Monday, June 3, 2013

Lesson #145: Issues to Consider Before Selling to Big Companies

I was lucky enough to be involved with two startups that were both sold to $1BN revenue businesses:  iExplore was sold to TUI Travel, and MediaRecall was sold to Deluxe.  In both cases, the investors were excited to get an exit and return on their investment, and the founders were excited about joining up with a big company to help accelerate growth.  But, despite the best of intentions of parties on both sides of the transaction, integrating a startup into a big company can present numerous challenges which we will discuss in this lesson.

I think the key challenges revolve around: (i) having realistic expecations of what the big company can really do for you; (ii) handoffs between the people that negotiated the deal and the people integrating your startup into the big company; (iii) the slower speed of making business decisions; (iv) the bureaucracy and procedures of bigger companies; and (v) issues related to any earnout payments that may be paid down the road.  I will tackle each of these points below.

Startups can easily be "romanced" by the idea of getting tied up with a bigger company.  And, for logical reasons.  Big companies typically have bigger budgets to spend on product development and marketing, a bigger base of customer relationships to tap into and a well-known brand name to assist with trust and credibility of your sales efforts.  But, unless specific support is well-documented upfront in the merger or sale agreement, often times, big companies will not bring the dramatic upside the startups are expecting.  There are many reasons for this, mostly stemming from a big company's focus on other more important areas of their business.  So, "seller beware" and make sure you get everything you are hoping for well detailed in writing.

Related to this first point, is the drop-off of focus and support the further you get away from the people that actually negotiated the deal.  Typically the people that negotiated the deal, are not the same people that will implement the deal.  So, your future success is riding on people you have never met before, who may or may not be equally incentivized to see you succeed.  Big companies are full of busy people, typically set up in various fiefdoms internally.  The last thing they need is another project on their list, to help a startup they have never heard of before.  So, where you can, make sure the people who will be implementing your deal, are the same people involved in negotiating the deal, so nothing gets lost in translation in the handoff, as to the importance of the transaction to both parties.  The deal has to be material in scope and equally important to both parties to succeed.

And, for all you fast-paced, A-type personalities that like to make quick decisions and move at lightspeed, get ready to jump into a pool of molasses in comparison.  Big companies just naturally take longer times to make decisions.  They are typically consensus-building organizations that need buy-in from the various stakeholders involved in any project.  So, what used to be a five minute decision stand alone, could easily become a month long process.  So, make sure you are ready for this material shift in culture and personality.

Related to this is the higher level of bureaucracy and procedures that come from being part of a bigger company.  Think about all the budgeting processes that now need to be approved.  Think about all the monthly financial reporting in consistent formats and new systems.  Think about legal having to get involved to approve any new contracts.  Think about HR getting involved in any new hires.  As an example, my CFO at iExplore said he lost 25% of his former startup day, having to deal with all the corporate requirements each month.  So, get ready for these unexpected strains which may create additional needs for your business.

And, the last point relates to earnout payments negotiated in the deal.  Earnouts are any additional monies the selling shareholders may receive from the buyer, based on the future performance of your business post the sale.  These payments can be tied to future revenues, EBITDA or whatever other metrics that are mutually agreed upon.  The problem is, earnouts rarely get paid out.  And, when they do, they are materially lower than expected.  So, don't get romanced by the deal value assuming the earnout will be paid in full; make sure you are happy only with any upfront payments made, assuming no earnout is ever paid down the road.  If not, renegotiate the deal or walk away.  This is a complicated topic, which I more fully address in Lesson #146.

In addition, be sure to re-read Lesson #135 on why big companies struggle with innovation, for additional considerations here.  As merging startups with big companies, is often like trying to merge oil and water, culturally, at the root DNA level.  Just make sure you are clear on what you are really signing up for as an employee of a bigger business.

The most important thing is to make sure both parties are 100% in agreement on: (i) why the deal makes sense to both parties in the first place, and (ii) the execution plan, budget and timeline after closing, to make sure no disappointments by either party post transaction.  As an example, if the big company is simply taking a competitor out of their way, prepare to die on the vine.  Or, if the big company does not provide sales & marketing support for its other businesses, it most likely won't provide much support for your business.  Or, if they do bring support, it may come a year down the road, not the month after the deal, given their pace of doing business.

Please do not read this lesson from the perspective that you should never do a deal with a big company, or that deals with big companies never work.  That is not the intention, as these deals can often work perfectly to plan and expectation.  I just wanted to make sure you were aware of potential pitfalls to avoid.

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