When and how should you sell your startup? M&A (mergers & acquisitions) are always a high stress process, and there are a lot of things you have to consider when you are trying to get a startup exit executed in the right way. Garry's startup Posterous was sold to Twitter for $20M and Andrew Lee's startup was sold to Zynga too. As venture capitalists today we work with more than a hundred startups from the earliest possible stage to now a total market value of over $36 billion. We've seen nearly every kind of startup exit and regularly try to help founders as they navigate these problems. This short video encompasses a lot of the advice we end up giving frequently to our community.
Andrew: Are you recording now?
Garry: Yes, recording. The reality is like, we sold our company because the company was ****ed.
Garry: We were out of money. This is why you really sell your company. You made something good and then you're not growing. You can't raise more money. The company's going to die.
Andrew: Yeah, but sadly, what's happening is you always get approached when your company is growing, it's doing super well, and you don't really need anybody, and that's the time when it's probably the best time to sell. That's the classic problem.
Garry: That's the conundrum! It's okay, though, this video is to help you figure out how to actually get it done.
Andrew: And remember, companies are not sold, they're bought.
Garry: Welcome back, guys. This week on our channel, we're talking with my partner, Andrew Lee, we're talking about M&A. How do you actually get your company sold for millions of dollars?
Andrew: And not make millions of mistakes in the process.
Garry: My startup, Posterous, got sold for $20 million to Twitter.
Andrew: And my startup, JamLegend, was bought Zynga as part of the IPO. And returned money to investors and then we made money in the IPO, actually.
Garry: Same here. I think it's safe to say I'm pretty happy about the exit that we got. It wasn't quite that I hoped for, I really wanted to make something for a billion people, and we didn't quite make it. But on the flip side, our employees made money, our investors made money, and we learned a lot about this craft of making startups.
Andrew: Yeah, and I think the, as we've seen more with our portfolio, we've seen a number of different types of acquisitions, not just the ones that we experienced, but all types of different acquisitions. I think that our founders have asked us a lot of questions, and we keep on giving the same advice, so we thought we'd share it with the rest of the community.
The three different types of M&A
Andrew: What are the types of acquisitions? What are the types of acquisitions that we see? What are the ones that pay more? What are the ones that pay less?
So I think that there are three types. And three types are pretty easy. And these are in order of, I would say highest purchase price down to lowest purchase price.
So the first type is called the strategic threat. So what that is is a company is their existence and their mode of work is a threat to an incumbent within the market. A good example of this was when YouTube was bought by Google for like a billion dollars.
Interlude: Hi YouTube, this is Chad and Steve, we're the co-founders of this site. And we just want to say thank you. Today, we have some exciting news for you. We've been acquired by Google.
Andrew: So Viacom was also in the running for that and Viacom saw YouTube actually as a real threat to its business. They couldn't sell cable subscriptions, and it would change the way their advertising business worked because now people could easily be able to get personalized video delivered to them via the internet. So that's a strategic threat, something that fundamentally changes how industries evolve. So most of the companies that we work with are companies that we believe can change industries. So we want them to be strategic threats because that means that they will be bought or better yet, is they IPO and they just crush their competition.
Revenue Generating Acquisitions
The second type is what we call revenue generating. A good example of this might be when Guitar Hero was bought by Activision for about $100 million. The CEO at the time knew that if he threw in a bunch of marketing into Guitar Hero, he would make more money than the actual purchase price. So, that's a very simple one, which is basically I am buying this company in order to generate more than I paid.
And the last type is what we call team and talent acquisition. There is something that is focused on the tech or within the team. And the company wants to purchase that because it's going to help them either strategically, it's going to help them add more engineers, for example. One example of that would be when Salesforce bought Quip, 'cause they really wanted the tech and talent of Brett, who was formerly the CTO of Facebook. But in addition to that, there was some technology built there. And Quip was pretty useful as Salesforce starts to think about what are the other offerings that they want to have as an enterprise company.
Startups are bought not sold
Garry: There really is some bigger company that has something to protect, sometimes a moat or a new business line that they really want to own. That's the moment when they decide to go out and buy a company.
Andrew: Yeah, the old adage, I think, rings true that companies are bought, they are not sold. When your startup was about to sell, what was the sort of market landscape? What was the situation at the time?
Why Posterous sold
Garry: For Posterous, the crazy thing was that we had been growing really, really fast for two years straight. And then we stopped growing when Instagram came out.
Andrew: Oh, interesting.
Garry: We grew very quickly off of a totally new technology, a new platform, and a new set of behaviors. And when Instagram came along, it actually flatlined our growth. Apps had not really been rolled out yet. They were sort of primitive iOS apps, the best photo sharing apps had not really started yet. The easiest way to get photos off of your phone was actually to email.
Andrew: And what were the, do you think, were the hopes and fears of the company at the time?
Garry: Oh, at the time, we had to figure out how to pivot. We knew we had a committed userbase. We knew had made something that millions of people were using. At the time, the company chose to become a private group sharing, and that's actually left to go work at Y Combinator. If you don't have some other network to grow off of there wasn't going to be that virality.
Why JamLegend Sold
Garry: How about for you? When did you decide to sell JamLegend?
Andrew: So, effectively, what was happening was we had started doing a lot of social games. We were really wedded to the world of music games. And I sometimes wonder, if we had not been wedded to music games, whether we could've just built a social gaming company and had it become, you know, the next Zynga, or any of other friends' companies like Kabam or--
Garry: You could've kept making new games.
Andrew: That's right.
Garry: But you had the initial game first.
Andrew: That's right. At the time, Zynga had started doing, well, what they liked to call fast follows. What they would do is they would find a game that was rising up in the charts and they would just immediately copy the company. And they would copy the game, split it out in like a month or two, and then, and they were doing pretty well as a result of that. And we saw them basically gobbling up a lot of talent. We thought that was a big change that was happening within the market at the time.
Garry: Was it a growth thing? I mean, for Posterous, it was definitely, you know, crazy, outrageous growth, growth to the top 200 on the internet, anyway. And suddenly it stopped, and that's how we knew that we weren't reaching, we weren't continuing to scale product market fit.
Andrew: Yeah, I think it was similar to us. We were, we grew virally quite a lot, we were like C-Net Webware 100, we were in the Alexa 100, it was--
Garry: I mean, that's a big feat, you know, top 100 is really impressive.
Andrew: Yeah, there is nothing more powerful than having viral growth. Viral growth just on its own is just a sight to behold. Yeah, we started flatlining. We could make bigger and better social games, but at the time, the cost of production was starting to increase. So, unless we raised another round of funding at a significant clip, we would be competing against a huge number of other gaming companies. And this was hard, I mean, I think this decision was really hard. When you're sitting down, we had these couch moments where we'd sit down on our couch. And then we would talk amongst the co-founders and ask, hey, is this worth it? Is it what we want to do? Do we want to have the independent company?
Garry: It's a serious moment.
Andrew: Yeah, I want to do well financially. Or is that, you know, we just want to be surrounded by these really smart people? Do we do the IPO? And I think the thing is the choice was never to take an offer 'cause there wasn't one in front of us. The choice really was do we want to potentially talk to people who've asked us, who wanted to potentially acquire us? So, we did everything, we actually met with a couple different companies. One I remember in Seattle, and we met with all the big companies, we got offers from a number of them. And eventually we ended up at Zynga, because I think it fit correctly with our contours of things that we cared about. We wanted everyone at the team to have a place, and we wanted to make sure that our investors got something. We wanted to make sure that our team was taken care of, 'cause we were just, you know, I mean, working pretty hard for the past couple years. And wanted to see the opportunity to grow ourselves and potentially have a payout, and I think a lot of people who were bought by Zynga had the same thing. The IPO was coming along, and it was imminent, right? It was basically in a year or two, a year and a half, the IPO would just happen.
When should you consider M&A?
Andrew: When I should even be having these types of conversations, right? They raised money from us, they raised money from the series A, their series B, even their series C, right? At what point should they even be doing this assessment?
Garry: This is a really a sort of personal question, right? I can only tell you what I would do if I were the founder. The magnitude of outcome that can happen when you have product market fit and you have a clear path to building something really great is just so obvious and so tantalizing that that's always my plan A.
Early stage and still have capital? Focus on product market fit.
It's so hard for founders to even get to product market fit that if you don't have product market fit yet, you don't have anything to sell. Basically have the team that you built and that's it, and so, that's purely acqui-hire territory. And the reality is, you can just go get jobs at these big tech companies. If that's what you want, just go do that instead. Early on, pre-series A, it's almost always exactly the right thing to just focus on product and market and, you know, getting your product out there.
Going to run out of money? Get M&A options on the table as a Plan B or C
And then the only time I would really start thinking about it is if I'm managing risk. Every time you need to raise when you are not default alive, and I'm going to link in the description to Paul Graham's essay about being default alive or default dead. If you are not default alive, the future of your company is not in your hands, right? Then that's okay, right? Like, you're trading off growth for safety.
At every sort of journey from this, you know, from the pre-seed to seed, from seed to A, from series A to series B, you will have built product, you have built a set of customers, you've built recurring revenue, sometimes negative churn, which would be great. All of these things are really powerful real aspects. And at any given point, those things, whether it's your team or your product or the customer base that you've built is valuable to someone else. And so, if you're looking down the road and you think you're going to run out of gas before you get to the next gas station, or the gas station might be closed for you, that's when you need to think about M&A because you need to take care of your employees, you should take care of your investors, you should take of yourselves, right? Like, as founders, you own so much of this business. It's okay to sell your business along the way, actually.
Andrew: Yes, and it's such a personal decision and it hurts. I think everybody needs to recover from that. There's this whole of this, like, you feel like a fraud or you lose confidence because you set out to do this one thing, but you're not even there, you're midway through. And I think that that's probably one of the most the difficult problems is that great entrepreneurs are able to stare into the abyss and the abyss will stare back. And you just have to not fall in.
Questions from Atul Gawande's "Being Mortal"
What we do at Initialized is we use a four-step question process that we took from Atul Gawande, from his book, "Being Mortal." It actually is usually used in counseling around end-of-life care. Similarly, we want to ask the same questions when they're dealing with a startup. So in this case, we ask really four sets of questions.
1/ Understand your situation and impact
The first one is what is your understanding of the situation and its potential impact? That means understanding what your runway's like, what does the market landscape look look? All those different factors.
2/ What are your hopes and fears?
The second question we ask here, what are your hopes and fears? And the reason why we ask about hopes and fears is you're a combination of people and founders themselves have hopes and dreams that they want for their company. It might turn out that the thing that you want to do is still continue pursuing your vision, but because the market has changed, it makes sense for you to team up with someone else.
3/ What tradeoffs are you willing to make? What tradeoffs are you not willing to make?
The third question we ask is what are the tradeoffs that you're willing to make, and not make? Again, what are the tradeoffs that you're willing to make and not make? And that's a tough one because for a lot of folks, they care about certain things. Whether it's I care about my salary or I care about what I'm doing, or I care about the people that I surrounded with, or it's not just the people that I'm surrounded with, then it's just don't ever want to move to North Dakota. Nothing against North Dakota, great people there. Those are questions that we need to help answer to understand the contours of what it means to go and do an M&A.
4/ What is the course of action? What's the plan?
And the last and probably the most important question is then what is the course of action, given this understanding? And that helps us then formulate a plan. So with those four questions, that's how we dive in. And more importantly, it should help you evaluate whether you want to go ahead and sell, and what you want to do with your company.
Levelsetting with your team
For a lot of folks, the first place to go and start is levelsetting where your situation is. So in that case, what that means is knowing things like your metrics, your annual recurring revenue rates, your runway, your burn, debt that you might have, debt, this turns out to actually be a really big issue. Another one is talking amongst your co-founders to figure out what is the situation between amongst the co-founders and the leadership. Are there certain people who are brilliant assholes, who you're just like, oh, this engineer is really, really important for the product and we need to keep them, but honestly, everybody hates working with them.
Garry: That happens.
Andrew: Yeah, and that can kill companies.
And I think we've seen sometimes that happen as well. Where somebody holds up a deal because that person isn't on board. But trying to understand sort of what's the employee temperature? Especially if you're going to be aiming for like the talent and tech side, you need to get a sense to whether your employees are sort of in on that that.
You want to sell— How do you do it?
So, if you've decided that based on your runway, your hopes and fears, we've already talked about the tradeoffs, you want to go ahead and sell, there are many different ways to do that, but here are a couple key things that would be very helpful.
1/ Start with strategic partnerships
One is start strategic partnerships, especially if you're an enterprise company. It's very hard to sell yourself to a larger company if they have no idea who you are and they can't tell the difference between you and Adam. You need to build trust with some of these other companies, and the best way to do that is to create make them be one of your customers or potentially a very good partner.
2/ Go through product, not corp dev
The best way to go and get an in is never go through the corporate development department, no matter how much we love those folks. It's usually actually go through whoever runs the line item budget or whoever runs that particular team. That person is the number one person you should talk to because they're probably the key champion that you're going to have, who's going to help you fight against the decision makers who may not be want to go and purchase the company.
3/ Extend runway: get revenue and decrease burn
And probably the two other things that are really important that we don't talk enough about is if you know that you're going to sell and you need to extend runway, it's now time to go and increase your sales, pull forward some of that revenue, and, on the other side, instead of just increasing revenue, it's also decreasing burn. So that means decreasing your costs. This might be a hard time that you might need to go and lay off some folks. It's not great, but if you're going to cut, cut quickly, cut deeply, and be able to put yourself in a good situation to either pivot yourself out of the situation that you're in. Or potentially be able to find yourself in an area where you can extend runway and get more customers. And so you're in a good position to sell.
4/ Have leadership interview first, and protect the broader team from the process unless you have a real offer
When it comes down to talent and tech acquisitions, many times, they'll want to go and interview your employees. You want to go ahead and first do interviews with your leadership, then do interviews with your employees afterwards, when there's significant and true offers on the table. Many times, it is highly disruptive to your team. You might be in the middle of a pivot, you might be working on things, and it's kind of scary to an employee. They're not a founder. When thy start seeing that they're interviewing another company, they get kind of scared because if it doesn't happen, it really hurts them quite a bit because you know, they're not the founder, they are not built to deal with this type of risk.
5/ Check references while you continue to work on other alternatives
When you are talking to an inquiring company, you should talk to them about two different things. One, get a sense as to who the previous acquisitions, the previous acquiring acquisitions that they've done and who are those companies and what are the contours of those deals. Ask to speak to some of those previous founders or CEOs or whoever executed on the deal. And number two, while you're doing this in parallel, have a best alternative to a negotiated agreement, your BATNA, if you will. That includes raising money, like doing a fundraiser at the same time. That includes increasing revenue and decreasing costs. And then also think about potentially having more competing offers from other acquirers.
The #1 thing that kills deals: Don't treat your M&A process like a VC fundraise
Andrew: So Garry, we've seen a lot of folks, not just in our portfolio, but just generally friends within the ecosystem. What is the number one thing that really seems to just kill deals? Like, they're about to sign or they're very close--
Garry: Oh, for M&A, it's almost always people treating their M&A process like another fundraising process.
Andrew: Oh, interesting.
Garry: Corp dev and VCs are very different. Their motivations are very different. In the end, it comes back to principal agent problem. What will get a junior VC at a VC firm promoted is different than what will get a corp dev person at a big firm of any sort promoted. And so, you know, corp dev is about not paying too much, it's about, you know, fighting for the deal, like, you know, they want to get the deal done, but not at any price, right? Whereas VCs often have extreme groupthink, and so the more bidders there are, the more rabid they are to win the deal at any cost, especially if there's a 100x on the other end. None of that dynamic occurs at the M&A corp dev level, and then the only other thing is the best alternative to the negotiated agreement, like, always keeping that in mind, because if you don't have that, actually, we've seen corp dev be extremely unscrupulous around that.
Deals fall through, Always maintain some sort of BATNA. [Corp dev's] entire job is to bring the price of the deal down.
Andrew: But there's an amount that they're allowed to pay, and then if they can get that below that, there's actually a bonus that's given to them to a certain extent. And it's funny 'cause I remember one of my angel investors at my previous company over at the JamLegend, he was the right hand to Barry Diller over at IAC. And he would say it was very funny how the two deals that would go really well were ones that were very small 'cause it was like, oh, we don't really care, this is, yeah, we'll do it.
Garry: It's all upside.
Andrew: And then the ones that were really, really, really big because those ones were existential strategic threats.
Closing thoughts: Take care of yourself and your people
Garry: So, I think that that's one of the best things about tech startups is that as long as we build something valuable, even if it doesn't work out exactly to plan, there's still a way forward. And you know, a way forward that allows you to take care of all the people around you.
Andrew: I hope it helps and more importantly is we wish you the best of luck as you through your M&A process and sell your company for millions.
You can follow Andrew Lee on Twitter at https://twitter.com/ndrewlee