M&A: Negotiate the acquisition – High Growth Handbook

Negotiate the sale: Team or product buy

All negotiations are about relative leverage (or the perception of leverage). In order to understand more about the company you plan to acquire, you should ask about cash position/burn rate, cap table, team size, product growth rates, and other factors. This will allow you to determine how desperate the founders are to exit.

Some additional rules of thumb:

1. If a company closed a funding round in the preceding 3–6 months, you usually need to pay at least a 50% premium on the valuation. In some cases their investors will try to push for a 2–3X valuation bump. However, if the overall market has shifted dramatically, the founders are desperate to exit, or the company has poor future prospects, you could trade at the last-round valuation or a discount.

2. The typical value per engineer, product manager, or designer is between $1 million and $3 million per person. Business, operations, or community managers tend to have low-to-negative value for a team buy (since in some cases they will not be part of the acquisition and you will need to pay severance). For special or outsized talent this may go as high as $5 million. Note this money is often spread across the cap table (mainly investors and founders) and retention.

3. Get a range of valuations to offer from your CEO or board, and then anchor as low as you reasonably can. A board typically approves an “up to” price for an acquisition, with an agreed-upon likely range (e.g., $15 million up to $20 million). If the situation is not super competitive, the deal team may anchor on the lower side (e.g., $12 million) to provide some room to move. If the situation is competitive, the deal team is more likely to open with an aggressive offer (e.g., $18 million).

4. Many corporate development teams quote total deal value in their opening bids without mentioning what part goes to the cap table (i.e., preferred and common stock) versus retention. This can materially impact value to founders, investors, and employees. Bids usually also ignore cash on hand.

As an example, say you offer a $10 million purchase price to a six-person team with $1 million still in the bank. Since you are buying the company, you also get their cash, making the real purchase price $9 million. (Some people even use part of the company’s cash to pay bonuses to the team in a manner that does not impact the acquirer’s cash holdings.)
In reality this offer may mean $6 million to the cap table and $3 million in retention. So, if a founder owns 20% of the company at this stage, she will receive $1.2 million, not the $2 million she likely expected when you quoted a $10 million offer. The remaining $3 million may include additional retention for the founder, but is likely to also be split among the other five employees (i.e., $500,000 in four years of retention each, including the founder).
In many cases, once an entrepreneur decides to exit and is excited by an initial offer, she will not walk away once she fully understands the nuances of the deal. At that point, she has already seen the light at the end of the tunnel (“I don’t need to wake up in a cold sweat in the middle of the night anymore!”) and has mentally spent the money (“I can finally pay off my credit cards and buy a condo!”). This is why entrepreneurs should always talk to a small subset of their investors or advisors when they receive an acquisition offer. They need experienced people, who have seen this happen a bunch of times, to help them avoid the common traps laid by savvy corporate development people.

In general, it is important that the person negotiating the deal with the founder not be the same person that the founder will eventually report to or work with day-to-day. There are often bad feelings between a deal person and at least some of the entrepreneurs who get acquired. Letting go of your startup baby is hard to do, and negotiations can be tough on first-time entrepreneurs.

Negotiate the sale: Strategic asset

When buying a strategic asset some key principles are:

1. Buying strategic assets is also a sale by your company. Facebook’s ability to buy Whatsapp and Instagram was a reflection of the relationship Zuckerberg had built with each founder in advance. Over time he sold the other CEOs on the benefits of joining Facebook and built a trusted relationship. Effectively, Zucerkberg sold Facebook to Whatsapp rather than the other way around.

2. The CEO needs to get involved. As CEO, you will need to be part of the relationship building leading up to the acquisition, and some aspects of the actual deal itself. If your counter party CEO feels they have a relationship to you, they will trust you with their, and their company’s, future. It will be easier to negotiate and close the deal.

3. Move quickly. Especially if there are multiple parties bidding on the asset, moving quickly to a conclusion may benefit you enormously by creating time pressure or a sense of inevitability that you are the right choice. It will also show professionalism and a lack of dickering on minor items. Google famously bought YouTube in less than a week for $1.6 billion.