HEIDI: Welcome to The Startup Solution, and “The Case of the Mythical M&A.” I'm Heidi Roizen from Threshold Ventures.
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The market for startup financing is all over the map right now. It seems every day, some AI startup announces a kajillion-dollar raise. But that’s not what the market’s like for everyone, including a former student of mine I’m going to call Julian.
JULIAN: Hey Heidi, it’s Julian. I’m still trying to raise our A round, but it hasn’t come together so far. I’ve only got about five months of runway now, so I was thinking it might be time to get a banker on board to run a process and get us sold. I was wondering if you have any connections to a good one that might want to take us on board. So, let me know your take on this and if you have any ideas. Thanks.
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HEIDI: Here’s a spoiler alert: this isn’t going to end well for Julian.
From what I’ve seen in my 25 years as a VC, once a company gets this low on cash, less than half of the ones looking for a buyer will actually find one. And even for those who do, the vast majority of them will be sold for less than the preference stack. That is, they’ll sell for less value than the money they raised. Which means that all the common shares – like the ones Julian and his employees have – will end up worthless.
Julian is trying to do the right thing, but he’s starting way too late. While we can’t help him, I’m hoping that by giving you some insights into how acquisitions really happen, you’ll be better able to avoid Julian’s fate – and potentially end up with a great outcome for your startup.
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To begin with, startup mergers and acquisitions, or M&A, don't work like raising capital. Some people think the M&A market is relatively efficient: sellers present themselves to buyers, some buyers will like their startup, and some of those will make an offer to acquire it, all in a few months’ time. It’s the same basic process as fundraising, just different people on the other side of the table.
This outlook is a myth.
The reality is pretty much the opposite. The incentive structures for VCs are designed for making investments. However, the incentive structures in big companies are almost all working against acquisitions. Acquisitions are expensive, time-consuming, risky, and highly visible. And no big company executive wants to risk their reputation on acquiring a startup.
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So, if big companies generally don’t want to buy startups, how come acquisitions still get done?
It’s because big companies run up against their own sets of challenges. They encounter emerging opportunities and threats that they have to address. As they figure out how to do so, they have to find the best and fastest ways to execute on their plans. And one of those ways may be through an acquisition.
Note that I said “their plans” – not “your plans”. Companies don’t generally acquire you for your plans; they acquire you to supercharge theirs. And you can’t know when their plans are going to be so well formulated that it becomes the right time for them to make an acquisition. They may meet you, learn more about you, and those interactions might even nudge their plans forward. But it’s very, very rare that the timing is just right for an acquisition within a few months of contact. It can happen, but I wouldn’t count on it happening for you.
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Instead, the way to position yourself for an acquisition is a very different process and something you should start much earlier than Julian did. In fact, I think you should always be working to create opportunities to be acquired, even if it’s not part of your immediate goals.
So, let’s talk about how.
As I said, the best acquisitions happen when the buyer has a big idea – and your startup becomes a key component of their ability to fulfill that big idea. They acquire your startup as a way to make that big idea happen faster, and the premium they may be willing to pay is often based on how they’ll monetize the combination – not your current valuation, or how much money you’ve raised, or even your current revenues. For those of you who went to business school, remember EVC or economic value to the customer? EVC says that the price someone will be willing to pay for something is its value to that buyer, not any prior value someone else gave it. Company acquisition, when done right, is just the big version of that! And in the best cases, it can be really, really big.
So, in order to put yourself in this magic position, you want to be part of the creation process of those big ideas. And you want to be in those processes with many potential acquirers. To do that, you need to meet people inside those relevant companies and work with them on new products or enhancements where you and your company can ultimately play a role.
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And here’s the great thing – most large companies will welcome your help!
Most of these big companies are painfully aware that there is constant evolution and revolution in their market segments and that startups, who don’t have the burden of legacy operations, can move and innovate faster than they can. That’s why many large corporations have venture arms to help them understand what’s happening on the leading edge of their sector – your edge. Even people working on new initiatives inside those companies are often very interested in startups. And many of these companies have teams specifically dedicated to cultivating relationships with startups. You just need to identify those people, reach out and show some interest, and then follow those leads wherever they go.
And when you’re not pressing M&A-or-bust conversations with the people at these companies, you may be quite surprised at how open many of them will be. You can end up in a position where you’re participating, as a collaborative colleague, in their strategy formation process. That’s an excellent place to be.
In doing this, you’ll likely reap other benefits beyond just the prospect of M&A. What you do with these partners may help you grow your business regardless of whether any particular partner ends up wanting to buy you. You’ll probably also gain additional industry knowledge and connections, potential sales channels, or other insights or advantages that will help you grow your company.
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And even if you don’t kick off lots of large and sophisticated partnerships, the conversations you’ll have around them are really similar to the early conversations around M&A. That can be a great way to learn about and lay the groundwork for M&A in the future.
Here’s a data point as to how powerful this concept is. It comes from one of the biggest acquirers in the world, IBM.
I was on a panel recently with the legendary Claudia Fan Munce, who led IBM Ventures for 15 years. During her tenure, IBM acquired 71 companies. And guess what? 70 of them had prior business relationships with IBM, whether development partnerships, co-sales agreements, or other kinds of deals.
This process is how my company T/Maker got acquired by Deluxe – a large corporation in the printing industry. It was the early days of the internet, and we contracted with Deluxe to create a way to order their printed products online, commonplace today but very innovative in 1993. We built them a white-label version of the software to meet their needs, while we retained the right to create a direct-to-consumer version to sell ourselves. We were working with Deluxe for over a year before they decided that they wanted to buy us. They wanted to not only direct our retail products exclusively to their back end, but also wanted our team so that they could continue to add more products and features in the future.
I’ll say it again: we worked with Deluxe for over a year before an acquisition was even floated. This is a pretty common timeframe, and it often takes even longer. It took that much time to develop and integrate our software into their workflow and then for them to realize the future value of what we had done. We were also lucky to be cash flow positive, so we didn’t have the pressure of a short runway. That gave us both negotiating leverage plus the option of turning the deal down if we couldn’t get it to an attractive price.
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My experience also brings up another thing to be thoughtful about and prepared for in an acquisition. The acquirer is usually buying the entire effort and energy of your startup – and a big part of that is probably going to be you and your team. They’re going to want you to stick around and help them go after that giant opportunity. So, for the most successful startup acquisitions, while you may pocket a financial return more immediately, you will likely still be working on that big idea for months if not years.
For some founders, the idea of working for somebody else sounds less attractive than going it alone. And I understand that – I’ve seen acquisitions work well, and I’ve seen them work poorly. But let’s face it, sometimes markets are out of your control, and the only way you can keep going is by finding a bigger home for your venture. So, it is always a good idea to be developing these relationships since they take a long time, and you never know when you might actually need them. It’s always nice to have another option, even if you don’t use it.
For some founders, the acquisition route has made sense even when they could have raised more capital because they saw the opportunity to have greater impact by leveraging the resources of a corporate partner.
And some acquisitions have made a huge impact. Ever heard of PowerPoint, iTunes, or Android? Well, those were all early acquisitions – and Microsoft, Apple and Google helped those become household names.
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I’ll summarize it like this: you may want to get acquired, or you may want to go all the way to an IPO and beyond. But, like much of entrepreneurial life, the path is somewhat out of your control. That’s why I think having the option for M&A is always good to develop, even if you don’t end up using it.
The joint development work you do with a potential acquirer might even provide you with sufficient revenue to continue forward as a standalone, with the M&A route being an option you don’t choose. After all, you don’t have to sell if you don’t want to, even if you get an offer, as long as you have a viable alternative. But if you wait to start this process until you have no other viable alternative, you’ve not left yourself enough time to build the opportunity. So, my advice, today is a great day to start.
Before we wrap up, you probably want to know what happened to Julian, my former student who was looking for a buyer. Well, with only five months of runway, no banker wanted to take him on, and there just wasn’t time to build the kind of strategic relationship that would lead to a great sale. He did have a small co-sales arrangement with a larger company, so he reached out to them. While they weren’t willing to offer much, they did offer to do an acquihire; that is, they paid a few million dollars, less than Julian had raised but still something, and brought him and his team onboard. Their common shares weren’t worth anything, but they got to continue to work together, and Julian and his team even received a small carve-out from the proceeds of the sale. And if you don’t know what I mean when I say carve-out, well, you’re in luck because that’s the topic of our next episode!
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So, what can you learn from the Case of the Mythical M&A?
First, if you wait until you are almost out of cash and then try to sell your company, chances are you won’t be successful. Instead, you should always be working to build relationships with potential acquirers.
Second, a buyer will buy you to achieve their strategic goals, not yours. To capitalize on that, try to work with multiple strategic partners that can use what your startup has to accelerate achieving their goals.
Third, most successful acquisitions start with a business development deal, like a co-sales agreement, joint development project, or some other deal that can also provide you with revenue, even if an acquisition never comes up. So, it’s a win regardless.
And finally, acquisitions also typically involve the founder and some of the team staying on to realize the buyer’s goals. So, your acquisition likely won’t be a complete exit. But instead, it’ll be an opportunity to have your creations achieve even bigger outcomes than you may have done as a standalone. And that can be a pretty exciting and rewarding thing.
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HEIDI: And that concludes “The Case of the Mythical M&A.” Big thanks to M&A adviser, author, and relative of mine, Ezra Roizen, for helping me with this episode - and if you want to go much deeper on this strategy, check out his book Magic Box Paradigm.
Thanks for listening to “The Startup Solution.” We hope you have enjoyed this episode, and if you have, please pass it along to someone who could use it. I’m Heidi Roizen from Threshold Ventures.
This episode touches on a strategy for M&A that is fully explored in the book Magic Box Paradigm, available on Amazon
In addition, the author, Ezra Roizen, explores topics related to M&A in his Substack
Here’s an interesting post about startups buying other startups
And here, some insights about the trend of big tech buying startups
And finally, Why Valuation is Storytelling with Numbers