You've got to know when to hold 'em

Know when to fold 'em

Know when to walk away, and know when to run.

—The Gambler, lyrics by Don Schlitz

FROM THE START, Eric Baker's story reads like every entrepreneur's fantasy. While a student at Stanford University, Baker co‐founds StubHub. The American online ticket exchange quickly grows into the largest secondary‐market for event tickets, selling tens of millions of tickets per year. As with many fast‐growing businesses, the two founders had different visions for the company and Baker was fired from his own company. Angry, and still believing in his vision for online ticketing, Baker flies to London and launches a similar service, Viagogo, in Europe. Viagogo is an instant success and grows quickly. Meanwhile, the same board that had fired him sells StubHub to eBay for $310 million, making Eric Baker rich but unhappy to see his creation owned by strangers. Baker continues to grow his European event ticketing business, and on November 27, 2019, exacts the revenge every fired founder dreams about: Viagogo acquires StubHub from eBay for $4.05 billion. “It's personally satisfying to have my two babies together and be able to reunite them,” Baker said in announcing the deal. His happiness wouldn't last long.

By the time the deal closed in February 2020, the world – and definitely the world of live events – had drastically changed. With the Covid‐19 pandemic shuttering theaters and stadiums across the globe, the two companies lost over 90 percent of their revenues and had to furlough the majority of their employees. Talks of bankruptcy were bantered about in the press and financial analyst Moody's downgraded the company's status to negative. “It's rare that you can judge a deal within months of completion,” Noah Kirsch wrote in Forbes, “but the verdict on this one is absolute: Baker's purchase of StubHub will go down as one of the worst deals in history.”¹

Events outside of one's control can take any entrepreneur from hero to zero in the blink of an eye. For every story of a founder like Mark Zuckerberg turning down a $1 billion buyout from Yahoo! and going on to make tens of billions more, there are thousands of examples of life‐lasting regret. There are two sides to every deal. With the shoe on the other foot, how brilliant was eBay's board to unload StubHub before it became a costly drain on its bottom line and net billions of dollars off an asset that might soon be worthless?

Yahoo! foolishly turned down a $44.6 billion offer from Microsoft. One‐time internet darling Groupon turned down a $6 billion offer from Google in 2010 and today is worth just a half a billion dollars. And in 20/20 hindsight, does anyone believe that in 2003, Friendster should have rejected Google's takeover stock offer that is today worth more than $1 billion?

Most founders spend all their energies raising capital and building their companies, with little regard for how to maximize the return on their investment of time and money. Many consider their creations as their children and can't imagine parting with them. Understanding how exits happen and then taking the steps to make them happen is the only way a founder stands a chance of becoming Future Proof.

The Art of the Exit

In the four decades since I founded my first startup, I have been on both sides of exits. I have sold companies to larger corporations and I have acquired smaller startups. I have taken companies public and I have worked on mergers between equals. I have been on the winning side and I have been on the losing side. I have completed complicated deals in record time and been left at the alter after months of due diligence. In this chapter, I want to demystify the process and arm you with the knowledge I have accumulated so that you will have the best chance of a positive outcome.

I wish I hadn't learned my lessons the hard way. When I was in my early thirties, just a few months after my startup released its first video games, a more established company offered a third of its stock for acquiring my startup. Not wanting to lose control of my baby, I turned down the offer. Today, Activision Blizzard, the company that offered us a 33 percent stake, is worth $61 billion. I have had much success in my career, but I have to confess that 25 years later, making a billion‐dollar mistake still stings.

My lasting lesson from that first experience is to not be afraid to sell early. Very few startups go public. Of those that don't go out of business, 97 percent are acquired. Often times, the very first offer for your company may in fact be the best offer that you will ever receive. A TechCrunch analysis of VC‐funded companies shows that 40 percent of startups are acquired after their series A funding and most other companies will go out of business. The reason for this is simple – VCs invest in sectors that are perceived as hot. The attention the startup gets after announcing its first funding from a major VC will alert everyone looking at the space. If the young company deploys its new funds wisely, the value of the company can grow exponentially in a matter of months. So, if a major company needs to enter that same market, the sooner it purchases the startup, the more time and money the acquirer will save.

Why Large Companies Acquire Small Companies

To fully understand the acquisition process, it is important to comprehend the motivation of a public company CEO. Though it may appear that CEOs make obscene amounts of money, in reality, most have a modest base salary and a huge upside for making their company more profitable and their company stock more valuable. With so much of their executive compensation tied to very strict metrics, most CEOs are rewarded for short‐term thinking. The result of this thinking is that many CEOs would rather cut the expense of long‐term research and development to make quick profits now. With the majority of public company CEOs keeping their jobs for less than five years, the job becomes a series of 13‐week quarterly sprints and not a well‐paced marathon. Without the costly investment in new products, large companies have in essence outsourced research and development in the form of acquisitions. Google didn't invent its advertising business; it acquired DoubleClick for $3.1 billion. Google didn't invent video sharing; it acquired YouTube for $1.65 billion. When the world migrated from desktops to mobile, Google didn't invent Android; it acquired it. One of the reasons Google continues to thrive is that it has attained products and services from the more than 200 acquisitions it has completed.

CEOs have many other reasons for buying startups. Defensively, they may buy a startup to prevent a competitor from getting into their space. A company may buy your startup just to acquire your talent (this is commonly referred to as an acq‐hire). I also have seen CEOs, whose stock is languishing, acquire companies for the press value of making their company look like it is making big moves.

So, it goes to reason that if VCs invested in a sector set to explode, other established corporations are also looking at the space for the reasons just mentioned. I was on the board of a pre‐revenue startup that a company offered $100 million to purchase just days after our $9 million funding round was announced. The founders, both in their twenties, would have been financially set for life. I tried everything in my power to explain why this was a fantastic deal and why they should take it. But with billion‐dollar dreams in their heads, they turned down the offer and I resigned from the board. The following year, competitors sprung up like daisies in summer, and the founders were forced to raise additional capital to stay afloat. With each subsequent cash infusion in the unprofitable company, their equity stake is reduced. The company's sector is no longer the focus of the industry and growth has stagnated. Eight years later, the business has no exit in sight, but if the owners had taken the money they were offered in their first month, that $100 million invested in an S&P index fund would now be worth at least $159 million.

Since that unfortunate experience, I ask every startup founder, before they launch their company, “What amount of money would it cost to buy your ‘idea’ today?” The purpose of the question is to get people thinking about how much money they really want (or need) before crazy dollar amounts get blogged about online. Would $10 million change your life? Would $20 million be enough for future proofing you? What could you buy with $1 billion that you couldn't buy with $100 million? With 75 percent of venture‐backed startups failing; how big does the bird in hand need to be to satisfy your desires?

“Selling starts on day one and is a leadership‐only function; work out who will be your buyer,” suggests former Ubiquisys CEO Chris Gilbert who sold his company to Cisco for more than $300 million. “Only the CEO can do this. Constantly articulate why a company should buy you.”²

Before considering any offer, you need to understand your personal goals and motivation for both starting and selling your company. Would you like to become wealthy when you are old, or would you like to start enjoying life now? Did you start the company to solve a problem or to become wealthy? Does the acquirer have the resources to take your mission further or are they buying the company to just acquire talent? The clearer you are in your mind as to your goals and purpose, the easier it will be to evaluate any deal that emerges.

Selling a company is a huge distraction and will take up a great deal of your entire management's time, so be certain that you are mentally committed to selling before entering negotiations. “All of your ability to run day‐to‐day operations of your company will grind to a halt,” warns Justin Kan who sold his company Twitch Interactive to Amazon for $970 million. “You should only enter an acquisition process if you are certain you want to sell the company and you are likely to get a price you can accept.”³

Valuing a startup is more of an art than a science. Since companies are bought and not sold, the company is either valued on its future cash flow/profit or its strategic value to the acquirer. CFOs, investment bankers, VCs, and a host of corporate experts will create an array of metrics – such as cost per user or net enterprise value – to justify whatever number is being offered.

Getting an Offer

Especially in Silicon Valley, where every major tech company has scores of corporate development people, anyone can say they are interested in buying your company. Unless the offer is accompanied by a detailed term sheet (usually with an expiration date), it is just talk. Rarely do offers come out of the blue. Most begin as conversations. The more you are able to expose yourself and your company to decision makers at the top of potential acquirers, the better your odds. What seems like an open conversation with your mentor or a key investor, may lead to them sharing your story with key contacts of theirs. Once someone is seriously interested, act swiftly. Time kills all deals.

I was CEO of a public company when a much larger competitor came in with an acquisition offer 40 percent above our current market cap. With such a fantastic outcome for our shareholders, I was eager to accept and close the deal as soon as possible. When the due diligence process dragged into months because the executive leading the acquisition had fallen out of favor with their CEO, the deal died. If your goal is to someday sell the company or take it public, then you need to run it professionally from the start and have all your diligence materials ready at a moment's notice. No acquisition goes through without due diligence. The more your books are in order, the smoother the process will be. Is your cap table up to date? Have you filed all of your taxes? Have all your employees signed nondisclosure and noncompete agreements? Keep accurate records and use bookkeeping software from the moment you open your first company bank account. That extra process in the beginning, when you have extra time, will save you from scrambling when your business is on fire and you don't have time to worry about paperwork.

Before you share any diligence material, you need to protect yourself and your company. Unscrupulous pretend acquirers may be looking to steal your customers or key employees, reengineer your source code or understand your cost structure. Always require any suitor to sign a nondisclosure agreement. If violated later, that agreement will enable you to sue in court for damages. In 2017, a jury determined that Oculus had to pay game maker ZeniMax $500 million for violating their nondisclosure agreement.

Outside of the record keeping, there are three pieces of information that every acquirer is looking to gather. First, do you own the intellectual property (IP) the company is using? Not to get too technical, but many acquisitions have fallen apart when it is discovered that the startup is using “borrowed” code. Next, an acquirer wants to gauge the capabilities of your team. “Instead of taking the opportunity to hire individual talent, some companies are buying for the talent and discarding the product,” says Shekhar Purohit, a managing director at executive‐compensation consulting firm Pearl Meyer & Partners in San Francisco.⁴ If the company is buying you for your products and services, then they really need to make sure that your customers are going to stick around after the acquisition.

You may know more about your company than anyone alive, but your business is not mergers and acquisitions. You will need legal and tax advice. The earlier you bring in the experts, the more control you will have over the process. The acquirer's term sheet may seem straightforward, but unless you have been through this process multiple times before, you may not know what isn't in the term sheet that could protect you. If your acquisition price is more than $100 million you may also want to consider hiring an investment banker. Though expensive, often they take 1–2 percent of the overall deal, investment bankers know how to structure deals better than most attorney's because that is all that they do. When the US Department of Justice Antitrust Division blocked AT&T's purchase of T‐Mobile, T‐Mobile received a $6 billion breakup fee that its bankers had included in the deal. Not a bad profit for a failed acquisition.

Be as transparent as possible. “Right from your first conversation through to every piece of documentation, be absolutely clear and transparent with the business you are selling,” Nicole Munoz, founder of Nicole Munoz Consulting, Inc., says. “It can be as difficult to purchase as it is to sell, but having a clear and transparent process is key.”⁵ Many potential suitors may not want word to get out about the possible deal, but that doesn't mean you should keep it a secret from company management and major investors. Secrecy builds distrust, starts internal rumors, and causes unhealthy office politics. In order to shepherd an acquisition through, a founder needs to build consensus for the deal. The last thing you need is a potential deal getting scuttled because of a shareholder lawsuit.

Lastly, when the deal looks like it is nearing completion, work with the acquirer to jointly inform key business partners and clients. You don't want to have unhappy customers and lose business because people felt blindsided. By seeking their input ahead of time, the process of integrating the two companies will go much smoother.

One last cautionary tale about the acquisition process. The acquirer holds all the cards. At the beginning of the process, when you sign the term sheet, it is only natural to have visions of how you are going to spend the millions of dollars you are getting. Many founders will have shared the news with spouses or family. In your mind, it is a done deal, and you are psychologically committed to the exit. Knowing this, the night before the deal is scheduled to close, the acquirer tells you that changing market conditions have spooked their board, and they lower the agreed upon price by $38 million.

That's exactly what happened to the Travelscape founders the night before they were to announce the deal had closed. Some corporate bullies believe that no one is going to walk away from the table at that stage after having spent a month dreaming about being rich. Most entrepreneurs cave to such pressure tactics. Travelscape's Tom Breitling and Tim Poster walked away from the table and, luckily, later sold their company for more money.

Depending on the pace of the acquirer, even simple deals can take a long time to get done. Turner Media's purchase of Bleacher Report for $200 million was an eight‐month journey. “It went from something that seemed out of reach, to something that was remotely possible, to something we thought might happen, to something we thought would probably happen, to something that seemed almost certain,” Bleacher Report co‐founder Bryan Goldberg says. “You go to bed every night thinking there's a really good chance this deal is going to go through, and knowing at any minute it could come apart for the smallest, most abrupt of reasons.”⁶

The easiest acquisition to complete is when the telephone rings. By staying in dialogue with key industry leaders, promoting your company's accomplishments in the press, and making yourself accessible, inbound offers will come. If you have already thought through what you really want, and have your house in order, the process should be quick and painless.