potential acquirers is evolving. In addition to big names in tech, companies in industries from advertising to insurance to retail are acquiring tech companies — for their products and for an injection of creative spirit.
When dealing with potential buyers, you don’t want to be too coy — nor do you want to show your entire hand. Companies seeking an exit should strive to have at least two suitors before charging into an acquisition process.
Be wary of the sneaking acquisition. Experienced and serial tech-company acquirers can morph an initial strategic or commercial deal into a solo-acquisition negotiation. In this scenario, the target company quickly capitulates to a bird-in-the-hand decision and skips any sort of sale process or market-check vetting for other potential acquirers.
This often occurs where a potential acquirer is an investor in the target company. Be wary of rights of first offer (“ROFO”) and rights of first negotiation (“ROFNs”) — and certainly try to resist a right of first refusal. Each of these can send a “not worth your time” message to the corporate investor’s competitors and other potential suitors.
5. Leverage your advisers early.
Deciding whether to hire an investment banker gets complicated. Some bankers with specific domain knowledge and experience can greatly enhance a deal. But many only work on large transactions — $10 million in earnings before interest, taxes, depreciation and amortization (EBITDA) or $50 million in value are common minimum thresholds. Further, finding a banker with industry chops and connections takes time and usually requires another adviser with a deep network.
It’s helpful to have the right legal counsel. Lawyers with tech mergers and acquisitions (M&A) experience can help determine whether a banker is necessary and, if it is, help find good candidates. Your investors, particular if they are venture funds, will have a strong opinion on whether to engage a financial advisor.
Experience in dealing with the dynamic influences of investors, acquirers, employees and founders is paramount. It’s critical that any keystone adviser, be it a lawyer, banker or board member, grasp typical deal structures and “gotcha” clauses often inserted by acquirers and equity investors. And just as critically, they must be involved in the earliest discussions, before the bigger terms get set or after the optimal time to voice key deal points has passed.
Every exit process unfolds differently, so there is no standard template to follow. However, there are certain common traits that distinguish the most successful sellers. And while there’s no guaranteeing success in a complicated transaction, understanding the steps described here will boost your chances of getting to an exit that leaves everyone on the selling side satisfied.
Gabor Garai, chair of Foley’s Private Equity & Venture Capital practice, and Todd Rumberger, co-chair of the firm’s Technology industry team, contributed to the development of this article.
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