But since this is part of a series of blogs about selling your #startup, I'll focus on specific issues I have faced in sales of my startups. If you want the whole story (though fictionalized quite a bit), check out my first novel, The Silicon Lathe. Everything in there is true and did happen but I've changed names, places, companies, and even some people.
Startup #1 - I loved my first startup. My team and I developed technology that was going to change the world. DARPA had deployed it world-wide, NTT had licensed it from us and was rolling it out in their backbone networks, we were one of the hottest companies in the Valley. We had religion. We truly believed.
When the world's biggest network product company came after us competitively, undermining us in their customers, it became clear we'd have to sell to a larger player who could compete with them. A bidding war resulted between two potential acquirers - the fastest growing software company in the world at the time, and a much bigger player. The first offered us integration of our product into theirs which would immediately go out into millions of user's systems. The second had a detailed 5-year business plan for our products and people. They were focused on large enterprise deployments. The first company offered an all-stock deal. The second offered an all-cash deal. Because of circumstances I won't go into here, our VCs made the decision and they went with the first company. So what went wrong with this deal?
1) The VCs laid out the deal including the effect of the liquidation preferences in our funding agreement. I had failed to understand this 'double dip' where the VCs got their monies out, then shared in the split of the rest according to their ownership, applied to a sale of the company. I thought it was just for closing up the company - not for a very profitable exit through acquistion.
2) It was an all-stock deal. I would be restricted from trading for 6 months. Some friends suggested I purchase 'protective PUTS' in case the stock went south, but I didn't do that. Worse, I trusted a close friend stock broker/investment advisor who advised me not to sell the stock on the way down - this was a solid public company with a perfect track record. Unfortunately, after almost tripling when the deal was announced, once the CEO decided to kill off our technology (after an interesting meeting with that threatening competitor), the stock plummeted to 1/200th of its value before I could trade. I did make some money on the 'dead cat bounce' but it was a tiny fraction of what was expected.
3) Did I mention that they killed off our technology? Even with multi-million dollar orders in hand, the CEO decided to kill it. Not only did it cause their stock to fall, our technology was put on the shelf. I offered to buy the company back, but no dice. Our change-the-world technology would never again see the light of day.
Startup #2 - Once our iron-clad employment agreements were up, we decided to do another startup. We decided to be mercenary about it. We were going to build a new company and sell it in three years. It would be about positioning for exit, not about changing the world. We build a core networking component that quickly became a critical part of VPNs, network optimization software, network inspection software, antivirus software and more. One of our customers was a Telco. When their largest competitor approached us, we leaked that and immediately got an offer. Again, it was an all-stock deal, but this was a large Telco. And, thinking we'd learned from past mistakes, the purchase agreement promised that we could sell 1/3 of the shares immediately - as soon as the company could register the shares. Sounded perfect. So what went wrong this time?
1) Shortly after the sale closed the SEC discovered irregularities in certain executive stock options. They froze the issuance of new stock. We were not allowed to trade because they couldn't register the shares. The investigation was long. During that period, the Telco industry crashed. The stock plummeted from nearly $180/share to 20 cents a share. I still hold the stock today as a reminder.
2) With Startup #1, the VCs hired a well-known firm to negotiate the purchase agreement. For Startup #2, we went cheap and hired a local attorney who had limited experience in acquisitions. The possibility that the stock might not be registered was not covered in the contract. Later, we ran into numerous other problems with employment agreements, escrow accounts, milestones, compensation, bonuses - all things that a more experienced attorney would have handled properly.
Startup #3 - The shareholders of the Telco filed suits which were eventually settled a few years later. We took advantage of this by convincing the Telco to give us the company back along with technology ownership (they got licenses). We weren't completely mercenary, but we did keep our eye on a future acquisition as we built some very cool products. Distributors signed up and we started growing fast. Several companies approached us but we were unable to negotiate the price we wanted. It was 2008 and things were about to crash. Fortunately, a relatively larger networking player decided that they wanted to integrate our technology into their products. A price was agreed, the term sheet signed, they promised a close in 30 to 45 days and it all looked great. But...
1) The company asked us not to take on major new customers or distributors as our products needed to be customized for each OEM sale. They didn't want our engineers tied up once the deal closed. Made sense, but then they had a reorg and our purchase was put on hold. Back on track two months later, they had another reorg. This time, they changed the people we were going to work for. At the end of 6 months, the deal closed, but we almost died in the meantime. We had suspended our new deals because of the pending sale. If it had dragged out a month or two longer, they would have picked us up out of bankruptcy for pennies.
2) Once in the company, we had milestones to meet to get payments. This turned into a battle as the milestones involved integrating our products into theirs. This should have been straight forward, but we had failed to determine in advance that the target products were fragile. This cost us time, money, and created tremendous pressure on the entire team to do the near-impossible in record time.
3) This isn't a negative, but is worth mentioning. We finally learned about all-stock deals so for this one, we did 80% cash. Of course the stock price tripled. Still, we can't complain with the financial side other than the issues in (2) with the milestones.
So bottom line, what have I learned?
Before the Deal:
0) Be careful negotiating the terms with your investors. Try to avoid a double dip in the case of a positive acquisition.
In negotiating the Deal:
1) No all-stock deals!
2) If you want your technology to survive, get it in writing.
3) Get the best lawyer possible.
4) Make sure you have a break up fee in the term sheet.
5) Do your own due diligence diligently - don't assume everything is okay with the larger player. Due diligence goes both ways!
Fortunately, I have used these lessons to help several friends sell their companies. Almost all have worked out very well. But be careful and don't assume that just because your acquirer is big and seems to know what they're doing, that you'll be taken care of. You shepherded your company and your team to the point that someone wants to buy you. Don't let up on watching out for possible trouble just because there's a lot of money on the table.
As we used to tell novice pilots in hang gliding, when you're landing, fly it all the way to the ground!