M&A cheatsheet for tech companies
I've spent 6 hours @ Tech Exit conference so you don't have to.
There were different kinds of participants: investors, both venture and private equity, founders, lawyers and M&A advisors. The scale is solid: speakers have bought and sold hundreds of companies with valuations up to WattPad's $600M.
I loved the format: there were real experience shared, no info business. That wasn't just about success stories but more of a deep dive into the world of M&A's with their pros, cons, successes and failures.
Missionary vs Mercenary buyers
There are two types of buyers: missionaries and mercenaries. Missionaries are interested in buying teams and integrating their products. Mercenaries are buying numbers to add to their existing revenues and customer bases.
To join efforts and accelerate: Missionaries
The missionary type of deal is usually an acqui-hire or a strategic investment and then an acquisition. These deals are more complex, there are more variables.
Why working with this type of buyers or strategic investors if the company traction is fine as it is? If you can see that together you can achieve in a year something that would take 10 years if you go alone.
The ideal scenario is when the result of acquiring a company is much better than just adding its revenue: 1+1 should result in more than 2. Meaning that both companies lack something important and the result of a deal is multiplying their efforts: the buyer gets talent and necessary technology to grow faster. The seller gets an access to a vast amount of resources he/she was missing.
The key components of these deals are the culture fit and a tech stack's fit. And of course, an alignment of short-term vision and hopefully a long term vision for both parties.
Missionaries plan to work with people, they're not just buying tech, so you can expect them to be willing meet the team, to spend some time together. This is all about synergy, so both of you should be really comfortable.
"The buyer was like a long lost brother"
Allen Lau, CEO WattPad
To multiply the revenues: Mercenaries
The mercenaries are looking for a steady traction they can add on top of their own. They are more numbers oriented. In some cases they are even ready to let the team go and operate a company on their own.
These deals are easier to execute: if numbers work, it's more than half a success. The valuations are also much clearer: there are multipliers that can be applied to ARR and that is it.
Is there a Hybrid model?
There should be, yes. But from what I've heard, most of the investors are leaning to one or the other.
There's also a Vulture model: companies who buy their not so successful competitors. The price is usually low, because in many cases founders are buying a ticket to freedom and any price works.
The M&A valuation cheatsheet
For strategic investments and M&A's by missionary buyers
How much is the value for the buyer? How much do they plan to earn?
That’s the real valuation.
For economic buyers / mercenaries
The simple ARR based formula:
- $2M — is too low. 3-4x ARR multiplier.
- $5M — better, there are many buyers with a 4-5M threshold. 6x?
- $10M — crazy demand, investors from the US will form a line. 6-10x+ ?
Deal derailers: what can go wrong
There are plenty of things, some of them can easily be prevented, some can not. Meaning, you can strike out some of the potential buyers if there's no cultural fit or tech stack fit.
- Hygiene
- A culture fit
- Tech stack
- Metrics and KPI's
- Reporting
Nice-to-haves for M&A
Potentially, none of these things is absolutely a must. But then, every of them reduces friction and thus accelerates the deal.
Transparency and frankness
Buyers value transparency: eventually they will figure out all the small details as a part of their due diligence or during post-closure period, so it's better to be frank about all the potential hiccups starting on the day you met. This easily applies to reporting – if the data is easily accessible, the reporting is set up, it's definitely a good sign for a buyer and it saves time for seller: less questions to answer.
The same goes for the team: if parents are fighting, kids will definitely know. To keep a healthy morale, it's better to let the team know about the plans long before the selling. The buyer will want to retain the team, so your goals should be aligned.
An exit strategy
Many investors ask about the exit strategy when you fundraise but no one usually talks about this. Which is wrong: you need to keep the strategy in mind to be prepared when an exit actually happens, it saves a dramatic amount of braincells.
A corporate hygiene
There are things that are easier to keep in order from the beginning:
- A data room with all the agreements with customers and partners, NDAs, incorporation documents and every other PDF that is signed by you or other shareholders.
- Agreements with all your employees and contractors, PIIA's and termination certificates. There are HR tools that can help you save tons of time such as Rippling (for employees and contractors) and Deel (for contractors).
- Bookkeeping. Again, tools like Xero, QuickBooks or Wave Accounting could be of good help. It's easier to keep your cashflow at a right order rather than fixing it afterward.
- Captable and written agreements with founders, ESOP program. There are tools like Carta and Ltse that can help.
Good company reviews by customers
Buyers look at companies' products reviews on websites like Capterra, Stackshare and many others. Make sure there are reviews and they're positive.
Good company reviews by employees
Buyers are interested to keep the team so any negative reviews on Glassdoor will definitely be a sign of a potentially high employees turnover.
Sellers remorses
- The valuation
A year after a capital injection the company could cost much more. - The culture fit
If you can't communicate with buyers team, it's definitely going to be a sad year (or even two). In case you didn't leave with cash after signing the contract. But still, it's your team that will struggle. - The corporate structure
This could be underestimated: every large company, even if the people who signed the deal are friendly, has its own structure with its own rules and a corporate ladder. Are you ready to become part of a corporation and spend some time there?
Buyers remorses
Most of potential buyers remorses are similar to the ones above, plus:
- Founders went to horizon
If a company was driven by its founders, the team could lose their motivation. If the processes weren't well set, everything can start breaking down. The rule of thumb is that the company should be able to continue running the business without founders. - The valuation
If traction starts declining after an acquisition – it's sad for a buyer. That's why mercenary buyers are very thorough with their business metrics analysis.
What else
Bring advisors
Advisors help to avoid common mistakes and to prepare the company before the sell. In the end their cut is covered by the extra value they bring on the table. Make sure they bring additional value. Speakers said that at first he thought that 10% advisors fee that he paid was a lot. And with his 2nd exit he was rather thinking 'Shut up and take my money'.
Make buyers compete
This works the same way as fundraising: more people interested? This helps justify the price and accelerate the process.
Two+ steps and partial exits
A part of a company can be sold for cash to a private equity investor: they can buyout secondaries from existing shareholders in full or partially. It's a good way to get some chips off the table and continue building the same company.
Secondaries — existing shares of common or preferred stock
Removing founders who've lost interest
It's doable and must be done in some cases. Private equity investors can buy them out by acquiring their secondaries. Banks can give credits to founders who plan to stay in the company so they can remove their passive co-founders buy buying out their shares.
Networking
Your name should come up frequently, private equity investors and advisors talk to each other. The more your name come up, the bigger the chance to find a buyer.
There are many other things related to M&A: the process itself, due diligence, the paperwork, post-closure appeals that can mess the price even after deal is closed. But they're a subject for another long read.
References
The Tech Exit conference took place on 20th of April 2022 in Vancouver. I've visited the following sessions:
Deal Killers Discussion (How to address & avoid them)
Thanks to speakers:
- Tarique Al-Ansari, CEO, Paystone
- Iain Mant, Partner, Fasken
- Katri Ulmonen, Partner, MNP LLP
- Justin Young, Partner, Emerging and High Growth Companies, Osler, Hoskin & Harcourt LLP
An Inside Look at Wattpad’s $754 Million Acquisition to Naver to Accelerate Growth & Become the Next Disney
Thanks to the speaker and the moderator:
- Allen Lau, Co-Founder & CEO, Wattpad (acquired by Naver)
- Sean Silcoff, Business Writer, The Globe and Mail
Valuation Check-In
Thanks to speakers:
- Ed Bryant, President & CEO, Sampford Advisors Inc.
- Catherine Andersz, Advisor & Investor. Co-Founder, Board Director and former CEO of PDFTron Systems Inc.
- Cameron Burke, Partner, Technology & Innovation Banking, Fort Capital Partners
- Devon Thompson, Director, Western Canada, RBCx
Your Liquidity Options: Partial Exits & Two-Part Exits
Thanks to speakers:
- Bruce Townson, Director, Growth & Transition Capital – Tech Sector, BDC
- Lisa Melchior, Founder and Managing Partner, VERTU Capital
- Shane Sparks, CEO, Enrollment Resources
The upcoming posts
- ESOP – should I give share options to my team?
- ESOP – should it be confident? How to make sure it's confident?
- Hiring remotely for 14 years: how was it, what has changed?