M&A – why it matters
The Myth: “Great companies are bought, not sold.”
The Reality: Great companies are sold—after a carefully orchestrated process.
Mergers and acquisitions (M&A) is term used to describe buying and selling of companies. And in the case of most startups and private companies, it usually refers to the act of selling your company. But most entrepreneurs, executives, and investors are rightfully focused on building a great company, not selling it. This, combined with the belief in the above myth that your company is not for sale because it is/will be great, leads to the common question: why do I need to think about M&A now?
While there are lots of reasons to think about M&A now, the simplest reason is that a sale is the most likely exit for your company. In the United States, private technology companies valued at $100+ million are more than three times more likely to sell than issue an IPO. And for companies under $100 million in value, a sale is about the only successful exit opportunity. So while blazing a stand-alone path in pursuit of an IPO is oftentimes the best value-maximizing strategy, the odds say an M&A outcome is more probable. Once you understand the odds, you’ll realize being prepared for a sale is less like preparing for the thousand-year flood and more like being prepared for a rainstorm.
As a lifelong M&A professional who now leads Morgan Stanley’s Global Technology M&A practice, I have been in hundreds of board meetings discussing the decision to buy and sell companies. From that experience, I can tell you that the decision to sell your company is the most important and challenging professional decision you’re likely to ever make. And just like any important decision, you want to be prepared and thinking about it well before the moment comes when you have to make it. You also want to have a general understanding of how a sale transaction may play out, so you can manage and optimize the outcome.
Be prepared - skate to where the puck is going to be
Being prepared is the best way to minimize the risk of M&A. Companies have enough risk as it is: execution, financing, competition, vendor/customer, regulatory, etc. So the best thing companies can do is “de-risk” wherever they can. The good news is, there are several easy things you can do to be prepared for and de-risk M&A.
Have a plan: M&A deals usually have a long lead time and require thought and tactics, so having a plan early is important. For example, most processes start with an approach by a buyer, so having a plan in place to quickly respond and decide what to do (e.g., engage with other potential buyers) is critical. If you’re not prepared by the time you’re approached, then you’re probably suboptimizing the outcome. As the famous ice hockey player Wayne Gretzky said, “skate to where the puck is going to be, not where it has been.”
Have advisors: Recognize that M&A is likely not your core area of expertise. So surrounding yourself with advisors you trust on M&A is just as important as surrounding yourself with a good board or good legal counsel. Early on these advisors are likely to be your board members or investors who have been through several sale processes before. As the company grows, M&A situations can get more complex, so having an outside advisor who you know and trust is also important.
The M&A process and transaction
No two M&A situations are exactly the same. Each has its own strategic and financial context, constituents (e.g., shareholders, decision makers, influencers, employees, customers, partners, and vendors), potential buyers, history, and timing. So while you can’t prepare for every scenario, there are some general things you can do to understand how the M&A process usually works and how you can successfully navigate it.
Engage early with potential buyers
Buyers tend to fall in love slowly with companies; it’s not love at first sight. It can take months, years, or even decades for a buyer to decide to acquire a company. This means you should have a plan for cultivating dialogues and relationships with potential buyers well in advance of a potential sale. Having your first-ever call into a potential buyer be “I’m selling my company, would you like to buy it?” is not a recipe for success.
Here are some key guidelines for engaging early with potential buyers:
Prioritize meetings where there is legitimate commercial/partnering opportunity. This way you have multiple reasons to meet and can adjust the conversation in real time as appropriate.
Limit meetings to your executives only. Don’t outsource it to your junior corporate development team. Your company is like your product. You need to sell it, and you want to be in control of making the most important sales pitch in the history of the company.
Similarly, make sure you’re meeting with a decision maker, key person, or influencer on the other side. Taking the right meeting is more important than taking just any meeting.
Don’t assume a potential buyer really understands your business. It can be difficult for a third party to truly understand what your business does, the value proposition you provide customers, the secret sauce that differentiates you, and the huge market opportunity being addressed. Unless there are competitive reasons not to, take the time to educate strategic parties. This way you are known by the ecosystem of buyers. If you’re not known, you may get passed up on the M&A chessboard.
And remember, the best time to take these meetings is when you’re not for sale. Allow buyers to get to know you without the pressure of a transaction and without you seeming eager to sell.
Know the buyer universe
The good news is, the universe of potential buyers for technology companies is bigger today than it has ever been. So if you think your company may appeal only to a few potential buyers, you may be pleasantly surprised to learn there are likely more. And more buyers can mean more competitive tension and a higher valuation. The bad news is, with more buyers it takes more time and effort to get on everyone’s radar screen.
Technology buyers can generally be placed into four categories:
U.S technology: For the past 20 years, the main buyers of technology companies were U.S. technology companies. Amazon, Cisco, Facebook, Google, IBM, Intel, Microsoft, Oracle, and Salesforce are examples of these serial acquirers. In 2005 U.S. technology companies represented approximately 60% of technology acquisitions, but now they represent only 25%. The reduction of volume isn’t because this group is slowing down on M&A but instead because new groups are ramping up their technology M&A efforts.
Cross-industry: Many large established companies in other industries such as industrials, retail, and telecom are being disrupted by technology. As this happens, these incumbents need to enhance their own capabilities or risk being dislocated. M&A is becoming a common solution, with examples including General Electric buying ServiceMax, Walmart buying Jet.com, and Verizon buying Fleetmatics. The technology M&A volume of this group has increased almost 300 percent since 2012 and now represents approximately 20 percent of technology acquisitions.
Foreign buyers: A new wave of international buyers has also emerged for technology companies. Notably, Chinese buyers have been extremely active increasing their annual technology M&A volume from $300 million per year in 2012 to over $40 billion in 2016. Examples of this include HNA buying Ingram Micro, Tencent buying Supercell, and Canyon Bridge acquiring Lattice Semiconductor. While there can be increased regulatory risks with cross-border deals, there continues to be strong international demand and this group now represents approximately 25 percent of technology acquisitions.
Private equity: The traditional private equity model is to pay low or reasonable prices for a company, add a bunch of debt, focus on cost controls instead of growth, and drive profitability. This model has not historically fit with buying technology companies who seek higher valuations, are not well suited for significant debt, are growing rapidly, and are less focused on optimizing near-term profitability. However, as private equity has to put more money to work, and the value creation opportunity in technology companies continues to outpace other industries, a new private equity model is emerging. This new model believes revenue growth is key, paying higher valuations is okay, no debt is fine, and the goal is to position the business for an even bigger sale or IPO. Examples of this include Vista Equity acquiring Cvent, Vista Equity acquiring Marketo, and EQT acquiring SiteCore. Private equity now represents approximately 30 percent of technology acquisitions.
Design a process
If you’ve successfully cultivated these relationships, then it’s likely one of these parties will eventually approach you with M&A interest. This is usually how a process starts. Designing the right process for your circumstances and goals is important. That process should address questions such as: How many other parties are you calling? What is the script for those parties? What do you tell the existing interested party? What information do you provide interested parties? What is the timeline?
A good process will create options, reveal information, and allow you and your board to make an informed decision. For the potential buyers, a good process will create competitive tension and get them to pay as much as possible. But even if you have a good process, you still need to have a good negotiation.
Like any deal, good negotiations are important in arriving at a good outcome. While there are many different ways to successfully negotiate an M&A deal, having done hundreds of deals, my main piece of advice is to have your company speak with one voice to the potential buyer(s).
That one voice could be you, another executive, an investor, a board member, or most commonly, a financial advisor, but choose who you want negotiating and stick with them. This strategy helps keep a consistent message. It’s okay and healthy to have different points of view on selling or not, valuation, or other key considerations in the boardroom, but telling a buyer all of those points of view can expose you to a weakened negotiating position. For example, if you tell the buyer you’ll only sell for $1 billion and take a hard stance on that, but one of your investors goes behind your back and tells the buyer $100 million because they just want to sell at any price, that is value-destroying for you.
Advocate your valuation
There are hundreds of books on corporate valuations. You could spend years reading about academic views on DCFs, WACCs, trading multiples, and precedent transactions. But here’s the secret: M&A valuation is just as much about tactics as it is science. Balancing the two is important, and here’s a simple way to frame a company’s value proposition to a potential buyer that combines tactics and science:
Stand-alone value (science): This is the value of the company on its current trajectory. This is what you could reasonably expect to get in a financing round. It reflects the company’s financials, market opportunity, competitive position, team, and technology.
Synergy value (tactics supported by science): If a strategic party acquires your firm, then there are most likely synergies, or joint opportunities, that don’t exist in your stand-alone value. Be able to articulate and quantify the value- creating synergy opportunities. These include accelerating your sales, enhancing the acquirer’s sales, and/or or reducing duplicative costs. A strong synergy case is usually a key reason a party is interested in acquiring you. Since every potential buyer has a different synergy opportunity, think about custom synergy opportunities for each one.
Scarcity value (tactics): There is only one of your company, and the more buyers believe you are unique or a “category of one,” the more they’ll pay. For example, LinkedIn was a category of one, which helped it achieve a $26 billion sale to Microsoft.
As you build and grow your successful company, it can be easy to forget about what history tells us is the most likely outcome: a sale. While a sale doesn’t need to happen and shouldn’t be a main focus of yours yet, you’d also be adding risk if you totally ignored it today. One solution is to find the right advisor. The right advisor should help you today to formulate a long-term M&A plan that can unfold over the course of several years. The advisor should be able to provide you access to all four categories of potential technology buyers, be able to articulate your strategic fit and synergies with potential buyers, be able to provide you valuation and negotiation advice, and help you navigate a potentially complex M&A situation. This carefully orchestrated process may lead to the successful sale of your great company one day.
Anthony Armstrong, Managing Head of Global Technology Mergers & Acquisitions, Morgan Stanley