28 May 2009

Key Elements for Selling Your Company

My friend (and former VentureArchetypes colleague) Jake Kaldenbaugh turned me on to this blog post by Matt McCall. Matt is a Chicago VC and MD at DFJ Portage VP (just to throw a few mysterious acronyms at you).

"The Art of Selling Your Firm"

Matt does an excellent job of succinctly summing up the real motivations behind any acquisition. While I generally believe startup founders should build their business with a long-term vision in mind (vs. building it to quickly sell or "flip"), it never hurts to keep a pulse read on the level of your "acquisition attractiveness".

In particular, I like two of the elements he lists as creating a strong sell:

Mortal Enemies: the surest way to have a healthy process is to get two bidders that viciously compete with each other

and,

Strategically Central: if your product or service is a central component to the acquirer's future, you will get attention.

In my view, these are the two elements that can create hot-as-hell acquisitions and enormous returns for founders and investors.

I am reminded of my first job, working as a Valuation Analyst at Arthur Andersen. Our group was called in to run independent valuations on acquired companies (analogous to "fairness opinions"). This was in the mid-1990's, before the dot com bubble was at its peak, but still heady times. Large companies like Sun Microsystems were angling to provide the underlying platform on which the Internet was being built, and they were all in a mad horse race to stay at the forefront of innovation. They made numerous acquisitions of small startups developing the "picks and shovels" of ecommerce...for example, things that would make their servers run faster or their JAVA programming language be more universal.

Most times, the acquisitions were pretty straightforward, and our valuation analysis would be based on either a reasonable multiple of revenue, or in some cases a "cost to recreate" formula (i.e., what it would cost if Sun were to build the technology itself instead of buy it).

But every so often, the price paid for the target company would skyrocket. I would watch in awe as a small development shop-- often 4 or 5 guys coding away in a Palo Alto warehouse, without any revenue and sometimes without any product in the market-- would get acquired for truly insane amounts, not justifiable by any "traditional" valuation metrics.

In each of these occasions, the acquiring company had either decided the technology was critical to its future competitiveness, OR they picked up on the fact that another competitor was sniffing around (and thus it became a game of "keeping the weapons out of the enemy's hands").

In sum, it never hurts to ask yourself-- are you strategic to a larger firm's future competitiveness? And, can you begin a dialogue with multiple 'mortal enemies'? If the answer to either is "yes", your investors will love you...

(As a postscript-- and this is pretty boring stuff-- the way we justified these outsized valuations was by placing most of the acquisition price in a bucket called "in process R&D" which also had certain tax benefits for the aquiring company; building IPRD valuations became an industry unto itself.)

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