You may have heard the old saying “companies are bought, not sold” and I tend to agree even if Bruce Milne doesn’t. There comes a time in almost every successful entrepreneur’s life when it will receive an unsolicited offer to buy her startup. This is the moment of truth. Should you take a bird in the hand or let it ride to see if you can build that billion dollar company your investors expect? In this post I’ll assume you’ve decided to sell and give you the benefit of a few of my experiences.
First, you need to realize that there is a very real possibility that at the end of the sale process you’ll still own your company. Most deals fall through for a number of reasons out of your control. Especially in hot sectors, there are lots of companies that simply want to conduct ‘undue’ diligence to better understand how you’re able to succeed where they’ve struggled.
Second, get ready to put your life and company on hold for months. Depending on how you decide to conduct your sale process it could easily take 4-6 months to conclude. During that time don’t expect to get anything done. Your metrics will likely go flat as the entire organization focuses on the exit and not the business.
Third, protect your interests as much as possible. In early stage startup sales breakup fees are unusual, but that doesn’t mean that you shouldn’t ask for one. You can run the sales process however you see fit and you alone can make the rules (assuming you’re being bought and not sold). Here is the process I recommend:
- Courting period. Exchange of basic information to determine interest on both sides. Get a basic understanding of ballpark value of the transaction. I recommend this period lasting no more than 2 weeks. Cut the buyer off after this point. They need to make an offer or move on to another target.
- Letter of Intent. The buyer will deliver you an LOI outlining the terms of the transaction. Assuming the consideration is acceptable you should put some teeth into the LOI. I’d recommend having the buyer pay any and all legal and accounting bills you will incur during the diligence process – usually around $10-20K – if he ultimately decides not to move forward with the transaction. This is a tiny sum and will weed out almost all tire kickers. I recommend negotiating the LOI for a period last no more than 1 week.
- Due Diligence. The buyer will conduct extensive legal and financial diligence. Give the buyer no more than 4 weeks to complete his diligence.
- Firm Deal Term Sheet. You should have the buyer reiterate the deal terms he outlined in the LOI and get him to agree to cover your legal and accounting costs as well as a small breakup fee ($100K for early stage startups) if they fail to close within a reasonable amount of time. I would recommend setting a 30 day time limit.
- Purchase Agreement and Close. Negotiation of the PA and subsequent close should only take 30 days.
This schedule is very aggressive, but very doable. If you’re in a hot space and have a great startup you should demand/expect this sort of timeline and process – 3 months is completely reasonable. The consideration of $100K plus costs is STILL a horrible deal for you if the buyer fails to close. You’ve surrendered 3 months of progress – $100K won’t come close to covering your costs, but may save you from wasting time with a non-serious buyer. Good luck!
In my experience acquisitions are hard and often fall through. Given the recent spat of news about an acquisition that we may or may not making, depending on who you talk to (Houstonia, Dallas Business Journal, D Magazine), I thought it might make sense to outline the steps of an acquisition.
- Step One: Determine whether or not you want to grow your business organically or through acquisition. Spend a lot of time answering this question. Acquisitions really are disruptive and sometimes detrimental to your business.
- Step Two: Find a target acquisition. Most targets are private companies and reveal very little about themselves publicly so it takes a lot of work to find an acceptable target. You can use a broker or investment bank to help you, but usually you’ll uncover the best opportunities in your own space on your own.
- Step Three: Approach management and/or the investors of the target to determine if they are interested in selling. More often than not most targets will be VERY reluctant to admit they would be interested in selling even if they really are. More often than not it is best to take a soft approach indicating you might be interested in making an investment or some sort of partners (ironically, these two options might be a better idea than the acquisition). This process will likely take a few weeks.
- Step Four: Meet the target. Once you’ve managed to pique the interest of the target’s management team and/or investors it is time to meet. Your goal is to get the target almost as excited about you as you are about them. You’re building confidence that a) you can get a deal done, b) the transaction will be lucrative and c) it is worth their time to work with you. Expect this process to take a week or two.
- Step Five: Execute an NDA. You’re going to ask for some basic financial and business information for use in the crafting of your offer. Usually an NDA will also include a confidentiality agreement that precludes you from talking to anyone about the fact that you’re in preliminary talks to buy the company.
- Step Six: Determine the value of the target and its value to you. You will likely have to pay some number in between these two values.
- Step Seven: Secure financing. Unless you’re going to use your stock as a currency or you’re flush with cash you’re going to need to raise debt or equity to fund your purchase. Expect to spend two or three weeks putting together a deal.
- Step Eight: Deliver draft Letter Of Intent (LOI) to the target. This letter will serve as your term sheet outlining what you’re willing to buy and how much you’re willing to pay.
- Step Nine: Negotiate the LOI price and other terms. More often than not your target will have a lawyer and his job is to markup the document. Additionally the target will likely want you to pay more than you’ve offered. It should take a week or two to negotiate the LOI.
- Step Ten: Execute the LOI. You need to set a deadline and stick to it.
- Step Eleven: Begin financial and legal diligence. This can take a lot longer than you might think. Expect at least a month depending on deal size. You’re going to need to budget a few thousand dollars for the legal diligence. The real costs come in when you begin drafting the Purchase Agreement.
- Step Twelve: Retrade the deal. In all likelihood you’ll uncover things you didn’t know when you made your original offer. Take the new information into account and determine if you should lower your offer. The target is NOT going to like this process. Don’t be greedy. The retrade will likely take a week.
- Step Thirteen: Begin drafting the Purchase Agreement. You’re going to start incurring a lot of legal expenses here – around $20K depending on the size of the target. The deal points should be settled before you meet with your lawyer. Your lawyer should be able to finish the PA in a couple of days.
- Step Fourteen: Deliver and Negotiate the Purchase Agreement. Once you deliver the Purchase Agreement to the target his lawyer will want to negotiate the language, but hopefully not the terms. This process could take a a week or two so be prepared for the delay.
- Step Fifteen: Complete the various schedules to the Purchase Agreement. This process could take a couple of weeks.
- Step Sixteen: Execute the Purchase Agreement.
- Step Seventeen: Fund and Close.
In my experience it will take about four months from your first conversation to close. Of course it isn’t unusual for a deal to fall apart for a number of reasons at various stages of the process. Remember a deal is never done until it’s done. There is no such thing as ‘late stage negotiations’ – either there is or isn’t a deal.
When you launch your first startup and raise your first round of venture capital you should simply feel lucky. Only 1% of companies seeking venture capital actually receive any funding at all. But by the time you’re raising capital for your second startup you should really start thinking about securing control. Far too many of us have raised venture capital only to be encouraged or forced to make silly decisions by our boards or investors. You don’t have to believe me, take it from my of my current investors, Dave McClure who suggests,
“Most VCs Are Stupid, Insufferable, Arrogant And Terrible At Making Money.”
Once you have one or two or three startups under your belt you’re FAR more experienced than most venture capitalists at running an early stage startup. Don’t let them ruin your company. Find a way to stay in control. If they don’t want you running the company FOREVER they shouldn’t invest and you shouldn’t regret not taking their money.
The very best way to maintain control is to issue the founders Class F shares. These common shares possess some powerful rights. First, they should allow you to keep board control by offering 2 votes for every director appointed by the class. Second, they should magnify your shareholder voting power by 100:1 or 10:1 depending on the number of shares issued. Finally, you should consider adding provisions to your employment agreement that outline the minimum fully diluted share percentage you’re willing to accept – in the event your ownership drops below, say, 15%, the board is required to gross you up. There are a million ways to keep control. The goal is to keep you in control so you can execute on your vision without worrying about getting fired or replaced.
At the end of the day, if your investor accepts the fact that you’re in control for better or worse you know you have a great partner.
Most mornings I do office hours either at Cafe Express (on McKinney) or Ascension (on Oak Lawn). When I get to either location I will tweet the venue and time period (follow me on Twitter @amuse). Office hours are primarily for members and applicants to my mentoring program. If you’re an entrepreneur you should consider applying to my mentoring program and even if it isn’t a great fit for you, you’ll be able to drop in and share a cup of coffee and some entrepreneurial fellowship.
In the startup world S.O.S. means ‘save our startup‘ and the most common life saving device is a bridge loan. Typically a current investor will pony up just enough capital to get the company to either breakeven or the next funding event. But more often than not bridges are simply a way to allow a CEO to stay in a state of denial hoping that a magical solution will present itself. Worse yet, bridge loans send a VERY bad signal to future investors. Fred Wilson explains it:
“So bridge loans are often bad investments made defensively. And so they are red flags to other investors. When a new investor looks at a company and sees a bridge loan in place, they will understand that all is not well… And it will make closing a financing more challenging.”
It takes a startup about six months to raise a major investment round. If you haven’t made significant headway during the first ninety days it is time to take a good hard look at your burn. Your most important job as CEO is to save the company. It may be painful, but you must start cutting costs – renegotiating agreements with employees and vendors – whatever it takes. You need to get your burn rate down so that you can cut it completely if you end up running out of runway.
Of course, most CEOs (including me) don’t start cutting deep or fast enough to prevent the need for a bridge loan. Ironically, VCs know that the bridge loan is almost ALWAYS a bad idea a ‘bridge to no where’, but they can’t help themselves. So if you need to take that bridge loan make sure can find a way to ensure that it buys you the time you need to save your company. Oh, and start looking for a new role within the company or a new job because your days are numbered. The best way to explain the need for a bridge to a new investor is to introduce him to you – the soon to be former CEO – they will only consider the investment if they can convince themselves that you were the problem.
When the Tinder mobile app hit the dating scene it was an immediate hit. Today more than 50 million people use Tinder to find a match. These 50 million people generate a billion profile swipes each month (right or left) making 12 million matches per day. Four brothers in Dallas decided to clone Tinder and make it even better by requiring that users propose a date in order to connect. Unlike Tinder which lets you indicate interest by simply swiping right (awaiting a similar swipe), the Courtem app requires you to propose a time and date for each match (or court in their terminology). This is so smart, but I argue it is a bridge too far for most users to cross.
Tinder is successful because it has such a low barrier to entry. There is almost no friction. You either like someone or don’t. Courtem requires you to make that decision like/dislike and then propose a real world date with a specific time and place. I might think you are cute, but am I really ready to commit to a real world date? Most people I talk to aren’t even close to making that sort of commitment until AFTER they chat.
If you asked me to bet on the chances for success for Courtem I’d give it a .01% chance of success. These guys are too clever by half. They’ve created the perfect feature that will make it more likely to find a match, but less likely to create a scalable business. Of course Mark Cuban totally disagrees with me (he is on their board and has an equity stake in the company) and it is hard to bet against him. What do you think?
The Founders Fund, a venture capital firm founded by Peter Thiel, announced they are investing in a cannabis company who sells Marley Natural brand marijuana. This was shocking to me because Founders Fund is a tier one, best-in-class venture capital firm. They’ve invested in startups you may have heard of like Facebook, Airbnb, SpaceX and Spotify.
Superstar venture capitalists like Peter Thiel, Ken Howery, Luke Nosek and Geoff Lewis (who is the lead partner on the Marley deal) NEVER get involved in so called ‘vice’ investments like pornography, drugs, tobacco, gaming and defense – until now. Don’t get me wrong, you can make a fortune in ‘vice‘ investments, providing OUTSTANDING returns for your investors, but firms like Founders Fund have had HUGE success focusing on their core manifestos. Did they need to take this risk? Was it worth it? I’m not certain, but it smells like a mistake.
The Founders Fund Manifesto, written by Bruce Gibney, describes two main objectives:
- finding ways to support technological development (tech is the fundamental driver of growth in the industrialized world).
- earning outstanding returns for their investors.
The manifesto suggests a strong belief that cynical and incremental investment thesis’s BROKE venture capital and that the Founders Fund method is the shortest route to social value. Does this investment provide any social value whatsoever? Does it support technological development? I bet it will earn an outstanding return (assuming the GOP doesn’t take control of the White House). Founder Fund claims they invest in smart people who are solving difficult problems. Well they picked a doozy this time.
As an investor where do you draw the line? If you there is a new porn provider that has built a great platform to deliver porn over the internet AND you are convinced you can make a fortune for your investors should you do the deal? For me it seems like a mistake to invest in a company that distributed illegal (at least on a Federal level) drugs to consumers. Maybe I’m totally off base here, but
Ten months ago I started my twelve month mentorship experiment. Initially called TEN and now called StartupMuse, my program offers entrepreneurs three different mentorship programs.
- Basic – $199 (6 entrepreneurs)
- Standard – $499 (3 entrepreneurs)
- Premium – $999 (14 entrepreneurs)
I had started out limiting my group to ten, but after Ethan (my son) suggested adding three different levels and prices points my group expanded to 23 members. About half of the companies are really thriving. 25% are struggling and the other 25% are headed to bankruptcy/insolvency. My original goal was to add $1M in enterprise value to each company within a year. Two more months and I’ll report my results. In the meantime I’ve been having a blast. Such an inspiring group of entrepreneurs.
You know you’re an entrepreneur if everything you hear or read makes you want to start a new company. If you’re not careful you’ll end up starting a new startup every month like Pieter Levels. Ten months ago he declared to the world that he was going to start 12 startups over the next 12 months. In my experience the hardest trait, but most important trait in an entrepreneur, is the ability to say NO to ideas. Instead, I believe, commitment to a single idea for at least 13 months is key to achieving any level of success.
I have a new idea for a startup almost every morning while I’m in the shower. For example this morning I was listening to NPR and was shocked to hear that the demand for rescue dogs is outstripping supply. Shelters are having to import ‘rescue dogs’ from other states including Puerto Rico. It occurred to me that I could build an online service for shelters to list all of their available dogs. The underlying rescue dog search engine could be embedded in the shelter’s website in an iFrame allowing for a more perfect way to match potential owners and pets all over the country. I went so far as to actually talk about the idea several times today until I realized that I was ‘stealing’ mental energy from my BIG idea – ViewMarket.
Startup ideas are fragile. They need 100% of your mental and physical energy to come to life. Pieter’s idea to start 12 startups in a year is ‘cool’ but it is unlikely to create a ‘hit’. I’d love to do ‘a’ deal with Pieter, but I’d be hard pressed to commit my time to working with him if I knew he was ‘cheating’ on me with 11 other startups. Commit. Pick. Focus.
Update: Pieter reached out via Twitter and suggested that “you need market validation before focus”. I agree completely. You need to validate your ideas before spending the next 13 months of your life trying to bring them to life. BUT, make sure you’ve invalidated your first startup before starting the second startup.
This morning I had a heart to heart with one of the entrepreneurs I advise about whether or not he should pivot or quit. His startup had raised a few hundred thousand dollars and managed to build an MVP, but struggled to secure customers and additional investment. His investors weren’t impressed by his inability to get customers to sign up for their service and were unwilling to invest additional capital. The question? Should he come up with a new idea and pivot the company or should he shut the company down and come up with a new idea and start over with a clean capitalization table?
What do you think? What would you do? Have you ever faced this sort of quandary? Love your comments. If I get a few comments I’ll share my own experience with this issue and the advice I shared with the entrepreneur. Cheers! Happy New Year!