Through TechStars, my other investments or just at random, I’m often approached by entrepreneurs who want advice on what to do when a potential acquirer first brings up the idea of buying their company. Often, the company being targeted for acquisition is “up and coming” and is very early stage. For that reason, the entrepreneurs are often rightfully concerned that the “acquirer” is really just digging for information. That’s a valid concern for many early stage companies. Here’s the advice I usually give concerning this situation.
Step 1. Assess the acquirer. First and foremost, you should assess the potential acquirer. Can you really see yourselves working with them? Do you like them? Are you willing to be an employee of that company? Do you trust that their interest is genuine? If the answer is no, recognize that it’s either a non-starter or that it’s going to take one heck of an offer to pique your interest.
Step 2. Notify the board. Notify your board and/or key investors. If you have a board of directors, you should promptly notify them (email is fine). You might also notify key trusted advisors and mentors. Make sure to mention that the interest is very early, and that you’re exploring it. As always, getting mentorship can be key.
Step 3. Set your number. Next, if you haven’t already done it, you should have an honest discussion with your co-founders and key management about the minimum number it would take for you to sell the company. When doing this exercise, it’s useful to think about the following issues:
- Talk about the stock/cash mix that would be required.
- Talk about how long you’d be willing to work for the acquirer at market salary. Assume at least two years.
- Assume that you’ll have no ongoing control of your company or product, and that it just won’t be your baby in any way, shape, or form any more.
Recognize that it’s very easy to trick yourself at this stage. It’s really important to define the minimum number without padding. In other words, you’re effectively deciding that if the offer clears this hurdle, then as a team you want to work towards taking it.
Step 4. Engage the acquirer. When you first enter into discussions with the potential acquirer, you should expect them to ask you all sorts of questions before they make any sort of offer. You can expect questions about revenues, expenses, headcount, conversion rates, attrition rates, and all sorts of detailed stuff.
At this point, it will be your natural reaction to ask for an NDA with the acquirer. While this is a good instinct, delay doing it up front. Don’t worry – you will use it as leverage shortly. Without mentioning an NDA, provide a few high level answers that you’re comfortable with them knowing and when the questions get into the “zone of discomfort” ask them to provide a detailed list of their questions via email so that you can work on them.
Step 5. Ask for the ballpark offer. Now that you’ve answered just a few high level questions and have a more detailed list of what they’re after, it’s important to go for the “ballpark” offer before proceeding. Explain that you’ve received their email, you’re obviously flattered with their interest, and that you’re happy to answer all of their questions under two conditions. The first condition is that you’d like all of the information that they requested to be covered by an NDA. The second condition is that before proceeding, you would like for them to provide the likely “ballpark” paramaters of the acquisition via a simple email, including the likely cash/stock split.
Most acquirers will happily accept the first condition (not doing so is a serious red flag) but will avoid the second condition. It’s important to stand firm on both conditions before proceeding. The acquirer will likely claim that they don’t have enough information to make an offer, and that they need their questions answered. Assuming that you’ve given them basic revenue and expense figures, this is bullshit. Hold firm. Explain that you’re very busy working with customers and improving your product, and that you can’t afford to distract the company without having at least a ballpark understanding of the offer. Explain that it’s obviously non-binding and that you won’t hold them to it, but that you’re just trying to get a sense of it. Sometimes there is a little dance at this stage, where they will look for a couple more tidbits of information in order to give this ballpark offer. That’s fine – use your best judgement. Just avoid dropping your pants completely until you get the ballpark offer. Note that this does not mean sign the NDA and give them all the answers that they’re seeking! This is your leverage to get the ballpark offer, so don’t give it away. Recognize that the NDA won’t protect you from giving the “fake acquirer” exactly what they wanted.
If the acquirer resists the NDA or the ballpark offer, they’re probably just fishing. You’re not being difficult. You’re asking a perfectly reasonable question about ballpark deal terms before wasting your time.
People who are not high up enough in the acquiring company to actually be making this offer will be scared off at this point. That’s a good thing. Perhaps they never had permission to be pursuing an acquisition in the first place. This technique weeds those people out since they have to provide the non-binding ballpark offer in writing via email.
Don’t proceed without the ballpark offer.
Step 6. Identify mentors. Now that you have a ballpark offer, you have what I would consider serious interest. Now make sure that you’re working with someone who has been involved in multiple acquisitions, ideally on both sides of the table. Perhaps one of your existing investors or advisors can fill this role. It’s critical to have someone on your team that can help you negotiate terms, and to help you understand their impacts. I can tell you from experience that when I had my first exit from a company I founded, I left millions of dollars on the table before I learned this lesson. Do not underestimate the ability of experienced mentors to greatly increase your ultimate outcome. If you don’t have an advisor, contact someone that you trust that has done this before and ask them to help. It’s fine to pay for this help if you don’t have other options, but you should only pay in a success case and you should recognize the dynamic that this creates: 1) This person loses nothing if there is no exit other than time and 2) they’re motivated to help you maximize the exit at the expense of everything else.
Step 7. Assess the ballpark offer. Take the floor value of any “range” that they gave you for both the total comp and the cash percentage of the stock/cash split. This is all you should “hear” – ignore the rest of the range. The actual offer is very likely to end up being very close to the low end of the range unless there are multiple competing offers. You should now compare this to what you discussed in Step 3. If the offer isn’t high enough to be interesting, then your best bet is to simply tell them that and politely decline to provide any other information.
Step 8. Get to know them and answer their questions. At this point, the offer is “interesting.” Your goal now should shift to getting some face time with the acquirer and getting to know them on a personal level. It’s fine to do this by phone, but find ways to spend time with them physically. This will help you figure out if they are “for real” or not. Ideally, if practical you’ll start to this before fully “dropping your pants” and answering all of their questions. It’s a fine line between being coy and stalling. You can’t stall too long, but you can offer to meet with them personally to go through their questions. Basically, the more time you spend with the potential acquirer, the more you can develop trust and build from there. Provide the requested information under NDA to continue the process. Be sure to mark all information provided as confidential under the NDA. Keep a copy of everything that you provide.
Step 9. Push for a term sheet. Even at this stage, many acquirers will go silent for a long period of time. Sometimes this is normal – these things just take time. Internal fires that have nothing to do with you come up. People go on vacation. Things always move slowly. Do not assume this is going to happen. Keep building your business in the meantime. Continually push for a term sheet fully describing the acquisition. At every meeting, ask what information you can provide to work towards getting a definitive term sheet describing the acquisition.
Step 10. Decide. If at any point in the discussion you decide that something is not right, just stop. Ask for the return of confidential information, and politely bow out. If the deal happens – congratulations! Assume it won’t until it actually has.
Good luck! I’d love to hear your thoughts and experiences in the comments.