Not all acquisitions are created equal
What’s more rewarding than selling your startup and pocketing a hefty check in the process? After all, some founders want to reach for the stars and turn their venture into a global empire, but many others would be content to settle for an acquisition instead (especially if that gives them the freedom to reach for the stars with their next venture).
In pursuing that goal, it’s important to realize that not all acquisitions are created equal. When the opportunity to sell your company comes along, you will be eager to move forward; but make sure to take a beat, think twice and assess the situation. To help do that, remember that there are at least four types of acquisitions.
The first category is the early one better known as an “acqui-hire”. You might not have grown your business much, but you have assembled a highly-skilled, cohesive team that is an opportunity for a bigger startup needing to accelerate but having difficulties in hiring quickly.
This is definitely not the worst kind of acquisition: at that stage, it’s likely you haven’t raised a lot, so most of the relatively small price will go to you. And if the acquirer has high growth potential, you might be lucky enough to be paid in shares and eventually make a lot of money.
The second category happens a bit later, after you’ve raised a seed round or even a Series A. Your company is growing slowly, but it’s not spectacular and your investors are growing impatient and would like you to sell to a bigger competitor.
This is not a good category to be in. Because you’re lacking traction and your investors are pressuring you, you won’t have a lot of leverage in the negotiation when it comes to either price or being paid in cash or equity. In the end, you’ll be able to tell a story about having sold your company, but the reality is grimmer: after your investors’ liquidation preference has been paid, there won’t be much cash left for you and your co-founders.
The third category is when your startup is acquired by a legacy corporation trying to tackle the challenge of getting more innovative. You may be able to agree on a price even without having positive cash flows, but the result still won’t be ideal.
In this case, the problem lies in what happens after the acquisition. You’ve probably been paid in cash, because what’s the point of receiving shares in an exhausted incumbent? And most of that cash will have to be earned by staying at the company for a few more years, all the while trying to achieve impossible milestones in an adverse corporate environment. You’ll eventually end up with the money but a/ that money will certainly not compound further (except if you invest it well on the side) and b/ you’ll be exhausted by the corporate toxicity, unsure if you want to found another startup and start the process all over again.
The fourth category, selling to a larger, faster-growing tech company on its path to becoming an empire, is the best acquisition you can aim for. The potential here was recently described to me by Pascal Levy-Garboua, a seasoned angel investor who invests primarily in the US:
One of my portfolio companies was purchased by DoorDash back when DoorDash was worth $1B. Today, DoorDash’s valuation as a public company is $50B. For me, as an angel investor, it has made a huge difference. Back when my portfolio company was acquired, I traded $1 worth of shares in the original company for $1 worth of shares in DoorDash. And now $1 has turned into much more—and the multiple on my investment is effectively 30x…
And so here’s the thing about exits: exiting is not only about cashing out. The most consequential exits are obviously when your startup goes public, like Spotify or Adyen did in Europe. But the second best is rarely when your startup is acquired by a legacy blue chip company—rather it’s all about the cases whereby a startup you invested in is acquired by a larger tech company which then goes on to become even larger (and you are paid in stock).
By the way, this is one of the biggest unfair advantages enjoyed by founders in the San Francisco Bay Area: they are so close, socially and geographically speaking, to potential acquirers with incredibly high growth potential that they can reasonably expect to become very rich by way of selling their company to a DoorDash, a Stripe, or a Square—companies that still have a very long runway and agree to pay in equity. By comparison, founders in lagging ecosystems have to make do with the acquisition opportunities that exist at their local level, which most likely don’t belong to this fourth category.
Don’t get me wrong: it’s always a good thing to have the opportunity to be acquired. Just keep in mind that not all acquisitions are created equal.
Join our next batch in September if you want advice and support when the time comes for your company to be acquired!
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