There are plenty of strategic buyers and private equity firms looking to invest in or acquire great tech-enabled -- also called “new economy” -- companies with great entrepreneurs.
But, the tricky part is what exactly do they mean by “great” and what can you, the leadership of a tech-enabled company, do to make it more likely the strategic buyer will be excited enough by your business model and team to start their due diligence, let alone acquire you on compelling terms? And, as importantly, what can you do to increase the likelihood your company will get to the end of the process without having to agree to debilitating claw backs and indemnities?
What I have learned through my many years working on mergers and acquisitions with tech-enabled firms, their stakeholders and their investors is that keeping a few key considerations in mind can help you better position your business for acquisition by a strategic or private equity buyer.
1. Have a written and compelling growth strategy -- backed up by periodic updates showing progress and accountability to your metrics.
Companies don't simply fall into an ideal exit because one day they wake up with an ideal company in an ideal market. The growth was planned in a manner that demonstrated the ability to show profitable, repeatable year-over-year growth in a niche market driven by a strong platform.
Not only does it have an admirable growth rate, but it also has compelling, forward-looking stories of keen ability to continue growing at this pace -- supported by industry metrics and well-timed for a strategic relationship milestone that escalates this growth due to combined scale.
Unsure where to start? Here you go: Build your plan to achieve $2 million to $10 million in earnings before interest, tax, depreciation and amortization (EBITDA). The $2 million threshold is critical.
Pro tip: Make sure to fully understand your competition; including which ones might be strategic buyers for your company and your differentiated positioning to become an attractive acquisition.
2. Focus on your growing niche. But first, make sure you are actually in the niche.
Not all niche markets are growing at attractive rates. Fewer have the staying power to continue that rate while you scale. And just because you have a growing business, doesn't mean you are in a recognized niche. How can you tell? Is your niche tracked by (for example) Gartner and Forrester? No? Then you are not in a recognized niche.
If you are not in a recognized niche or the niche’s growth rate is less than 20 percent annually for the next five or so years, then consider strategically repositioning your offering and brand. While the pivot might be painful, many of the most successful exits have been from companies that repositioned into more compelling niches.
A successful niche pivot example: The CEO of a Chicago-based IT firm saw that enterprise mobile was turning into a multi-billion dollar space with double digit year-over-year growth projected for the next decade, so he made the strategic decision to focus only on customers in the mobile space and to wind down customers in other spaces. Fast forward a handful of years and a strategic buyer purchased the business for a lucrative combination of cash and shares.
Pro tip: Pivot as necessary to garner customer and industry recognition in your niche. Align your company’s positioning and PR strategy to make sure it is continually mentioned as an “up-and-comer” and/or “one-to-watch.”
3. Surround yourself with great talent, showcasing the specifics of each team member’s contribution to the growth plan.
Strategic buyers are more likely to pay significant multiples for businesses with strong, committed executive management teams.
Once you have attracted the right people:
- Add their expected and measurable contributions to your growth plan.
- Align them financially to your growth and expected exit.
The latter, especially, will help keep them committed during the buyer’s due diligence process, which is important since this level of commitment can directly affect the likelihood and value of your exit.
Pro tip: DO create incentive and bonus plans that have equity-based or phantom equity components. DON’T promise equity in percentages or execute unclear equity agreements.
4. Use best practices for contracts and other key components supporting your growth plan.
The strategic buyer’s due diligence team can commonly have more than a dozen experts putting your entire company under a magnifying glass. They will be assessing how well your business has been managed while scrutinizing your contracts and relationships for anything that might entangle intellectual property, require additional deal negotiations or approvals or hinder future growth.
Start right now! Following these steps will better prepare you for legal and strategic alignment of your goals and, in turn, set off the fewest alarms during due diligence.
- Have a clear intellectual property structure and proprietary information plan that is safeguarded within all your customer, employee, vendor and distribution contracts.
- Establish a strong advisory or fiduciary board as soon as possible, including one or more independent directors that add strategic value.
- Prepare defensible financial statements backed by professional review.
- Ensure equity and non-equity based incentive plans pass legal scrutiny before they are promised.
- Ensure stock and financing terms align across stockholder classes and provide for a successful exit for all equity holders.
Pro tip: Defend against atypical stock rights and preferences, including ones that can send your business in the wrong direction. Take care with granting “one off” rights that will bring you back to the negotiating table later.
5. Engage a deal attorney and investment banker that understand your business and your strategy -- and gets M&A deals closed.
No need to kick your current attorney or banker to the curb, but assess if they have proven themselves capable of securing the type of exit you want. If not, get the right M&A attorney and investment banker on board two to four years before your expected exit. Regular check-ins with investment bankers can help your understanding of the market and tighten your positioning for a successful exit event.
The deal attorney is not only crucial to the exit, but also to planning and structuring any agreements, equity incentives and intellectual property treatment across your contract base. A seasoned deal attorney will better ensure these documents have been structured to pass the scrutiny of the strategic buyer’s deal team.
The time to start your exit planning is now.
Even companies with strong balance sheets can find themselves on the defensive once the due diligence team uncovers one issue after another, such as these three, to name a few:
- Customer sales contracts that include poorly-written intellectual property provisions
- Misaligned employee incentive programs
- Non-disclosure agreements (NDAs) that allow for joint ownership of your work product
Most importantly, your trust and confidence increases exponentially in the eyes of a buyer when there are fewer due diligence concerns, allowing you to unabashedly ask the potentially life-changing question: “What is our post-closing upside structure?”