Imagine you’ve spent years working on a startup with the hope and a credible plan to build a billion dollar business and along the way get an offer for $100M? You still believe in your vision, but a nine-figure sale would represent a rich premium based on your traction and early revenue growth.
Should you take it?
Entrepreneurs spend years dreaming of the day when they can “exit,” but when confronted with the actual opportunity to sell, the decision is rarely easy. M&A interest tends to embolden investors leading them to offer Series B or C rounds that close quickly and at higher valuations. The combination of inbound interest and easy money from investors leads entrepreneurs to feel like they’re onto something big. Many resolve to raise more money and “swing for the fences” without giving enough consideration to the greater statistical likelihood that they’ll strike out.
I’ve had the good fortune to counsel a number of founders who were fielding offers that were more “base hit” than home run. Sometimes the founders seem disappointed to share the news, when in fact, it is incredible validation. I never tell the founders what to do, instead, I walk them through a series of questions to help make the decision between raising more money and selling their company:
1) What’s the difference between your acquisition price and valuation of the next round?
Are you being offered a sum that is equal to or greater than 2–3X the valuation of your next round? E.g. if the offer to buy your company is $120M, and at best you can raise $10M on a $30M pre-money valuation for your next round, it probably makes sense to consider selling. Especially when you factor in the dilution that comes with new investment and the inherently risky nature of startups.
My partner Eric Paley has explained the math underlying this logic previously, but the key lesson is that startup valuations are non-linear. As Eric writes, “startups have inflection points where value increases significantly and meaningful future progress is assumed into the price of the company.”
It’s also important to remember that once a new round of funding is raised, the exit opportunity being evaluated presently will be off the table. Any future exit will need to be a multiple of the new valuation. Growing into these valuations is often harder than it seems.
2) Can you take money off the table in a new financing?
If you’re able to take a couple million dollars off the table in a new financing, pay off student debt, buy a house, and sock some money away in your future children’s college funds, going for “broke” by raising more money is a rational choice. If not, founders need to balance their need for personal liquidity with their tolerance for risk.
3) How many acquisitions have there been in your space?
Have there been a lot of acquisitions in your space? Who is making them? How much can they pay for startups based on their cash position and market strength?
Unless you’ve have a break-away traction in customer acquisition (WhatsApp) or a novel, defensible technology (Oculus), most offers you receive will be based on some multiple on your earnings along with a variable consideration to account for “strategic value.”
It’s important to be realistic here. If there haven’t been many acquisitions for a price higher than your offer, perhaps you should take the money. This is especially true if you’re being acquired by a company outside the tech ecosystem where acquisitions tend to be more based on traditional accounting than technical ambition.
Sometimes you find yourself at the highest offer you can receive before heading exclusively for the IPO track. This can be a particularly tricky decision since the IPO path is laden with all sorts of macroeconomic risk.
There is a point at which a startup commits to becoming the biggest player in their industry, purely because they have become too large for any company to acquire. Be sure you’re aware of when you cross that threshold.
4) Where do you want to be?
Much of the deliberation around the decision of whether to sell involves financial considerations, particularly for the investors. Yet founders are passionate about their businesses and often feel as though their work is unfinished. The larger question for the founder is where does the business belong and where does the founder want to be?
Some startups just make more sense at large organizations with heft, capital and brand of a large organization. Some founders are tired of some of the mundane mechanics of running a company and want the help of centralized accounting, HR, sales, and so on so they can keep on building — or begin thinking about their next “thing.”
Others, however, feel like there is simply too much upside to consider selling. Zuckerberg, Spiegel and many others have made this calculation. The founders need to stress test their financial model but moreover their own internal fortitude to ensure they feel like they can go big so that they don’t ultimately regret their decision not to sell. The decision to sell is as much about the qualitative factors as the quantitative ones.
Remember that timing matters — read the tea leaves
Timing plays a crucial role in the M&A process. Are the public markets frothy and do public companies have lots of stock “currency” to spend? Is there a big change in the industry that is driving incumbents to acquire technology firms? While it’s impossible to prognosticate the future, trying to understand where your company and industry is in the cycle is crucial.
Plenty of people chide the founders of Instagram for selling too soon. They “only” made a billion dollars and while independent estimates peg its current value at $35B.
But that story works two ways. Look at Oculus. The market for VR, and its attendant hype, has softened dramatically since the company was acquired for $2B. What if Palmer Lucky had decided to push his luck and raised $200M against a $1B pre-money? It’s easy to imagine the company following the path of Pebble — enthusiasm cools, money dries up, and a once promising company is acqui-hired into the dustbin of history.