Founders build value and then want to realize upon that value. But the typical road to success in the startup world is far from easy. Therefore, founders are vulnerable to manipulation and one of their softest spots is precisely the time when they think BigCo wants to acquire them.
I can't tell you how many times in these cases founders have caved to lowball offers with horrid terms once they have gone multiple cycles with the prospective acquiring company. How does this happen? They ask for what they think they deserve and they get an offer far below that. Having concentrated their efforts on a possible exit, they sound out other channels and find there is no immediate interest. They are then high-pressured by the prospective acquirer to do the deal on a short fuse or the offer will go away. They then begin to contemplate the risks of continuing down the path of uncertainty and begin to contrast this with how nice it will be to continue the effort under the rubric of BigCo, where they will draw a steady salary and no longer have to deal with entrepreneurial risks.
By this time, they are hooked. Then the details come in. It turns out that, low as that $10M (or whatever amount) was, they as founders will have to earn all or a significant part of it all over again by having to vest their interest over xx years once they begin working with BigCo. Do they have protection from termination and the possible forfeiture of their interest? Well, no, not really - company policy forbids this. So, if they want the deal, they will just have to take their chances and, if BigCo terminates them early, that is just the risk they take.
What about elimination of risks? Well, here they must represent and warrant that certain things are true as of the date of closing on the acquisition. For example, they must warrant that their IP doesn't infringe. OK, fine. But what does this mean? In a typical blanket warranty, it means that, if you sell your company and you know you haven't done anything whatever to steal code or otherwise compromise its integrity, you still bear all the risk of financial liability if someone later comes along and asserts, say, a patent infringement claim against your IP. With a multitude of trolls infesting the world these days, this is of course possible. What does BigCo say about this? It puts on its official corporate suit and weightily intones that it expects founders to stand behind their IP and will not allow them to hedge responsibility for it. Therefore, it doesn't matter that you didn't know about the potential infringement claim - if it hits, you pay the price for any liabilities and for any attorneys' fees in defending against it. Is there a cap on this? Well, maybe, but at a high level (e.g., 50% of proceeds received on the deal). As a founder, you wind up agreeing to this once you are committed to the deal because, after all, it is not likely to happen. But as to uncertainty and risk? Well, that still belongs to you on some pretty important issues.
And this is just one issue.
The point is this: once you as a founder start to rationalize, there is no bottom. You have rationalized that you can live with the low price. You have accepted the liability risk. You have accepted the renewed vesting terms without protections. Maybe you also agree to an outsized holdback on the purchase price. And who knows what else. The point is, by this time you are fried. You have no will to fight back. You have no leverage. You are stuck with the wishful thought that it will nonetheless be great to be working for BigCo and to have a chance to continue to realize your dream, even if it does involve some serious compromises.
I have witnessed this sort of thing for years and it always comes about when founders deal with professional acquisition teams from a perspective of relative weakness. They suck you in and then you need to fight like hell to get back into a mindset where you can tell them to take a hike. Most founders in this position just can't do it. That is certainly my experience.
This essay by PG captures the perils of this process in a way that is spot on and extremely valuable as a warning to founders who might succumb to temptation. Be warned. It is exactly as PG says. A truly important essay for all founders.
Just went through exactly this and managed somehow to muster the courage (or insanity, time will tell) of walking away. The last straw for me was when we flew to their offices to nail down the final deal and the price was still decreasing, decreasing. They couldn't help themselves from trying to squeeze every last dollar out of the deal, and putting more and more of the upside behind earn-outs and future growth. By the time it was 'here's our actual final offer' it was barely a P/E of 5 on current year earnings when YoY we were growing a triple digit percentage.
Sometimes the lack of liquidity can get to you. Funneling every last cent of profit back into growth is a crucible. The offer of taking a rest at 20 miles is the perfect analogy. The level of distraction in trying to close the deal is immense. And how, after so much pain, can you really make an objective decision to walk away at the 11th hour?
This all ties right back into the liquidity discussion a few weeks back. I have no interest in taking payroll and seeing less than half after taxes. So finding a fund interesting in purchasing a fractional interest of Common Shares (no preferences) at FMV (versus investment value the VCs pay) is a really great bridge past the CorpDev route.
> it was barely a P/E of 5 on current year earnings when YoY we were growing a triple digit percentage.
I'm kinda curious: Did you point that out as clearly as the line above? along with something to the effect of "If you think this number is close to the value we'd take, then we're wasting each other's time"?
Well, I think what we said was, "The price is just not compelling, perhaps the time just isn't right. We want to keep growing this and lets talk again in a couple years." But hopefully the meaning was not lost in translation.
Perhaps part of the problem is that it was the wrong partner who didn't value the technology nearly enough, and was too focused on discounted cash flows with an absurd discount rate, and too conservative a growth allowance. They passed that off as "their model" which couldn't be touched. Add in the fact they weren't even paying up-front but where much of the value was earn-outs with lofty targets, including a minimum 20% net operating profit... somehow they didn't see we could earn just as much, if not more, by keeping all the equity and just keep working for ourselves. It would have been this weird "half-exit" where all the upside was still in front of us. No thanks!
> somehow they didn't see we could earn just as much, if not more, by keeping all the equity and just keep working for ourselves
Yes, that was exactly the message that I was hoping you delivered with a sledgehammer, because I would have guessed that their reaction would be telling.
Anyway, kudos to you and your team for making (imho) the right call.
I can't tell you how many times in these cases founders have caved to lowball offers with horrid terms once they have gone multiple cycles with the prospective acquiring company. How does this happen? They ask for what they think they deserve and they get an offer far below that. Having concentrated their efforts on a possible exit, they sound out other channels and find there is no immediate interest. They are then high-pressured by the prospective acquirer to do the deal on a short fuse or the offer will go away. They then begin to contemplate the risks of continuing down the path of uncertainty and begin to contrast this with how nice it will be to continue the effort under the rubric of BigCo, where they will draw a steady salary and no longer have to deal with entrepreneurial risks.
By this time, they are hooked. Then the details come in. It turns out that, low as that $10M (or whatever amount) was, they as founders will have to earn all or a significant part of it all over again by having to vest their interest over xx years once they begin working with BigCo. Do they have protection from termination and the possible forfeiture of their interest? Well, no, not really - company policy forbids this. So, if they want the deal, they will just have to take their chances and, if BigCo terminates them early, that is just the risk they take.
What about elimination of risks? Well, here they must represent and warrant that certain things are true as of the date of closing on the acquisition. For example, they must warrant that their IP doesn't infringe. OK, fine. But what does this mean? In a typical blanket warranty, it means that, if you sell your company and you know you haven't done anything whatever to steal code or otherwise compromise its integrity, you still bear all the risk of financial liability if someone later comes along and asserts, say, a patent infringement claim against your IP. With a multitude of trolls infesting the world these days, this is of course possible. What does BigCo say about this? It puts on its official corporate suit and weightily intones that it expects founders to stand behind their IP and will not allow them to hedge responsibility for it. Therefore, it doesn't matter that you didn't know about the potential infringement claim - if it hits, you pay the price for any liabilities and for any attorneys' fees in defending against it. Is there a cap on this? Well, maybe, but at a high level (e.g., 50% of proceeds received on the deal). As a founder, you wind up agreeing to this once you are committed to the deal because, after all, it is not likely to happen. But as to uncertainty and risk? Well, that still belongs to you on some pretty important issues.
And this is just one issue.
The point is this: once you as a founder start to rationalize, there is no bottom. You have rationalized that you can live with the low price. You have accepted the liability risk. You have accepted the renewed vesting terms without protections. Maybe you also agree to an outsized holdback on the purchase price. And who knows what else. The point is, by this time you are fried. You have no will to fight back. You have no leverage. You are stuck with the wishful thought that it will nonetheless be great to be working for BigCo and to have a chance to continue to realize your dream, even if it does involve some serious compromises.
I have witnessed this sort of thing for years and it always comes about when founders deal with professional acquisition teams from a perspective of relative weakness. They suck you in and then you need to fight like hell to get back into a mindset where you can tell them to take a hike. Most founders in this position just can't do it. That is certainly my experience.
This essay by PG captures the perils of this process in a way that is spot on and extremely valuable as a warning to founders who might succumb to temptation. Be warned. It is exactly as PG says. A truly important essay for all founders.