Monday, January 24, 2011

M&A Ladder: Position Your Startup To Sell it For More

There is a hierarchy in the value of a startup to an acquirer.  As you move up the hierarchy, potential acquirers will value you on different metrics that increase the multiple that your company is worth.

Similarly, if you can convince a company that you are at a higher value point in the hierarchy relative from their perspective, they will pay more for you.

The hierarchy is: (the higher the number, the more your company is typically worth, and the larger proportion you get up front rather then vest over multiple years)
  1. Team Hire ("acqua-hire")
    • Valuation: 0 to $1 million (on a multi-year vest, per founder)
    • Basis for valuation: Typically the valuation is based on team size and the retention bonuses given to the team.  The company is bought for the technical talent (or maybe even just 1 person), but the team is immediately dispersed and does not continue to work in the market or area they did before.  Often these companies don't have good alternative options (e.g. raising a round or other strong acquisition offers)  Usually founders will walk away with at most a few hundred thousand dollars each over a few years.  This is a soft landing for the founders, but often investors get at best a fraction (or none) of their money back.
    • Examples: Most people who are acqua-hired don't talk about it publicly, or it is framed as the more valuable "true" team or tech buy.
  2. Team Buy
    • Valuation: $4-$50 million
    • Basis for valuation: Usually $1 to 5 million is paid per engineer or team members.  Median is probably $1.5-2.5 million per person, but it really depends on the acquirer, how competitive the auction around the company was, or alternative options the company may have (e.g. a funding offer from a venture firm).  Usually the team has expertise in the area they will execute for the acquirer, but not substantial differentiated IP that the acquirer will use long term.
    • Examples:  DivvyShot, ShareGrove
  3. Technology Buy
    • Valuation: $10-$500 million
    • Basis for valuation: The purpose of buying a company for its technology is to integrate that technology into the core of what the company does (versus a team buy, where the focus is on the talent itself only, as all the tech gets thrown away).  The valuation for these companies are often driven in three ways: (a) A flat premium (tech value).  (b) A bump up in the value of the per-engineer multiple of a team buy  In some cases this premium can be many tens of millions of dollars.  (c) The creation of very strong auction dynamics, particularly if a company is bought either to fill a big technology/product gap for a company (that its competitors may or may not have), or alternatively to keep differentiated IP/technology out of the hands of competitors (which the company itself already has).  Usually, technology buys do not have much of a business (i.e. lots of revenue) in place when it is bought.
    • Examples:  Powerset, Applied Semantics, Kaltix
  4. Business Asset
    • Valuation: $20 million-$1 billion
    • Basis for valuation: These types of acquisitions are valued almost entirely on financial models.  This is the opposite of the technology buy in some ways.  In this case, the company is bought either for its customers/contracts, or it may be bought by another company that thinks it can increase the revenue of reduce the costs of the company being bought.  This is how a lot of "rolls ups" in private equity work - e.g. costs are reduced and revenues/distribution channes are merged or optimized.   Often the valuation is a multiple of revenue/earnings, or is based on a financial model that will show the increased profits the acquirer can optimize for if it owned the asset and ran it differently.
    • Examples: Almost any company Demand Media or Glam have bought.  Many social gaming startup acquisitions.
  5. Strategic Asset
    • Valuation: $100 million to $N billion
    • Basis for valuation:  These are uniques assets that can either alter industry structure by one player owning them versus another (e.g. Apple vs Google owning AdMob), or which multiple bidders view as truly unique/network effect based product (YouTube).  In this case,  valuations can get stratospheric as multiple companies drive an auction.
    • Examples: YouTube, AdMob, Applied Semantics
Your Goal As An Entrepreneur
  1. Convince the acquirer that you are higher up in the M&A hierarchy.  E.g. pitch a technology buy as a strategic asset, or a team buy as a technology platform.
  2. Find alternative acquirers that view you are higher up in the M&A hierarchy.  Salesforce paid up for Heroku because they viewed it not only as a technology platform, but as a broader asset with a thriving developer community which was a part of the strategic future direction of the company.   Other companies with less of a focus on developers, or with a massive developer base themselves, would probably have paid less.
  • All valuation ranges in this post are rough estimates.  There are always outliers.
  • The line is sort of hazy for some of these - e.g. it is sometimes hard to draw the line between a team/tech buy once valuations cross a certain line.  E.g. Applied Semantics could probably be viewed as either a tech buy or a strategic buy by Google, as it kept AdSense-style technology out of the hands of other competitors such as Overture at the time.
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