Startups, here’s the difference between selling and getting bought

Photo credit: Savvas Stavrinos

One of the unavoidable dictums of the startup and VC ecosystems is having a liquidity event within a relatively short time span—typically five to seven years. This is necessitated by the structure (and thereby horizon) of a typical venture fund, which are generally set up as partnerships lasting seven to 10 years.

If a startup does not exit (think M&A or IPO) within this time, then there is an issue of what happens to the VC fund’s shares in the startup. In cases where the VC fund raises a new fund, they might be able to transfer those shares or look at less-than-ideal ways of getting their money back: buyback arrangements with the investee company.

While growth, especially profitable growth, is the foremost imperative for any early-stage company, savvy founders do subtle things that make their startups attractive to suitors, without compromising on explosive growth.

Growing to get bought

Some founders grow their startup in a way that makes it likely they will get bought. In other words, they will get incoming acquisition offers in due course as opposed to the more traditional (and in my opinion inferior) strategy of hiring an investment banker and formally going out for a sale.

Common sense dictates that impressive growth should automatically result in incoming interest. The world, however, is a bit more nuanced than that.

Common sense dictates that impressive growth should automatically result in incoming interest. The world, however, is a bit more nuanced than that. Startups should, in a subtle way, reveal to potential acquirers the benefits that would accrue from an acquisition. These benefits, incidentally, are the “pillars” of a good business plan: team (pedigree, experience, connections), addressable market (which should become larger for a combined entity vs two standalone entities), and intellectual property (patents, knowhow, “six-month lead”).

The best way to reveal these capabilities, at least for enterprise tech startups, is to have a couple of joint customers with larger firms in the industry. Getting joint customers often means creating technology integrations, a great way for product teams to know each other and get acclimated with respective corporate cultures and a very important factor in M&A.

Working together also helps each party understand the other’s capabilities. Success at one customer site often results in joint marketing activities and, by extension, gives the acquirer an insight into gaps in their product portfolio and the time/effort required to build those capabilities in-house.

If all goes well in the above activities, a “deal sponsor” emerges from the acquiring company. This is typically a product head, the corporate development group, or in some cases, even a C-level executive. They make a strong case for acquiring the startup and ideally build consensus within their organization for the transaction. The startup can help in this process by providing crucial information—on their technology, team, IP, market, marketing strategy, deal pipeline, etc.—that makes its profile irresistible to all stakeholders in the acquiring company.

So, let’s head back to the original premise: Why is getting bought better than selling?

Valuation

An M&A transaction, like any other business deal, involves negotiation. If a startup is not in a hurry to sell, it can more easily reject incoming offers. Going out to sell implicitly articulates that there is some financial duress—a lack of profitability or an inability to attract VC funding—and by extension removes one of the most important levers in a negotiation: liquidity alternatives.

Not soliciting offers actually gives the startup more leeway when deciding on a potential offer. They can do this by buying some time to look for other offers (through what is referred to as a “go shop” agreement) and then make a decision on the best one.

Startups in this enviable position often select the highest offer but also the ones with the least variability (when all or most of the money is paid upfront in cash vs stock) and which leave little to outcome-driven earn-outs. These startups are often in a position to influence what happens to their product after the acquisition.