Monday, April 16, 2018

Sell Your Startup To A Breakout Company

A startup CEO recently pinged me about an offer their company had received from a larger, fast growing, breakout company. He did not know how to assess the offer. Here are some of the components a founder should consider when receiving an offer from a breakout company:

Financial considerations.

If you have a $100 million offer from a break out company, it is actually worth a lot more. Considerations:

1. Company upside multiplier. 
Suppose you had an offer from Airbnb a few years ago when it was worth $10 billion.  If Airbnb ends up at its current valuation of ~$30 billion (I think it could be worth much more) then the $100 million offer may turn into $300 million or so at exit as Airbnb itself has grown 3X (ignoring dilution).

2. Dilution.
If instead of selling to Airbnb, you kept going as an independent company and needed to raise money, you would experience further dilution. For example if you still needed to raise a series A, B, and C and issue more options to employees, you may dilute another 30-50%. Assuming that you will dilute on the low end of this (e.g. 25%) you will have needed to exit on your own for $400 million later to achieve the equivalent of the $100 million exit to Airbnb in the past (3X multiple, and then 25% dilution). If you experience 50% dilution then the Airbnb offer was worth $600 million.

3. Risk adjusted time value.
One key element is timeline and risk. The average M&A exit takes ~6 years from founding. During that time a lot can change in the industry. In parallel a Stripe or Airbnb has a dominant enough position that momentum will continue to carry them forward and likely increase valuation. This means that on a risk adjusted basis exiting to a breakout company is, for high dollar acquisition offers, the right thing to do. For a lower value offer (e.g. $5 million exit) depending on your financial situation it may make sense to keep going unless you are running out of money or energy.

The decision in part depends on where the acquirer's own valuation is likely to go. For example, when we sold my last startup MixerLabs to Twitter we assumed the company had a 5-10X in upside as a minimum (it is now almost 20X more valuable).

4. Vesting.
The financial downside of an acquisition offers may lie in vesting. If you leave the company that buys you before you fully vest, you may lose much of the value of the acquisition. When thinking through the value of a purchase, you should consider whether the acquirer would truly be a long term home for you.

5. Other considerations. 
Selling your company is not a purely financial decision. Impact your product could have on the world, the joy of building your own company (or selling and learning from others), who you get to work with, and other factors all matter. However, the purpose of this post is the financial aspects.

Ease of sale

Many founders fail to consider that the lower your valuation, the easier it is to sell your company. M&A offers tend to fall into a set of ranges. The higher the range, the harder it is to exit and the fewer companies can afford you.

  • <$20M. Companies with $1 billion or more can make a fast decision to buy others in this range.
  • <$100M. Companies worth $5 billion or more can make a fast decision in this range. At less then $1 billion in valuation $50 million to $100 million equates to 10% of a company and is a major buy requiring a lot of agonizing and board discussion.
  • $100M to $250M. OK for a $10 billion company but will take real discussion and back and forth. Only will happen if truly existential or strategic for a $1 billion company.
  • $250 to $500M. At this point only companies worth $5 billion or more can even consider it, and you will generally need valuations above $10 billion in many cases to pull it off. This will require real debate. For a Google or Facebook scale company, some of these buys can still happen quickly as it is small as a proportion of market cap.
  • $1B+. Acquisitions of this size are very rare and generally requires extensive discussion and few buyers can get there. In general you need to be worth tens of billions to buy a company worth a billions plus, and you must hold strategic value to the acquirer. Since exits of this size are broadly reported on they seem common. In reality billion dollar startup acquisitions are rare.

Example exits. Instagram versus Friendster.

Both Instagram and Friendster were companies that had early acquisition offers. Friendster famously turned down a $30 million offer from Google in 2003 (probably worth billions today) and then eventually sold for $26 million in 2009 after raising tens of millions of dollars. While not selling Friendster at the time was the right decision given its traction, in hindsight enormous upside was lost for the founders. In contrast, Instagram sold to Facebook in 2012 for $1 billion. With Facebook's appreciation this is now many billions of dollars. However Instagram would probably be worth tens of billions today as a stand alone. One could argue Instagram sold too early, although the founders and investors obviously did well.