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Bridging the Gap Between EV and Post-Money Valuation

The conventional wisdom is that startups are typically bought rather than actively sold. In other words, simply wanting to sell at some point won’t create a buyer magically.

However, this prevailing notion often leads to a problematic belief that if you create something cool and innovative, industry giants will come knocking with hefty acquisition offers.

From a marketing perspective, this idea is grounded in something other than reality. Those industry giants making headlines with eye-popping acquisitions are often unaware that your company exists.

Besides, if you’ve taken money from early-stage investors, you can’t afford to stay in the waiting mode for too long. At some point, you will feel like being in a family where, at every gathering, relatives relentlessly ask you when you are getting married. This increasing pressure can become uncomfortable, pushing you beyond your comfort zone.

As you venture out to gauge buyer interest, you’ll quickly discover that these industry titans are unlikely to offer a sum close to compensating for the years of hard work, dedication, and sacrifice you’ve invested in your company.

Why? Because they often overlook the single most valuable asset your company possesses: your intangible assets.

I’ve written before about the importance of positioning your startup as a company with operating characteristics driving a high level of growing, predictable, and durable cash flows.

Among these attributes, the ‘durability’ aspect is closely associated with intangible assets, which include famous concepts such as defensibility, competitive advantage, or ‘moats.’

While they may not appear on a traditional balance sheet, these intangible assets are, in reality, your company’s most valuable assets. As a Tech M&A advisor, my approach to all M&A processes is centered on bringing to light and marketing these invaluable intangibles.

However, it has become clear that my performance is closely tied to the level of awareness potential buyers already possess about a company’s intangible assets before the M&A journey begins.

To illustrate my point, allow me to take a physics analogy.

Picture this: As a child, you were captivated by rocketships, and that fascination remained with you as you grew. You ventured into the realm of physics and eventually became a rocketship engineer with a singular mission: designing engines for space travel. Your world revolves around deciphering the laws of physics and fighting against formidable forces like gravity, all while seeking the financial resources to realize your vision.

Now, consider this — startup founders embark on their journeys with a similar enthusiasm. They begin with a passion, a compelling idea, and a desire to make a lasting impact. To turn this ambition into reality, they seek funding from VC and embark on the VC path. Their goal? To overcome the gravitational pull of the market and propel their startup into orbit.

After a couple of years of working on your engine since your first round of funding, you may end up with a Helicopter ($1–3m in revenues), a Plane ✈️ ($10m+ in revenues) or a Rocket 🚀 ($100m+ in revenues).

If you possess a Helicopter 🚁 or a Plane ✈️, you will be out of the VC path. Despite your burning desire to build a Rocket 🚀, fundraising is now out of reach.

So, what do you do?

There are a few options on the table:

  • You could look for a partner just as excited as you are about the rocketship project and team up to make it happen.

  • You could join an existing rocket team where your engine expertise would boost their performance.

  • You could pass on your Helicopter 🚁 or your Plane ✈️ to someone who can put it to good use.

But here’s the kicker: Your equity is buried under liquidation preferences. It means that according to the usual way companies are valued, there’s a real chance you could walk away with nothing despite years of hard work and sacrifice.

I’ve written before about the difference between post-money valuation (implied valuation) and enterprise value.

If you have raised $10m at a $50m valuation, I won’t be surprised if you believe your company is worth $60m. However, the $60m is an implied valuation. Selling 20% of your shares for $50m only means that 20% of the company is worth 50m. We don’t know the value of 100% of your shares, the enterprise value, post-Series A. Raising $10m at a $50m valuation means that you will use the $10m to try building a company with an enterprise value of $60m in various market scenarios.

The $10m investors put on the table always come with liquidation preference clauses. In typical scenarios, if the company is sold for less than $60 million, these investors will be paid out first until they recover their initial investment, leaving you with what remains.

To overcome this challenge, you decide to hire an M&A advisor.

During early chats, you provide in-depth insights about what makes your company unique and list potential buyers you believe would be interested. If you’re having this conversation with me, I’ll likely ask you something like this:

Do these target companies even know your company, and more importantly, do they have a clue of what makes your company special?

I experience a moment of silence to that question more often than I can count.

The reality is that M&A is an infrequent and time-consuming event for most companies where the scrutiny is immense.

Put yourself in a buyer’s shoes — would you prefer to invest tens of millions in a company or solution you’ve never heard of or in one you’re already familiar with, where you’ve established a working relationship over months?

While these business partnerships are tickets to the M&A game, they often remain a blind spot for founders until it’s too late. Without these tickets, brace yourself with a long M&A process leading to a sub-optimal valuation.

The velocity of an M&A process depends on the number of addressable Active Buyers for a given company.

Active Buyers are characterized by their readiness to engage in acquisition opportunities. When a promising target emerges on their radar, they are quick to initiate discussions, conduct assessments, and proceed with the acquisition if all factors align.

Depending on their activity level, buyers come in various categories, each having a specific dynamic. I typically categorize them into two main groups: the Financial Buyers and the Strategic Buyers.

While Financial Buyers constitute a relatively uniform category, Strategic Buyers come in various sub-categories.

Among all buyers, Financial Buyers are the most active. Their primary mission is to acquire businesses, actively seeking investment opportunities and swiftly taking action when encountering a promising target. A substantial number of such buyers characterize this category.

Within Strategic Buyers, you’ll find a range of approaches to M&A activity.

Firstly, there are the Serial Strategic Buyers with dedicated internal M&A teams. These entities recognize M&A as a potent growth catalyst and, much like Financial Buyers, are constantly looking for promising investment opportunities. However, their numbers are limited.

Next, we have the M&A-friendly Strategic Buyers. These buyers don’t have an internal M&A team but have recently undertaken acquisitions or raised funds expressly for M&A pursuits. While not actively seeking opportunities, they are receptive and open to engagement when presented with an M&A prospect. Their presence in the market is relatively modest.

Then, we have the M&A-opportunist Strategic Buyers. These buyers have little or no history of acquisition and tend to view M&A as more opportunistic rather than a well-defined and proactive strategy. Typically, they have minority financial shareholders. Engaging with this category can be challenging due to their cautious approach, though they are relatively numerous.

Lastly, we have the M&A-resistant Strategic Buyers. These buyers have never ventured into acquisitions.

Engaging with them is challenging as they tend to be risk-averse toward M&A or have ample opportunities for organic growth. However, they make up the largest group of buyers.

So, whenever I evaluate a company’s M&A potential, I aim to understand the different types of buyers involved. If I’m facing:

  • a VC-backed Plane ✈️ with a track record of limited or no profitability.

  • a VC-backed Helicopter 🚁

I know that Financial Buyers, who make up the largest group of highly active buyers, will be out of reach.

For these companies, M&A is a painful process as we end up with a segment of the M&A market where buyers are slow to respond and hard to push forward.

Even when we successfully bring a Strategic Buyer down the pipeline, they tend to leverage the profitability track record or the modest scale to make a lowball valuation offer, often far from the post-money valuation.

Remember, the founders of these VC-backed companies are likely to end up with nothing because of the liquidation preference tied to the post-money valuation.

Unless we’ve got several Strategic Buyers competing against each other, we won’t have much leverage to close the gap between that first offer and the post-money valuation. And let me tell you, trying to get several strategic buyers to move smoothly through a 3 to 6-month pipeline, from top to bottom, is no walk in the park.

However, things get easier when a company is already on the radar of potential buyers. When buyers have prior knowledge about a company, it often indicates a certain level of interest or curiosity in what that company brings.

That’s why all the marketing actions undertaken before you are ready to sell to raise buyer awareness about your company can yield extraordinary outcomes. Overlooking this aspect has proven to be costly, especially for VC-backed companies.

I refer to these marketing actions as Corporate Development, and if you’re bear with me, I’ll walk you through these actions and the advantages they bring.

Corporate Development: Turning unaware buyers into warm M&A prospects

Corporate Development extends beyond PR-related activities like featuring articles in industry-specific magazines, being a sponsor/speaker in industry-specific events, or turning key opinion leaders into ambassadors for your company.

These PR efforts are great at putting your company on the map and converting unaware buyers into cold M&A prospects. However, PR often falls short when it comes to raising awareness about your intangible assets.

I’ve found that kicking off an M&A process with completely cold prospects doesn’t work well for VC-backed Plane ✈️ and Helicopter 🚁. What has shown more results is starting with warm M&A prospects.

This is precisely the aim of Corporate Development — turning unaware or cold prospects into lukewarm ones.

Corporate Development includes:

  • Implementing commercial alliances with your potential buyers.

  • Applying to a Request for Proposal against your potential buyers.

  • Applying to a Request for Proposal with your potential buyers.

  • Establishing a tech integration with your potential buyer’s technological stack.

  • Involving your potential buyers when you seek funding.

  • Implementing a client/supplier integration dedicated workflow with your potential buyers.

I know these moves seem to take time, and you’re right. It does require an incompressible 12 to 18-month prep phase, which can sound like an eternity.

However, it’s an investment that truly pays off. It lets you forge strong working relationships, which not only boost awareness of your intangible assets but also turn those intangibles into concrete ROI for your potential buyers.

That’s the secret sauce that turns M&A prospects from being completely unaware into warm and ready to engage.

Launching an M&A process with multiple warm prospects sets the stage for a successful and dynamic bidding war. This bidding war is critical to bridging the gap between EV and post-money valuation.

It’s crucial to get acquainted with buyers long before you even consider selling and to cultivate working relationships over time.

After all, startups may be bought in a moment, but they are sold over time.

See you!

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