3 Ways to Lower Your Startup's Acquisition Risk Factor
In late 2016, several established companies acquired innovative startups to add new revenue streams and additional technology, paving the way for future growth.
Walmart purchased Jet.com for $3.3 billion. General Motors Co. bought Cruise Automation for more than $1 billion. Unilever PLC purchased Dollar Shave Club for $1 billion. Those were (and are) significant numbers. And they were hardly isolated events: Retail and manufacturing companies spent nearly $10 billion buying startups in 2016, and that number is expected to increase this year.
This is great news for tech entrepreneurs. Unfortunately, theirs is still an uphill battle. Buyers continue to view startups as expensive and inherently risky. What makes existing shareholders of the purchasing companies nervous is that these startups carry high valuations dependent on excitement about their growth.
So, entrepreneurs interested in being bought by a bigger company need to be ready and willing to present a profile indicating long-term profit. Here's how to do that:
Stability is key.
Investors want to know with as much certainty as possible that they will quickly make back the money they spent acquiring a business. No buyer wants to spend a significant sum to buy something he or she will never see a return on. ROI matters more than anyone wants to admit, and the security of the investment lies within the longevity of the business.
For tech businesses, this means having a life span and presence of more than five years. Factors considered before an acquisition include evidence of continued growth, the ability to rebound after hitting a rough patch and consistent expenses and persistent growth. But even considering all these relevant factors, startups will find that sizable risks still exist that can cause an acquisition to fall through.
Entrepreneurs can use these three unique strategies to decrease those risk factors when a potential buyer appears.
1. Sell the "business future," not "the business past."
Everything depends on the type of business a company engages in and whether it is honest and transparent. Investors rarely care about the financial or personal sacrifices a company made. They want to know more than the backstory and would rather understand where the business is headed. Entrepreneurs need to sell the future of the business as much as its current state.
For example, Google goes after three things in its mergers and acquisitions strategy: talent, future-oriented technology and the ability to expand Google's core search business. That future-focused growth allows Google to diversify its revenue stream and expand its reach.
Ensure that your company's strategy is focused on the future and that its growth is evident from the outside, in the same way that Google's innovation is obvious to observers.
2. Offer to stay on after the sale.
It might sound bizarre or ignorant for you to consider continuing to work fter receiving a big check for your business, but most investors like to see the passion, dedication and willingness of the founder(s) to stay onboard.
EBay CEO John Donahoe revealed during a TechCrunch Disrupt interview in 2013 that 15 of the founders who joined eBay and PayPal after their acquisitions still work for eBay. Donahoe said that eBay offers these founders opportunities to grow within the company, with many working in executive positions. He said he is specifically interested in acquiring companies whose current management teams believe they can continue to execute their visions inside eBay.
This shows confidence and a comfort in actions, rather than a focus on the sale price. If the business is as good as the startup's leaders say it is, they should offer to stay on for a year or two, tying more of the financial gains to the success of business's future.
3. Tie the sale to an earn-out period.
If a startup's leaders know their business is good and know they can definitely make things happen, they should challenge themselves longer. Tie the sale to an added earn-out period, which can entitle sellers to more money if they meet benchmarks set for the business.
In April 2016, AbbVie paid $5.8 billion in both cash and stock to acquire Stemcentrx, a cancer-treatment research company. The deal further incentivized the startup's investors with the possibility of earning up to $4 billion more if Stemcentrx successfully hits clinical development milestones. With additional cash on hand to be returned to shareholders, the total deal is worth up to $10.2 billion, making it one of the five biggest sales ever of a venture capital-backed company.
This won't make for the most restful nights at times, but it's a way to convince investors that the business is worth the risk when they see the founders risking their own profits from the sale on the business's performance.
By keeping these three strategies in mind and continually focusing on the future, startups can reduce their risk factors for a potential acquisition. Keeping their name (and some stake) in the company has far-reaching rewards and lets acquiring companies know they are purchasing something built with passion and pride.