M&A stands for mergers and acquisitions. Mergers are when a company buys another company and integrates it into its organization. An acquisition happens when a company buys another company; and the bought company, then, either continues to operate on their own or is merged into the buyer’s company.
“A merger occurs when two separate entities combine forces to create a new, joint organization. Meanwhile, an acquisition refers to the takeover of one entity by another.” — Investopedia
Why is M&A important to startups? Once you take investor money, you’re expected to reach an exit event in order to produce returns for your investors and for your team. There are two main exit options: go public (IPO), sell in an M&A transaction. Generally, there is a greater probability that your exit will occur through an M&A. So, it pays to take a closer look at how the M&A works. Think of the data points below as tools to add to your exit success toolbox.
Here are the topics that will be covered.
- M&A Data + Trends
- Purchase Price + Key Terms/LOIs
- When + How to Start Thinking About M&A
- What About Buyers’ Thinking?
- Key Terms
M&A Data + Trends
Number of M&A deals are down but the dollars spent are still high.
Most VC-backed exits are via M&A.
Most VC-backed M&A exits are between $100M and $500M.
Of the companies that exit through M&A, most VC-backed companies exit early. 59% of companies exited before raising a Series C, with 78% of startups raising up to $30M pre-Series C.
- Video: The state of the deal: M&A trends 2018 by Deloitte. Start at min 5.
- Article: CB insights Tech Exits Webinar Presentation
- Report: 2018 Annual M&A Report by Pitchbook
Purchase Price + Key Terms/LOIs
Once you have established relationships with potential acquirers, launched the M&A conversation, and garnered interest. You will get a letter of intent (LOI), it may look something like this…
1. What are you getting paid?
- Cash: Getting paid in cash provides certainty and freedom.
- Stock: Getting paid in stock has up- and down-sides and can lead to lock-in. You will need to consider the nuances of public and private stock, as well as the rights that come along with stocks.
- Certainties/Conditions: Look out for what certainties and conditions LOIs lay out. Consider: 1) Third party conditions such as customers, suppliers, landlords, government agencies, stockholders, and employees. 2) Pre-closing covenants: does the target company need to operate in a particular way or take certain action in regards to relationships? For example, the target company may need to work under a particular team within the buyer’s company. 3) Material adverse effect: do any of the legal provisions in M&A contracts have an adverse effect on your company?
- Post-Closing Liability: Consider, 1) Indemnification: have you breached any agreements? This may mean that the buyer can “claw back” some of the purchase price. 2) Escrow: how much money will be withheld by the bank? It’s usually 15–20%. 3) Survival: what is the time period in which the buyer can execute on indemnification activity? It’s usually 12–24 months.
- Video: The M&A Term Sheet or LOI
Science versus Gut Valuation: There is no one right way to calculate valuation. Below I present two schools of thought and activities that can support valuation of a company.
- Sciency valuations include, but are not limited to: comparable company, precedent transactions, discounted cash flow, acquirer’s business, revenue multiples, and other math approaches.
- Gut valuations include, but are not limited to: value proposed to acquirer, acquisition price of similar companies, and deal competitiveness.
When + How to Start Thinking About M&A
Depending on who you ask, you will get different answers. Consider that it’s never a bad thing to start relationships with business/corporate development contacts who can help add to your customer set and/or future exit. Relationships take a long time to build.
When you don’t need to make a deal, you will have time, options, the ability to compete, or walk away.
The best times to seriously think about M&A is when you face a:
- Business inflection point — have you achieved big milestones?
- Market inflection point — are competitors getting bought up?
- Acquirers are coming to you — you have options and leverage.
1. Plan: Have you done your homework and math? Know and keep track of — on a sheet or Excel:
- Who can acquire you and why they would.
- Your company’s numbers (runway, metrics, etc).
- Your exit math and make sure it works out for the company and your investors
2. Be patient because M&A is all about relationships and relationships take time to build.
3. Know and understand your stakeholder expectations (e.g., investors, founders, employees).
- Cheat Sheet: M&A 101 Musts
- Article: The six types of successful acquisitions by McKinsey. A related problem is hubris.
- Infographic: Tech Led M&A from Art to Science from Accenture. This infographic makes a good point about the “science” of valuation; it notes that companies that are focusing on tech led M&A they “USE DIFFERENT VALUATION AND COST MODELS FOR DIGITAL DEALS.” Note that valuation methodology can vary by industry.
What About Buyers’ Thinking?
Who are the key acquisition players? You will want to build a relationship with the key acquisition players.
- Corporate Development
- Deal Sponsor(s)
- Other Acquirer Leadership
The acquirer will consider whether or not…
- There is a strategic fit
- To build vs. buy
- There is sponsorship or buy-in from a product or business unit
- The price is right, or if it can get to a good price
- They are buying: talent only; team and product/IP; or team and product/IP and Business
- Podcast: Episode 18: Special — An Acquirer’s View into M&A with Taylor Barada, head of Corp Dev at Adobe
- Letter of Intent (LOI): basically an M&A form of a marriage proposal from Buyer.
- Base Purchase Price: purchase price to be paid for equity/assets of the target, normally on a “cash-free/debt-free” basis
- Earnout: this is a provision written into some financial transactions whereby the seller of a business will receive additional payments based on the future performance of the business sold.
- Escrow: money withheld at closing to provide buyer with recourse in the event of any breaches or unknown liabilities
- Holdback/“Revesting”: portion of purchase price payable to founder(s)/key employees held back at closing and to be paid overtime
- Lockup: alock-up period is a window of time when it is not allowed to redeem or sell shares.
- Fuse: deadline used to encourage action.
- Target company: company to be acquired
- Merger and Acquisition: management and strategy dealing with purchasing and/or joining with other companies.
- Indemnification: an indemnity is a contractual tool that buyers and sellers use in acquisitions to allocate risk between them. Each party agrees to indemnify the other party for its actions.
I hope you found this M&A deep dive helpful. If you have any questions, please tweet me @lolitataub.
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About Lolita Taub
Lolita is a Principal at Backstage Capital. Her prior early-stage tech investing experience includes Portfolia and K Fund. Before joining the VC world, Lolita spent nearly a decade in B2B enterprise tech, consulting, and selling solutions to Fortune 500 companies at IBM, Cisco Systems, and Silicon Valley and NYC startups. Lolita holds a BA from the University of Southern California and an MBA from the IE Business School.