Tech Startups: Exit Early via M&As

You attended a cocktail party with your friend Kenny, a seasoned angel who’s flexing his wings. During meet-and-greet Ken was approached by Jan, an upbeat entrepreneur who managed to pull off a pitch with near perfection. Ken dug her vision, energy, and character. He asked Jan, “What’s your ideal exit?” To which she replied, “Ideally, I’d sell the company via M&A and generate an attractive return on investment for my investors in 2 to 5 years.” She continued enthusiastically, “And I wish to stay with the company after the M&A.”

Sure you’ve heard — M&As (mergers and acquisitions) have become the primary exit for investors and entrepreneurs, partly because SOX (Sarbanes-Oxley) has made it so expensive to go public and partly because of the recent recession. In a down economy, valuations drop and some companies see it as an opportunity to snap up smaller competitors or to bargain-hunt for startups that are strategically valuable to the acquiring company. Which means investors can cash out and the startup can increase liquidity when the business is merged or sold. According to The Deal, “M&A accounted for 70% of the angel investment exits [in 2008], while bankruptcies made up 26% and IPOs 4%.” [1]

What Are the Motives Behind M&As?

Basil Peters of AngelBlog.net summed it up nicely –

The only reason any company buys another company is because they believe:

-    they can increase the value of the company being acquired, and/or
-    the acquired company will increase the value of their company. [2]

For example:

• eBay acquired payment platform PayPal to increase efficiency
• Yahoo bought Flickr to acquire its tagging technology and the Flickr team
• Twitter bought Summize to build out its search capabilities
• Consumers Union acquired Consumerist to reach a younger audience
• Facebook bought FriendFeed to enter the real-time space and get its hands on the team of seasoned ex-Googlers behind FriendFeed

In many cases, the common motive is to acquire innovation. Big companies are better off buying smaller companies outright than to waste time and resources on internal R&D. Growing by acquisitions allow them to begin adding value and/or generating revenue pronto — assuming they’ve made the right purchases, of course.

Focus on Smaller Transactions

According to Peters, you should focus on smaller M&A transactions if you want to exit and make several million dollar capital gains within a few years after the startup’s launched. Big companies typically purchase tech companies that are under $30 million (USD). [2] Once the selling price exceeds that sweet spot, it becomes more difficult for the corporation’s M&A department to get approval for the acquisition. For early exits, don’t wait till the startup has grown so big that it’s become an unattractive acquisition target.

Instead of waiting to get noticed, you (and the startup founders) may want to seek help and advice from M&A professionals. Below, I’ve summarized two of Peters’ posts [2, 3] on this topic:

In other words, companies under $30 million (USD) should look for individual practitioners and boutique firms. And for these smaller transactions, be sure to look for an M&A advisor that’s close to home – the farther away the company is from the M&A advisor, the higher the transaction failure rate. [4]

Notes:

[1] Angel investing down, but not out
[2] Exit Strategy – Creating Strategic Value When You Sell a Business
[3] M&A Advisor Fees
[4] M&A Advisers Should be Local to Reduce Transaction Failures