You are running your first startup. You are starting to build your team and gain customer traction. You have taken advantage of a wealth of blogs about the right hygiene for starting and building a company. It is starting to feel like you might be living the dream after all.
Then, bang! You get an unsolicited offer to buy your company. The offer is too high for you to dismiss it out of hand. And it has what amounts to a take-it-or-leave-it clause that only gives you a few days to make up your mind. Getting this offer was the furthest thing from your mind and you are unprepared.
What should you do?
The answer depends on the size of the total purchase consideration. If the offer is for something like a few to several hundreds of thousands per employee when you have a small number of employees, then you have one set of guidelines. If the offer values your business at a million or more per employee and you have preferred shareholders, then your investors will become immediately engaged, likely hire a banker, and you will have less to say about what happens next. It is in the smaller scale buyout scenario where the burden falls on you.
As it turns out, what you should have done before receiving such an offer is largely common regardless of the purchase consideration.
Before you even get an offer, make sure you have done the following things:
1. Research your industry and know the acquisition patterns of the public companies. You should know how many deals they’ve done, what the history is on how many offers got accepted, what it was like to close, and how successful recent acquisitions have been. Your current investors and your outside counsel are a great starting place for this investigation.
2. Make sure your records are easily accessible for the buyer’s due diligence and are accurate and complete. This means sales contracts, financial statements, cap tables, board minutes, patent filings, etc. This always seems deferrable, but have it done before you get the offer.
3. Prequalify your legal counsel on their experience with M&A transactions in your industry. Ask about trends in standard terms, ratios of earn outs to total purchase consideration, time to close after the term sheet is signed. If your attorney is not on top of this, get access to one who does and get to know that person. Put their name in your speed dial list because they are going to become your new best friend.
4. And, most importantly, determine in advance the minimum amount you would consider accepting for your company, given the stage it is at and keeping what you learned in Step One in mind. If you have raised a priced equity round, that exercise gets a lot easier because your last post money should set the floor, unless something has gone wrong since your last equity raise. If you have just done unpriced notes, this becomes a very important point of judgment.
So now you have completed this preparation and an officer of a public company floats the idea of a deal including a number with you. Your response should be “If it is not in writing, it is not serious. Put it in writing if you want to continue this conversation.” Then get up and leave, even if it seems rude.
Legally, there is a huge difference between the suggestion that there might be a term sheet coming and receiving a fully complete term sheet. Anybody can float a verbal offer, but a real term sheet is a legal document that requires lots of approval and thought on the buyer’s part. It is the first sign that you have a party in serious acquisition mode.
The reason I say you should walk away and not discuss a verbal offer is that it is not an offer; it is a fishing expedition, and you are the fish. The other party has a mammoth informational advantage on you, and they’re trying to gain even more by seeing how you react. When you force them through the approval process of a serious term sheet, you are now making them give you more information and evening out that informational asymmetry.
So now let us assume you have been handed a bona fide term sheet. There are a ton of terms in the document, but fortunately there are only three you need to understand before you decide to take the term sheet back with you. They are:
1. The initial purchase consideration
2. The time between now and when the term sheet expires
3. The time to close called out in the term sheet after both parties sign the term sheet
If the initial purchase consideration is below the minimum amount you are willing to sell your company for, hand it back and tell them the offer is too low. If you’ve done good research on the deal history in your industry, you should be able to state with confidence that the consideration is well below industry norms and you will not interrupt your business to consider it. This is very tough to do, but you must do it.
(You might ask why I did not factor in the earn outs into the total price offered. The simple reason is that the acquiring party has far more control over whether your earn outs are achieved than you do. Since certain revenue thresholds in a given period of time are almost certainly part of an offer, and since you’re counting on their sales force, not yours, to achieve those earn outs, you should factor them down to zero as a base case.)
If the time to close after the term sheet is greater than 60 days, hand it back because this is likely a fishing expedition as opposed to a serious offer. Remember that once you sign the term sheet you are obliged to put satisfying the buyer’s due diligence needs ahead of building your business. Unless the economic consideration is very large, the stakes for the buyer are tiny compared to your interests, and they should be able to do this in less than two months, especially if your records are in good shape.
Assuming that the initial purchase consideration is above your floor, and the time to close is reasonable, you want to thank them for the offer, take the term sheet away with you, confer immediately with your pre-qualified counsel, come to a determination about what you think should be done for the benefit of all stockholders, and then inform your board of directors that you have a written offer that needs to be discussed now.
You might wonder what should go into making the decision. It’s exactly the same criteria by which you should be evaluating your business all along. Where are you in your chase for product/market fit, how fast are you growing, how much competition are you facing, what is the likely environment for future equity raises, and how enthused is your investor base?
In the case of a small scale buyout, there is not enough money here to pay a banker’s fee. You and your board will have to come to agreement about what to do and who will lead the negotiation. If you’re a first-time CEO without any M&A experience, do not resist a board member taking the lead.
As a last point, I see too many CEOs wanting to hit the ball out of the park on any deal. Frankly, being able to claim that you gave a positive return to your investors in a short period of time is a lot better than riding your startup into the ground waiting for an offer that your business fundamentals did not support on a rational basis. Remember that your track record with previous investors is a huge determinant of your ability to get another startup off the ground. Do not lose sight of that fact.
Perform your advanced preparation now, and don’t forget these simple rules for dealing with an unexpected potentially positive outcome.