Navigating Early Exit Offers
I hate when people say this.
What is true about this statement is if you build a great business – you will have many exit opportunities along your path. I have been doing M&A since 2008 from both the buy side and the sell side - which offers me a unique perspective as I help entrepreneurs navigate these early offers.
In my experience, optimizing the sale of a business is hard. Really hard. It rarely takes care of itself. It takes careful thought and planning. More than just timing and price, in an ideal situation the sale should be in the best interest of all stakeholders including employees, customers, suppliers, investors, etc. If not handled properly, unsolicited early exit offers create misalignment between stakeholders. Fear and greed kick in and soon you have lost trust.
LET’S LOOK AT THREE – NOT SO HYPOTHETICAL – EXAMPLES:
Example #1 – No, thank you.
The company is in a market with lots of urgency and growth but the business has gone through some tough times. The executive team turned over including the founders. The new team has been operating for a little more than 18 months and has addressed the easily identified challenges setting the stage for future growth. Sales are beginning to come. Soon, private equity begins to sniff around. They lob in a fair, but relatively low offer. The Board discusses and quickly decides to turn down the opportunity. The private equity firm comes back with another, higher number.
This offer provides an opportunity to have an important, strategic discussion with the Board.
At what price would we be willing to sell?
Who would be an ideal acquirer and why?
What do we think the ideal timing for a sale to be?
What risks are still inherent in the business that may make this offer attractive?
Does the team, and most importantly the CEO, want to continue to play on?
After answering these questions, the Board decides there is more upside opportunity left in the business. The offer is turned down before too much time, energy or mindshare is burned. But, they have used the forcing mechanism of an early exit offer to align the Board around some key points.
Example #2 – Maybe, let’s date.
This time the company is on a scream. With strong funding partners, the team is executing on all cylinders, sales are pouring in and important strategic partnerships are being formed. The only question is, can the company execute fast enough to stay ahead of the growth. New executives are being recruited and all signs point to a rocket ship. A key customer starts expanding, rapidly. The customer begins to invite the team to important strategic planning sessions and influencing the product roadmaps and priority of implementation. Soon, the customer is courting the team hard and it is clear they are going to make an offer. The Board begins to engage and determines the best route is to begin fundraising the next round as well as identify a few additional suitors. This will create optionality.
Unfortunately, the frothiness of the market creates some interesting dynamics. It causes the team to get unrealistic pictures of grandeur and begin negotiations a bit over-confident. The parallel fundraising route is built on projections, largely from sales to the customer that is trying to acquire. Soon, the negotiations with the customer fall down. Then, the sales pipeline dries up as the customer becomes worried about having all their eggs in one basket with a start-up they do not own. The potential investors get cold feet and pull their term sheets. The rocket ship has lost its fuel.
Example #3 – Yes, let’s get married!
In the last example, the startup has category defining potential and is at the intersection of two industries undergoing massive disruption. However, the company may be just ahead of its time. They have been at it for four years and while they have impressive growth driven by upsells with major customers, they still do not have a repeatable, proven sales model. The team is committed, but, somewhat frustrated with the slower growth from the last two years. Strategics are circling as everyone in the industry is looking for an answer. One strategic put in an offer and the CEO wanted to explore the option.
After some negotiation, a letter of understanding was accepted by both parties and the process started. It was a fair price for where the company is currently at, but significantly undervalued the potential of the business. The team spent significant time with the strategic in diligence, negotiating a complicated rollover of stock for the executive team. However, due to constraints on the side of the strategic, completely outside of control or influence of the startup, the strategic pulled out of the deal. With no break-up fee, the startup was left with no deal, less runway and about four months of distraction.
REALITY OF EARLY OFFERS
Until you have gone through it a couple of times – from the operator side – you do not realize what happens. The minute you start getting courted, you feel validated and special. More than that, you start doing all the calculations – what it means for option holders, investors, yourself and family members. Will it be considered a success, will it be considered a failure. You envision yourself working in the new environment. You start spending mindshare on what your new future looks like. You start working your new relationships and positioning in new power structures. You start thinking about how long you will stay with the new company. What is the earnout? Will the team get the opportunity for additional upside? Most likely the acquirer is offering not only a payout but also a reset of compensation for the executives and a bright future. One that appears to have less risk and more upside.
Now, this is inevitable. And it is normal to envision the unknown future to be much more attractive than continuing to push the current boulder uphill. You will justify your arguments in this moment because it is an emotional moment – one that plays on the fear and greed continuum.
And not just for you. This is also the moment independent board members are critical. See, the dynamic of having investors on your Board whose funds can be made or lost on your investment creates additional complexity. And, while in a perfect world your Board members should only be thinking about what is in the best interest of all shareholders of the company, the reality is it is emotional for most of them also. So, you must have strong independents that can be more objective about the early exit offer to help guide the conversation and bring it back to center when it gets off the rails.
This is why I believe it makes sense to be planful and thoughtful about your exit strategy. I believe you need to create a framework to evaluate opportunities before you are triggered with an emotional response.
HOW SHOULD YOU PLAN?
Here are my top five suggestions:
1. Create the Chessboard
I refer to this as the Chessboard because it provides an outlook on all the possible short and long-term exit alternatives and changes with each successive move. It’s most helpful to craft this document from two perspectives. The first being, the pros and cons of each potential alternative from your perspective. The second being the value proposition to each potential acquirer. Why does it make sense for them now? If you execute on your strategic plan and roadmap, how might this change in the future? Then, evaluate any potential implications to your strategy.
To me, if you do nothing else, you need this simple framework. But an important note, it cannot become your strategy – it should act as another lens to view your strategy through. The risk here is not building your own vision and forgetting about your own customers. This can be disastrous and is why so many people default to “Build a great business and the exits will take care of themselves.”
It is also important to understand that you cannot involve your entire management team in this process as it too quickly can become a distraction for some team members. It is only the CEO and one or two other executives (depending on your team) along with your Board that should be working through this framework. It should be updated in real time as changes occur, but at least annually. It is important to remember it is a dynamic plan. It moves and shifts with new information, changes in the market, product innovation and M&A activity.
2. Build a Relationship Matrix
For the top potential suitors on the Chessboard, begin developing a relationship matrix to the top people. I am surprised more CRMs don’t have a tool like this, but the most effective ones I have seen are simple matrices. Down the left side, the matrix lists key individuals at the company and their role, across the top your team, board and key advisors. Then, some type of simple color code at each intersection with green (strong relationship, positive impression), yellow (met once or twice but no real connection), red (negative impression), no color indicating no relationship. Gaps are easily identified to be focused on in the future.
The time to build the matrix is early, with the idea that you find ways to build the connections over time. This is imperative as it is much better to build the relationships when there is not an urgent need. Much like relationship selling, you are simply understanding more about each other’s organizations and where they may be overlap or opportunity.
3. Establish Multiple Commercial Partnerships
Building commercial partnerships, with not one but multiple potential target acquirers allows you to evaluate the potential acquirer from multiple dimensions. Obviously, this should not be forced. And, you want to be careful not to put your all your eggs in one basket or reveal too much to competitors. But, getting a feel for whether the target might have similar or dissimilar values, where your points of differentiation occur, what the natural synergies are can be invaluable. It will also allow you to further refine the chessboard as new information becomes available.
Like the relationships these partnerships need to be intentional but evolve over time. It is okay if this starts lower in the organization with a few integrations, joint sales or customer collaborations. Giving your teams some joint wins early and knowing when to bubble these partnerships up and make them more formal is key.
4. Identify Signals to Determine Timing
What are the signals that will tell you the timing is right to trigger a process or consider an early offer? Is it a certain revenue threshold, maturity of key accounts, a strategic partnership, a global expansion, a market dynamic that you want to take advantage of? Whatever the signals, think about them objectively, before you are facing a specific offer. This will help keep the entire Board intellectually honest and help you ask the question of what has changed.
A note here is that many entrepreneurs see exiting as an alternative to raising additional capital. There are some instances where I have seen this be appropriate, but the more likely case is that it seems easier to sell now than raise. Whatever the choice, don’t allow yourself to be backed into a corner with a limited runway. You want to go into the negotiation with at least 12 months of capital.
5. Build Competition in the Process
When you decide to move forward, use whatever means necessary to create urgency and competition into the process. Sometimes this means hiring an investment banker, and sometimes it just means managing the process closely and creating options. Too often an exclusive process drags on too long when it is clear it will not ultimately close. If teams are motivated and the fit is right, the teams will move quickly. If the ultimate plan is an IPO, you still want/need the Chessboard, it will help you consider dual process path that may actually be a better outcome in the end.
Last, remember planning exit alternatives is not about accurately predicting the twists and turns, false starts and failed negotiations. It is about creating alignment early and an objective framework that is dynamic and constantly updated to help you stay objective when the stakes are high.