M&A Issues: Price

This is my final MBA Mondays post on M&A Issues. I've been posting about M&A since last December. It feels like a semester long effort. And frankly I'm a bit tired of talking about M&A every monday. But selling your company is an important topic and I think we've done it justice now on MBA Mondays.

Price is certainly the most important issue in a sale transaction. You need to consider all of the issues we talked about when deciding whether or not to accept an offer to buy your company. But at the end of the day, price is the big issue.

The best way to get the highest price in a sale transaction is to have a competitive process. Multiple serious bidders will force the buyers to bid more agressively than they would otherwise.

However, most buyers don't want to be in an auction. You can lose potential buyers, maybe your best buyers, by overtly conducting an auction. So you must be careful about this. My favorite approach is to get one bid, then quietly get another, and all of sudden you have a competitive process. I don't like to start out the process telling everyone that "we are running an auction."

Sometimes, you will get your best price from a buyer who wishes to pre-empt the auction process by putting out an early agressive bid in an attempt to win the deal without competition. Pay serious attention to these offers. I have seen pre-emptive offers top bids obtained in a competitive process.

 The problem with pre-emptive offers is you don't really know what the "market will bear" if you go through with a competitive process. So the pre-emptive offer needs to come with a premium over what you think that fair price is to incent you to avoid the sale process and sign with the pre-empting buyer.

You should go into a sale process with a target price. That target price needs to be based on some sort of logic and rationale. An investment banker can help with this. It is one of the best reasons to get an investment bank involved in a sale process. But you don't need an investment bank to do this valuation work. If you have venture capital investors, they can help you do it. Or if you have a strong finance team, led by a transactional CFO, you can do it yourself. Some of the early MBA Mondays posts can help you do this valuation work. Here is a table of contents of all the MBA Mondays posts to date in case you want to look back at some of them.

I generally like to look out a couple years, no more than three, and figure out what the business would be worth if it remained independent based on cash flow multiples, revenue multiples, or mutiples of active users who have an established lifetime value. That becomes the target price. My rationale for using this method is the buyer ought to be willing to pay a premium over what the business is worth today for asking the company to give up all future value potential. But you can't ask the buyer to pay now for all the upside that the business could obtain if it remained independent. So a few years of future value, especially if it is reasonably visible to everyone, particularly the buyer, is a reaasonable approach.

If you run a process and you cannot obtain a bid at or in excess of your target price, you should stay independent unless you are in a distressed situation. As painful as it is to the senior management team and the entire company to go through a sale proceess and end up with nothing, the alternative – accepting a price that you believe is not fair – is worse. I've seen plenty of companies go through a sale process, come up with nothing good, and then go back to business and continue to create value and come up with a much better deal a few years later. It's tough the first six months or so, but then everyone moves on and the failed process becomes a distant memory.

If a buyer meets or exceeds your target price, you will want to seriously consider the offer. If you made the decision to sell the company, ran a process, and hit your target price, you should think very hard before walking away from the deal. If however, you did not set out to sell the company, but were approached, that is another story. I've seen many entrepreneurs regret selling after the fact. Don't let a great price force you into a sale that you are not ready to live with.

In summary, when selling your company, do the work upfront to get to a target price that makes sense to you, your senior team, your investors, and will make sense to the universe of buyers you want to target. Then figure out how to get multiple bidders to the table to get the best price. And make sure you want to sell the business before you go through with all of that. Because getting a great price for your business is not easy and when you've accomplished that, you'll want to be able to say yes comfortably.

#MBA Mondays

Comments (Archived):

  1. awaldstein

    Fred…do you consider it your role for your portfolio companies to be the coach on this?Sure it’s up to the company, but few folks have the chops you’ve built in this area. It has to be a hard role to balance?

    1. fredwilson

      i’d like to be the coach on this stuffbut the entrepreneurs have to want that

      1. awaldstein

        Entrepreneurs when they take funds from you Fred, ask themselves “Why Fred” and I would bet that this is one of the items that is high on the list. For me it would be.

      2. Brad

        I look at my financiers as partners and would expect them to get involved. That is the point of partners, I would expect as a partner for you to want to be involved.

  2. Bill Ferretti

    Fred, well done as usual. Would you also advise sellers to beware of the buyer who pays a premium price with onerous terms?

    1. fredwilson

      Yes. Terms are often an indicator of life post transaction. Same is true forVC deals

  3. Aaron Klein

    One other component to the price, especially in a distressed situation, is the assumption of debt.So when you come to your target price based on earnings/revenue/user multiples, I’ve generally found that you can add your cash to it (and inventory if you’re that kind of business), and subtract your debt from it, to true it up with your balance sheet.Not true in every case though…

    1. JLM

      My advice is to steer clear of anything which is a measure of CURRENT value. You don’t want to get drawn into discussions of enterprise value or other valuation techniques.What you want to focus on is FUTURE value. What the buyer can make it worth in the future. Make them buy the next three years growth and they can have the balance thereafter.I always position the conversation to make a profit well above current value.

      1. Aaron Klein

        I completely agree under normal circumstances, but I probably should have been more specific in my first comment on when that’s an interest for the seller.I can’t write too specifically about it (I wasn’t the owner), but I’ve seen situations where the company’s Accounts Payable was personally guaranteed (only way to build the business in the first place).The entire industry had a huge downturn and earnings fell deeply into the red. Consolidating with a larger player became critical. Assumption of that debt by the buyer became a very important interest of the seller.It most definitely reduced the purchase price but everyone I talked to was quite happy with the outcome. (Relatively speaking, of course, for a distress sale!)

      2. fredwilson

        yup. i tried to convey that in the post. totally agree JLM

  4. kidmercury

    valuation becomes exceedingly difficult in a bubble, one of the many problems with a bubble, and why they do more harm than good, especially the ones created by govt monetary policy (the source of most contemporary bubbles). take your cash quickly and put it into reliable stores of wealth in our global economy, though finding places to store wealth is a bit nuanced now as we are in the midst of a massive economic shift.

  5. Fernando Gutierrez

    You say the best approach is to get one bid, the quietly get the second one and make them compete. I guess that “quietly” is key to avoid alienating the first bidder. Any tips on how to manage that?

    1. Jevon

      Know, in advance, who you would quietly “shop” (by “who” I mean– a specific person(s) at specific company) it to and make sure you have built those relationships in advance. If they are going to respond, they won’t have much time, so you need as little friction as possible. If you are coming in cold, it could take a week+ just to get the first meeting.

    2. markslater

      yes – use a quality banker who is properly incented to achieve a price within constraints of the process.A buyer will automatically know that you are seeking best price by the mere presence of one. If nothing more it will keep a buyer honest in his initial approach.

  6. celestus

    What are your thoughts on giving valuation guidance to buyers- not necessarily giving them your target price but saying “we are looking at a multiple of revenue between X and Y, based on a revenue of about Z” or something like that? If that’s something you’d discourage, what should you tell buyers when they ask a question about your valuation?

    1. fredwilson

      i like to do exactly what you suggest. don’t give them a number. but give them some math that they can use to get a sense of where you will do a deal. the problem with giving them a number is you are then held to it.

  7. markslater

    Cautionary tale.My last company we had an investor who was also a top tier M & A banker at a firm you will all know.We made two errors. We did such a good job selling him on an investment that he paid over what in reality the stock was worth. this began to distort our value in ways we would come to regret later.When the buyer appeared, we set a very high bar – in my opinion wildly high actually. This was in part influenced by his price on the way in.When the retrade came (and note to entrepreneurs – it nearly always does) the gulf between the price the buyer could justify after diligence, and what we had asked for was too great to bridge and they walked away.

    1. research papers

      thank you very much. people dont ususally like sharing information like this but exactly this – knowing mistakes of other people – gives us a kind of experince, even if we still do this mistakes by ourselves. i really appreciate this and say thanks again

      1. markslater

        you are welcome.Everyone has had bad experiences in their professional lives and most are way too afraid to share. I don’t trust those types of people.i’ve learnt a great deal more from my failures than i have from my successes i can promise you that.

  8. markslater

    entrepreneurs would do well to seek counsel from people like fred.when you go in to a process, you can very easily jump in to a shark tank, especially if it is a financial buyer.If you have never been through a forensic diligence process then you need people like fred who have. If you haven’t you can get eaten 10 ways from Sunday.At the end of the day – you need to get on with running the company – and trust in the people who are your partners to manage the process. The big conversation should be up front amongst you and your partners – aligning interests, price etc – once that is settled – get back to the corner office. or cube.

  9. Rayhan Rafiq Omar

    Out of interest, as an experienced VC have you had a situation where a buyer comes in for a portfolio company and the founder wants to stay ‘independent’? Is it always easy for a VC to fully back the founder?

    1. fredwilson

      it is not easy, but i think it is generally the right thing to do

  10. Gregory Magarshak

    I have a philosophy as an entrepreneur, but I think it’s pretty unorthodox: I would tell most entrepreneurs to overfund, properly build up, and sell a controlling stake in first business soon (within 3 years or so)… but not before setting it up to run well without you. Mainly for the following reasons:1) You can always own a greater stake in your next businesses. Chances are you will start another one in the future.2) You will have money to survive mistakes your first time around, and since you don’t have the reputation yet, you will need money to attract talent. In the future, your reputation will help you attract more talent and sponsorships.3) You will build a reputation for getting things done and making good returns for those who invested in you. And therefore you will get better deals on funding next time.4) You will have a more comfortable experience all around — in your first project, since you have more money, and in your later projects, because you have money. Whatever you think you can accomplish by yourself or with a tiny team, you can probably accomplish more when you have $4 million in the bank. All those projects you wanted to try but didn’t have the time, you can now scale up your man-hours by hiring teams and managers.5) You will have more opportunities that you can’t even imagine right now, because when you have enough money, and you are making big strides, you start meeting people you wouldn’t have met otherwise. Celebrities, passionate investors, etc. And they will know you even after you have had an exit on your first project.Anyway I guess what I am saying is, how much money you should raise and what the price is, can be things that aren’t just determined by the startup itself, but also the founders’ utility function over their lifetime.I just wish I followed this advice myself, but I seem to be building REALLY, REALLY big ambitious things (potentially like facebook / twitter) and therefore I am planning to grow the company value a lot between investment rounds.

    1. JLM

      OK, so where is the unorthodox part?One never goes broke taking a profit.

  11. David Shellabarger

    “I’ve seen many entrepreneurs regret selling”Its very refreshing to see a VC that cares about entrepreneurs even after they have left your fold.Money, while a big thing, is not *everything* it seems.

    1. fredwilson

      our job is to serve entrepreneurs

    1. fredwilson

      yeah, isn’t that great?

      1. paramendra

        We need something similar for a-l-l your blog posts. Maybe one per year?

  12. JLM

    Selling a company is a skill and is much like staging an open house to sell a residential property. Put the company on the very best footing to be able to sell it. This will get you the best price.I think that a skillful seller and a disciplined sales approach can get up to 20% more for a company. Value is in the eye of the beholder and what something is worth is purely subjective. Resist the temptation to substitute your judgement for that of the buyer.Sounds dopey — spruce up your offices. Get rid of all the junky furniture. Get the people to dress just a bit spiffier. The guys who own options will understand this.Give yourself a chance to get lucky.First consider what the transaction documents are going to look like — the letter of intent, the purchase/sale agreement and the due diligence checklist. Review all of this stuff long before you ever decide to sell and then anticipate each and every problem long before it happens.Then fix them all.Put together a due diligence package which incorporates each and every element of the prospective purchaser’s due diligence, don’t wait until they ask for it. As an example, clean up the options schedule until it is perfect and you can simply hand it to the prospective purchaser.Assemble a list of every — every — every prospective financial or strategic buyer for the company. Do research on each and every one of them. Know them. Know who the deal makers are and research their methodology.Don’t kid yourself about trying to auction the company on the QT — not going to happen. A shrewd buyer is going to insist on a “no shop” provision in any LOI.Your rejoinder is a “no shop” provision exhibit excluding a long list of folks with whom you are “already in contact”.Give them the no shop provision just carve out the likely suspects and then make sure you have, in fact, contacted them.Appoint a single person to be the seller’s primary and sole point of contact. Create an electronic and physical due diligence room. Put all the due diligence materials in that room and do not allow the buyer to speak directly to any of your people until they are ready to turn to the HR elements of the deal. Log in each and every document exchanged and keep track of all of them.Have a weekly phone call initially and then a daily call when things go live. Insist on a single point of contact on the buyer’s side.Get the CEO’s together socially. America does business with its friends. Force the friendship.Figure out what the buyer has to buy with — cash, securities, notes, options, warrants, etc and anticipate that this is what the trade bait is going to look like.Get references on past deals and don’t ever believe you will get a better deal than ones already closed. Never, ever.Strike and move quickly when you think you have the right deal. It will get the deal closed and, if not, the embers may still be glowing on another opportunity.Be gracious, firm, disciplined and tight lipped. Never provide more info than the buyer requests. When you are at the closing table, never leave and never get up. Get it closed.

    1. markslater

      this is all great advice.We had a situation where the owner of the company “wanted” to buy us. We knew that there were some reservations within the management team – but he went ahead.My first day sitting down with their corp dev team who reported up to the CFO told me all i needed to know.The CFO did not want to buy us and his team were of the same opinion.This is a very difficult nuance to deal with.