Once your startup picks up steady traction, you, your colleagues or your investors will begin thinking of next steps. Perhaps you want to keep the momentum going and continue growing organically, a process that may include further fundraising.
You may also consider an exit. After all, running an education startup tests patience and wallets. Your investors and shareholders may want to make their financial returns. You may also want to cash out. Or maybe you’re simply burnt out.
Getting acquired is one of the more common paths. And if you’ve decided to sell for whatever reason, here are some tips and what to expect, based on my experience. For both my startups, I couldn’t grow them beyond a certain point due to a burnout factor after a few years. I can start and get companies to a profitable turnkey state that run like a well-oiled machine—but that’s about it. My first company, Isavix, had several Fortune 500 customers and sold in 2003 to a private group named InScope International.
The second, a digital literacy platform called Big Universe, had school customers in more than 30 countries. It was acquired by K12 Inc. in 2017.
Preparing to Sell
Someone once advised me: Operate your company like you’ll own it forever but keep your records like you’ll sell tomorrow. That means keeping your accounting, legal, HR and other business documentation in good order. Of course, having a good lawyer and accountant from the get-go is essential.
As you shop your company and court buyers, at times it will feel like wrestling with having bipolar or multiple personality disorder, since you’ll need to run your company at the same time. Your personal and professional lives will blur even more. Try your best to maintain a reasonable work-life balance to keep your sanity, since it’ll be extremely stressful. Stay focused on daily operations, particularly sustainable growth, profitability margins, customer retention and employee satisfaction, so that you don’t adversely affect your acquisition potential.
There’s no other way to say it: the process can be an emotional rollercoaster. Be prepared for the fact that it may be months, even years before acquisition offers come. Worse, they may never materialize. Here are some things you should do before contacting prospective buyers:
- Financials: Your historical and projected financials will be one of the most important items, so get these in order (e.g. P&L, cash flow, balance sheet, budget, forecasts).
- Product: First impressions go a long way, so give your product a facelift if needed and take care of any technical debt.
- Advisors: You’ll want to have trusted financial and legal advisors to help you navigate the acquisition process and possibly offload some of the work so you can focus on running your company.
- Pitch: You’ll need a pitch deck (e.g., book or prospectus) to send out containing high level information on things like your solution, history, traction, financials, business model, market, competition and team. You might also want a shorter version (executive summary) of the full deck.
Through the acquisition process, be sure to closely monitor costs, as legal, accounting and other expenses can rack up quickly.
Finding a Buyer
While I agree with the premise companies are bought, not sold, you do have to let prospective buyers know who you are since they might not be aware that you exist. Personal networking goes a long way, but many of the same marketing activities involved in selling your product also apply to selling your company.
It helps to attend or exhibit at conferences, generate stories in the media and win industry awards. For Big Universe, half of our prospective buyers came through personal networking at conferences such as ASU GSV Summit, Bett Show, EdNET, SIIA, and SXSW EDU. Working with distribution and sales partners can also boost one’s visibility.
The rest of the interested buyers were introduced by our investment banker, and going through a broker is how I ultimately sold Big Universe. Firms that specialize in the education industry involve Arcady Bay Partners, Berkery Noyes, Cherry Tree, Oaklins DeSilva & Phillips and Tyton Partners.
Bankers and brokers, naturally, come with a price tag. They typically charge a retainer, which can range from $20,000 to $50,000 or more, paid upfront or in monthly installments. There is also a “success fee” which is payable upon closing, which is typically 2% to 5% of the deal price. Also, most bankers and brokers will have a minimum success fee ($250,000 to $1 million) payable irrespective of the sale price, and accordingly will not represent smaller deals below a $10 million transaction value. The company needs to have enough annual revenue, or have the growth potential to support that valuation.
Finding a buyer can take months to years, and you may have to kiss a lot of frogs before finding the right buyer. We started out with a list of a couple of dozen prospects. Once you find a potential buyer, make sure you develop a rapport with an executive there who can champion your deal to the rest of his colleagues. That support can make all the difference in the world.
Valuing Your Company
Determining the value of your company is more art than science and based on several factors, including: demand for your product, your business model (selling products and/or services), strategic fit for a buyer, and your team’s dynamics. It comes down to what a buyer is willing to pay based on its expected return on investment. Other factors that shape the offer price include how much the buyer wants your product (versus building their own), its desire to keep up with market competitors, whether it wants a new product to excite its sales team, and your enthusiasm for the potential.
Of course, if you can create a competitive situation with multiple bidders, that’ll help drive up the price too.
Valuation is typically determined as a multiple of your company’s revenues or EBITDA; the exact number can be all over the map. Some banking firms, including Berkery Noyes and Cherry Tree, publish periodic reports on the latest selling trends.
In general, the sale price range between 1X to 3X of revenue, but getting a reliable estimate can be like throwing darts in the dark. Multiples can be higher for exceptional cases where a company boasts rapid adoption growth or proprietary technology. Other factors impacting the valuation include whether your company is profitable or pre-revenue, and whether the multiple should be based on previous fiscal year’s revenue and EBITDA or the current year’s projections. (This became a problem for us on one deal since we weren’t hitting our target revenue.)
To maximize valuation, consider selling your company when your growth is on the upswing. Don’t be afraid to walk away from the deal if it doesn’t feel right, since the buyer might come around. Also, it’s better to discuss your valuation expectation early on since it can avoid a lot of dancing around the barn to see who blinks first.
Outlining Principal Terms
The formal acquisition process starts with a Non-Disclosure Agreement that involves sharing preliminary and proprietary information, including historical financials. Assuming there’s further interest, it’ll move to either a Term Sheet and/or a LOI (Letter of Intent). You might even hear terms such as an IOI (Indication of Interest) or EOI (Expression of Interest).
All of these are non-binding, but it’s important to read them carefully with the help of advisors, as these documents lay out fundamental terms that should be ironed out sooner rather than later. It can also save you legal fees. (Lawyers are invaluable, but I sometimes feel they get paid by the word.)
These terms include the purchase price, how it gets paid (stock or cash?), the exclusivity period, and how many employees remain. Agreeing on them terms sets up the framework for due diligence and the definitive closing phase that follows, so it’s crucial to get them as close to perfect upfront, as possible.
Lastly, push for a short closing period (30 to 60 days) to avoid the distraction of running your company or the deal falling through if you’re not hitting your sales targets. In the end, remember you know more about your company than your broker, lawyers and others, so take their advice seriously but trust your gut and don’t let them sidetrack a deal.
Surviving Due Diligence
Due diligence begins after a letter of intent is signed. Prepare for a tough grind! There’s just no other way to put it since everything will be scrutinized. Some of this will feel redundant, exhausting, uncomfortable, tense and even irrelevant but it’s important to respond quickly and transparently to the buyer’s requests. There were times I wanted to pull my hair out (just to realize I’m bald).
You can easily be asked for over a 100 different items, for things like every single NDA you’ve ever signed. The laundry list of due diligence items can include the following:
- Corporate: Capital structure, shareholders, corporate filing documents;
- Financial: Financials, forecasts, accounting policies, banking, debt, taxes ;
- Customers: Major customers, geographic footprint, retention rate, interviews;
- People: Key employee bios, full employee list, management, board, PTO, benefits, compensation policies;
- Sales: Compensation plan, conversion rates, pipeline, efficacy studies, international business, pricing and discounts, marketing, competition, new versus renewal revenue, resellers/partners;
- Technology: Demos, accounts, roadmap, IP, technical debt, documentation, 3rd party verification, scalability, risks;
- Legal: NDA, contracts, agreements, patents, trademarks, past and pending lawsuits;
- Other: Suppliers, strategic partners, third-party vendors.
The whole idea of due diligence is to produce definitive closing documents and items (e.g. purchase agreement, earn-out, escrow, employee hires). Also, watch for “gotchas” such as net working capital (the difference between your current assets and liabilities), which can be a potential deal breaker—something I personally experienced. From the buyer’s perspective, the purpose is to make sure there aren’t any skeletons in your closet.
Even after everything mentioned above, you’ll still be waiting on the buyer’s board approval, which can be nerve-wracking since you’ll be wondering why that’s necessary after an exhaustive due diligence process. But hang in there.
The sad part is the deal can still fall through far into due diligence; this happened to us once and I estimated tens of thousands of dollars in lost productivity since I wasn’t able to fully focus on the company during the process.
Hold off on customer and employee interviews as long as possible. Keeping this a secret from employees can feel wrong at times, but trust the fact that you’re selling your company for good reasons.
Closing the Deal
Finally, the day will arrive when you close the deal! This involves signing the final documents at the buyer’s or law firm’s office; the money is typically wired to your designated bank account(s), excluding payments to your broker, lawyer and accountant, which will likely be paid directly to them by the buyer (costs you should factor in early on). This is a well-deserved moment after a long and hard road but it marks the beginning of a new life for you and your employees.
Life with a new owner can be “interesting,” to say the least. It’s a whole new world, one in which you may not call the shots. Your employees will be in a different environment, some decisions will be seem illogical and things will move at a different speed.
Depending on your buyer, you might lose some or all your startup’s ethos over time. If you’re lucky, the new owner will let your organization operate somewhat autonomously; but typically, it will want the operations more fully integrated. This will be fine for some employees, but others will leave after a certain period.
Having sold two companies, I’ve learned some hard lessons. One common lesson across both companies was to focus on revenue and profitability early and often. As obvious as this sounds, many entrepreneurs like myself end up focusing way too much on the product and have to remind ourselves that some numbers matter more; using the Pareto Principle (80/20 rule), in my opinion, the product is only 20 percent of the overall battle.
Starting a company is tough and growing a company is even tougher, so look at the grueling acquisition process as the home stretch. For me, it was a tough race and I’m taking some much needed time off. While I have an idea for a third startup, for now, I’m planning on helping startups succeed by avoiding mistakes and having successful exits.