Merger and Acquisition Tips for Startups
For companies going through an acquisition, adding a strategic CFO at any time can help both the process and the CEO, who is still actively running the business. In an earlier post, we discussed how a fractional CFO can help the company prepare ahead of time for the acquisition. Below, we will discuss how they can help the process from the LOI through the transaction’s close.
Understand the Situation
Once a company decides to find an acquirer, or the process starts from inbound interest, the company needs to determine its financial situation before thinking about price or deal structure. The more options the company has, the larger the price they can demand. If the company is a fast-growing business with strong metrics, it can demand a high multiple of revenue or EBITDA. Those factors provide alternate options to an acquisition, which provides leverage in the negotiation. However, most startups are not in that position when they decide to sell. Their investors or board have told them it is time to find an acquirer, and founders need to understand the goal is to return as much as possible to shareholders. The options are limited, so the asking price needs to reflect as much. Holding out for a premium return is much more likely to return no exit and company dissolution than the premium asking price.
A typical M&A process will take at least six months from start to finish, and the company needs to be sure they have at least that much available. This may mean layoffs or cutting other expenses, but having enough cash to run a thorough process outweighs the slowdown in the business. While six months seems like a long process, preparing for outreach and the initial outreach will take 1 to 2 months, then 1 to 2 months of evaluation and negotiation leading to a Letter of Intent (LOI), then 1 to 2 months to close the transaction. Acquirers will know early in the process of cash burn and cash on hand and will use that information to their advantage if the company is not well positioned.
What is the Value to an Acquirer?
Many founders think the purchase price reflects what they built, a revenue multiple, or even their prior round’s valuation. But those factors apply to large transactions or fast-growing startups, not startups that must sell. Revenue multiples are derived from publicly traded (or unicorn-sized private companies) and do not reflect the reality of smaller businesses. The valuation at the last funding round signified how much investors thought the business could grow, but an acquirer has very different plans for the company. An acquirer wants to understand how much revenue the acquisition will generate through the seller’s current revenue base or within the buyers. They will also evaluate how long it would take to build a competing product or the value to keep the company out of a competitor’s hands. But across all cases, the acquirers’ valuation criteria are driven by their internal use case, not a founder’s perceived worth.
Don’t Forget to Include Metrics and Reporting
While the term Close normally refers to the accounting process, we always recommend including standard metrics as part of the process. If the company presents SAAS metrics like ARR, MRR, or bookings, the sales operations team should be included in the process to reconcile those metrics. In other blogs, we have discussed budgeting and forecasting, and part of the Closed process should include comparing actual results to the budget to understand the variance. The result of that analysis might require an update to the future forecast.
Strategic versus Private Equity
These are the two types of acquirers the company will find in an acquisition process. Strategic acquirers are businesses in the same industry or looking to move into that industry. They will normally integrate the company into theirs or potentially run it as a subsidiary. They are typically willing to pay a higher premium for the company as the ability to cross-sell products can drive incremental revenue to their existing clients and within the company’s client bases. Private Equity firms will either roll the company into another one of their portfolio investments or continue to operate the business but with their guidance. Private Equity firms have a very structured method to value the business driven by cash generation potential, which normally results in lower transaction values.
When a company has to sell quickly, it can maintain some leverage by running a broad process to keep multiple potential acquirers interested. Reiterating an earlier point, multiple options (or acquirers) enable the company to drive the pace of the process and use the competitive nature of the process to their advantage. Until the LOI submission date passes, interested acquirers will assume the process is competitive and act accordingly. But if the LOI date passes and the only interested party needs more time, they will quickly realize they are the only bidder and will likely change their offer. Once in that 1:1 negotiation, any negative changes to the buyer’s business can impact the transaction and potentially derail a close, so having backup options may provide the seller another chance with a different buyer.
Driving the Process
Once an LOI is reached with an acquirer, the process changes to a deep review of the company and the purchase agreement negotiation that requires legal, tax, and accounting expertise. Having a dedicated resource internally to drive the process is key, which can be done by the CEO, investors, or outside counsel. However, an outside fractional CFO can aid the CEO as they understand deliverables, meet with the proper internal and external resources, and create deadlines for both parties to drive the transaction forward. The fractional CFO will resolve low-level issues and more complex questions with the CEO or the Board. This allows the CEO to continue to run the business and only be involved in the most important decisions.
As you navigate the intricate journey of mergers and acquisitions, remember that the key to a successful transition lies in robust financial health and strategic planning. At Bagchi Group, we specialize in analyzing your financials with a 360-degree approach, identifying risks, uncovering opportunities, and optimizing your budget. To delve deeper into how we can assist your startup during this critical phase, don’t hesitate to contact Tim Debone at Bagchi Group. Your business’s success is our priority, and we’re here to guide you every step of the way.
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