Monday, August 29, 2011

What Is Your Startup Acquisition Offer Really Worth?

I have helped more than a dozen entrepreneurs think through their exits.  There are a large number of non-financial issues to consider when selling your company (your role, manager, network, impact to your employees, etc.).  This post focuses solely on how to go about making a financial assessment for the entrepreneur.  

In particular, I focus on items that impact the *real* versus perceived value of the deal.

1. How Long Will You Really Stick Around?
How long is your vesting period?  E.g. suppose you have 2 offers:

Offer 1: $10 million vesting over 4 years.
Offer 2: $3 million vesting over 1 year.

Offer 2 is actually much better for the entrepreneur who only plans to stick around for 1 year, even though Offer 1 is much higher in total value over time.  

This suggests as an entrepreneur you should never go somewhere you think you will be miserable, even if it seems to pay more over multiple years.  Entrepreneurial people tend to quit more often and more easily, so don't mislead yourself on how long you can stick out working for someone else.

2. How Much Upside Does the Acquirer's Stock Have?
If you are getting stock offers, how much is the stock likely to be worth?  Does it still have 10X in it?  Selling to Google or Facebook when it was valued internally at $10 billion is much different from selling to Google or Facebook today.  A $50 million acquisition can suddenly become a $500 million acquisition if the acquirer's stock appreciates dramatically.

3. Are You Getting Options Or Stock?
You need to exercise options, which means you pay money to convert the option into stock.  For a later stage company this can be e.g. 1/3 the price of the common stock.  In other words, $30 million in options may be worth $20 million in stock (assuming it costs you $10 million to exercise the stock).

Ask the acquirer what their strike price is, if they are largely compensating you with options.

4. Taxes.
How tax efficient is the acquisition?  Will your acquisition be treated as long term capital gains versus e.g. cash compensation?  This can change the value of the deal dramatically.

5. Is the Offer Net Cash?
Suppose you have $1 million in the bank and you are acquired for $10 million.  Who gets to keep the cash?   If the acquirer keeps it, you just subsidized the deal to the tune of $1 million.  I.e. the real value of the deal is only really $9 million and the acquisition is worth 10% less.  You should ask for the cash to be dividended out to your shareholders or use this point as part of the negotiation.

6. Other Intangibles (these matter most if the acquisition price is low):
a. Vacation Transfer.  You have not taken a vacation over the last 4 years and on your company's vacation policy have accrued 6 weeks of vacation.  This should either transfer over or get paid out.  (6 weeks of vacation is either an extra 1.5 months of free vesting for you, or if you cash it out could be a reasonable sum depending on your salary)
b. Vacation Accrual.  Some companies have seniority tied to vacation policy - e.g. if you have worked at the company for 4 years you get an extra week or two of vacation.  Negotiate the transfer of this seniority for you and your employees.

Anything else you think makes a big impact?  Let me know what you think in the comments!

You can follow me on Twitter here.

Monday, August 22, 2011

5 Reasons To Sell Your Startup

Many entrepreneurs get really distracted when Google or Facebook or another acquirer approaches them and asks if they want to get acquired.  I frequently (a) ask - why do you want to exit?  and (b) suggest the entrepreneur stop talking to the potential acquirers - this is usually a huge distraction that does not lead anywhere.  [aside - I wrote another blog to be posted soon on moments when you should NEVER sell your company]

When most entrepreneurs approach me for advice on how to exit their startups, I usually first ask if there is a reason they should do so.  I think the following are legitimate reasons to exit a startup:

1. You are exhausted and dont want to keep going.
Sometimes you just don't have it in you to keep going.  The startup has been rough on you.  Your significant other left you.  You can't sleep anymore.  You show up at work without energy every day, and feel like you are clawing your way from morning to morning without end.

We all have periods like this as entrepreneurs (I think many entrepreneurs are a little bit manic depressive) but if you find that the startup has drained you to the point where the manic part is totally gone and doesn't feel like it will ever return, and nothing (vacations, new boyfriend/girlfriend, hiring someone to delegate to, etc.) can't fix it, it may be time to stop what you are doing and try a startup again at a later date when you have recharged.

Startups take a lot of energy and relentlessness.  If you lost both of these things, it may become impossible to roll the boulder up the hill singlehandedly anymore.

2. The founding team is about to blow up.
You and your co-founder can no longer stand the sight of one another.  You roll your eyes whenever she speaks (or vice versa) and spend long pointless days arguing.  Who is responsible for what is eroding or you can no longer do your own part effectively.

First you should talk things through and try to work it out with your co-founder.  Have a mature conversation on it.  Often you can work it out.  If this does not work, you can pull in a mentor, advisor, or investor to help work it through.  If you find things have truly eroded to the point where you can not work together anymore you need to either:
a. Leave the company (or have your co-founder leave)
b. Sell the company if you think (a) will kill the company for some reason

3. The acquirer is willing to "pay ahead" substantially.
Most disruptive companies end up with offers that look very large at the time that in hindsight don't properly value the company's potential.  E.g. Amazon's $100 million bid for Google and then Yahoo!'s conversation with Google that valued it at $1 to $5 billion.

That said, there are a number of times where an acquirer is willing to pay substantially more then a startup is likely to be worth.  Reasons for this may include:
a. The acquirers equity value will likely grow substantially faster then yours will (e.g. any company Google bought in 2003 or the early team buys Facebook made).  For example a $50 million acquisition by Facebook when it was worth $5 billion would appreciate into a $500 million deal value at current valuations. 
b. The acquirer can get more value out of your company than you can.  For example, if their larger sales force can ramp sales of your product much faster than you can you may be worth more as part of their company than as a stand alone.
c. You are in a hot space or the acquirer is desperate.  Sometimes you are just in a hot market, so people will pay for you much more then you will ever be worth - especially if they are desperate (see e.g. AOL buying Bebo for $750 million).

So the big question you should ask yourself is whether you are Facebook or Bebo? :)

4. You are about to get massively crushed by a competitor.
Sometimes there is a competitor in your market who has dirty tactics or uses a truly unlevel playing field to crush its competitors.  An example of this is the way Microsoft used to bundle multiple products into its O/S for free.  This both (a) created instant massive distribution for these products and (b) often killed its competitors by giving away the product for free, when the competitor used to charge for it.  This dried up the competitor's revenue stream leading them into a downward spiral, or the arms of an acquirer.

A great case example of Microsoft tactics lies in Microsoft versus Netscape.  Netscape was eventually bought by AOL for >$4 billion.

5. You need financial security or regular cash flow.
A family member gets sick.  You are about to have kids and can't afford it.  You need to support your family members.  There are a number of instances in which having liquidity can go a long way.  There are often alternate means of liquidity (a loan with your shares as collateral, secondary stock sales, etc.) but if all else fails, an exit into a larger company may both generate cash for you as well as provide you with a stable, higher paying job.

Any other thoughts on reasons to sell your company?  Let me know in the comments.

You can follow me on Twitter here.

Friday, August 5, 2011

Startups: Give Your Family Stock In Your Company

One of the things I regret not doing when I set up Mixer Lab (since acquired by Twitter) was that I did not gift any stock to my family members when incorporating.

When you set up your company, the stock is really cheap (e.g. 0.0001 cents per share or the like).  This is your opportunity to give your family, spouse, or other loved ones the equivalent of a tax free gift that could have a major financial impact long term (i.e. the taxes they will need to pay on the gift at this point could be either zero or very low in dollar terms).

More Tax Efficient For Your Family
Say for example you gave each of your parents and your siblings 0.25% of the company.  If the company sells for $100 million this translates into $250,000 for each of them*, taxed most likely as capital gains.  In contrast, if you were to just give a gift equivalent to $250,000 after the company exit the money gets taxes twice - first it is capital gains for you, then it is taxed (heavily) as a gift for them.

This becomes much more dramatic if you have a very large exit - e.g. at $1 billion the 0.25% gift could be worth $2.5 million - which means you have not only provided long term financial independence to yourself, but also for the set of people you care about.

Voting Rights
If you are concerned that the e.g. 0.5% of equity you divide amongst your loved ones will dilute your ability to control the company over time, you can ask your lawyer to give you voting proxy rights over the shares.  This means as part of the gift, the family assigns the vote associated with the shares to you.  So, you still effectively have the same voting block as you did before the gift.

Ask your lawyer (and tax accountant) for more details on the above as some things are pretty case by case.

Any other things people wish they had done when they first set up their company?

*Assuming no dilution from funding rounds - I am trying to keep the math simple)