Exit Strategies

Hadi PartoviStartupDay 2010

Possible exits

• Not many unique outcomes:– Acquisition– IPO– Stay private forever (pay dividends, no exit)– Failure

• For the vast majority of startups, this boils down to acquisition or failure

• Ergo, “exit strategy” = “how to get acquired”

On failure• The paradox of “Fast failure”

– It’s the next best outcome after success– However, it’s the complete antithesis of success

• Zappos/Tony Hsieh anecdote• Many, many other examples

• When to pull the plug– Obvious: if you run out of money– You clearly don’t have what it takes (try for a team-acquisition)– There’s something clearly better (Odeo anecdote)

• If success is out of the question, investors will prefer you figure it out before you run out of $

Relationships, and salesmanship• “Selling the company” = CEO’s #1 job

– Along with hiring the team, building the business ;-)

• Every single conversation is a chance to “sell” the company– At same time as heads-down building a company, you should always

be in “sales” mode, forging and strengthening relationships– Regardless of product/tech success, you want to be in the forefront of

people’s minds– This applies to bizdev, sales, recruiting– In particular, every PR push is a chance to “sell” the company

• Things often boil down to relationships– Buying companies is not like buying breakfast cereals. – It’s a LOT more like marriage – starts with dating, gets serious, etc– One ultimate litmus test will be: “do I want these folks on my team?”

Plan ahead• Map out potential acquirers early on

– Get introduced, connected, stay friends, stay close– Make contacts up and down throughout orgs of potential buyers – Ideally select investors who have high-up contacts too– iLike anecdote

• Build your company to be valuable to your acquirers– DO: make sure your product plan enables your exit– DON’T: build features ONLY because they might help you get acquired– Examples:

• if building a music company, you won’t get acquired if you haven’t figured out the record-label licensing story ahead of time

• If building a mobile company, even if the primary $ opportunity is on iPhone, plan to support Android and Windows Phone so Google and Microsoft can consider acquiring you

How to initiate the “A”-word• Timing is everything– On your side, the right time is when things are going WELL,

when growth is beyond your hopes and dreams– On the buyer’s side, the right time is when the stock

market is booming, the company is planning big bets

• Initiating the discussion is a game of finesse– Don’t say “acquisition”, say “deep partnership”– Dating analogy

• You’d never say “I think you’re hot. Wanna sleep together?”• Many stages of flirting, dating before getting engaged, married

– Find a 3rd party “match-maker” or Board member who can be more direct (Tellme anecdote)

Stages of acquisition process(after a Buyer is officially interested)

• Building the internal case– High-level strategy/synergy mind-meld– PPT and XLS files to “justify” the strategy and price

• High-level price discussion• Prelim due diligence• Term sheet (non-binding)• Full due diligence• Definitive agreement• Closing

How you come up with a price• There’s no science or equation to it

– Ultimately the CEO needs to be an exceptionally good salesman– If you quote too high, you may burn all future chances for a deal– If you quote too low, you may appear desperate

• Ideal situation = bidding war (LinkExchange anecdote)– If one doesn’t exist, try to concoct one. Hardest part is getting the first bid– Bankers are extremely helpful to navigate this – process generates timing urgency, and

you’re shielded from the price brutality (stay friends with all buyers, bankers take the heat)

• Team + technology acquisitions– Obviously a lower price, these are the most common. Price usually undisclosed, because it’s

barely more than salaries– But some exceptional cases – example Aardvark, tens of millions. In a good economy, even

these fetch amazing prices– Importance of PR especially in these cases, when your spreadsheet value is zero.

Closing a deal is NOT easy• Price is almost never the hardest issue.

– Getting buyer to fully commit is hardest (regardless of price)– You need multiple champions. Even when the buyer’s CEO is the

champion, things fall through. (iLike anecdote)

• Due diligence + process takes months. Anything can happen in that time (another iLike anecdote)

• Incredibly stressful time– Hard to juggle “day job” with full-time due diligence – Hard to maintain secrecy of proceedings.

• The closest you ever get is 50% - until it’s closed– Leave no stone unturned if it can help you achieve the goal– DON’T get greedy. (secret anecdote)

Early preparation can reduce stress• Due-diligence can eat up all your time, being organized early on makes it much

easier

• Share a Dropbox folder with your corporate legal team– All signed company contracts in a single folder (everything: office lease, corp NDAs, etc)– All employee agreements and NDAs signed, in a single folder– Proper exit-paperwork signed for departing ex-employees– All patents (provisionals, filed, granted) in a folder, with a summary of status across all patent

applications

• Use a Google Spreadsheet for your engineering team to keep a list of all 3rd-party code you use (whether open-source or not)

• Use a Google Doc for your engineering leads to document overall company architecture. You’ll need it for due diligence anyway, so may as well benefit from having it along the way too

• Advance prep also makes it easier to avoid broad disclosure

Challenges – you vs. investors• Liquidation preferences – if acquisition price is a “down-

round”, can put you at odds– Avoid “participating preferred” VC deals

• Retention bonuses – investors may question the $ split btwn shareholders vs future employees– Remember, your job is to create shareholder value

• Now vs. later – many investors (esp VCs) want to see you shoot for $1b valuation, not allow you to sell “early” for only $50m– The way to avoid this is to avoid over-optimism in Board mtgs

After deal closing (if you make it)

• Life isn’t over. For the buyer, it’s only just begun– Roles for the new team, employee retention– HR on-boarding, benefits, payroll, etc– Technology integration

• “hold-back” money– Retention bonuses– Earn-out based on goals– Escrow

Questions ?