VB: Any examples to highlight how the private equity route is beneficial to startups?
JM: Look at SurveyMonkey. The brothers sat in a warehouse in Portland, Ore. with an 11-person startup that brought in about $30 million in revenues a year. They wanted to get to the next level and brought us in. We recommended they do a recap of the company, and sell a significant portion of their equity. Spectrum Equity in Menlo Park [and Bain Capital Ventures] took almost two thirds of their equity. The founders were able to keep a third of the company. Since then, they have hired 200 employees. The company is on a strong run rate, and there will be an exit in the next 18 months or so.
“At the end of the day, we worry about going into a large company and being swallowed up into the mother ship.”
—Leonard Chung, cofounder and CEO,
VB: If the founders can make millions through exit, is there a risk they’ll walk away?
JM: Not really. We recommend providing the entrepreneur with liquidity so they will take more risks with the business. Tech investors want to swing for the fences. But if the company is bootstrapped and closely held, the team is less apt to take risks. In the past, none of the money went to the founders. Investors were worried they’d sit on the beach in Bermuda. That’s changed in the past several years. Founders work really hard and will do what’s right for the business, especially if they still own a significant part.
VB: What about these purported M&A horror stories?
JM: Sometimes cross-border deals are problematic. I had one open-source company that wanted to sell to this Irish software company. A the end of the deal, we were negotiating a purchase agreement, and they wanted our guys to take personal responsibility. We don’t do that. The founders weren’t going to put their houses and personal assets on the line!I’ve also seen deals blow apart when lawyers can’t get on the same page. A major buyer like Cisco or EMC might have a big, expensive attorney, and the startup has their guy on the street. But I don’t see hostile takeovers very often, as the people are too important.
VB: What’s to stop a potential acquirer from stringing along a smaller startup?
JM: It’s funny — these guys are so busy they don’t have time for that. Everyone is looking at 25 or 50 deals.
VB: Do you ever see founders get sellers’ remorse?
JM: All the time. I think people overestimate the uniqueness of their technology, and their product set. If they say they have a two-year lead on SAP, it’s usually about a six-month lead. Founders need to realize what they have and what they don’t have. It gets worse when they’ll get a higher bid than expected and will have ten parties saying they’re great. That said, if you have unique IP and a domain expert on staff and you’re in a sought after space, you can get multiples that go way beyond the comps.
VB: If a deal falls apart, are there any silver linings?
JM: Yes. Sometimes we can convert these meetings into corporate development conversations. For instance, if Dell isn’t interested in an acquisition, maybe they would want to resell your product.
VB: Startups grow so quickly; is it tricky for founders to be transparent about financials?
JM: Sometimes we have to go back and restate the financials. We spend a lot of time with accountants. Depending on the state of the books, it can take months, not weeks.
LC: I think it’s a misnomer to believe that finances are really that loosey-goosey. The moment you take institutional money, there are certain standards you have to uphold.
VB: When it comes to M&A,is there an emotional toll for a founder?
LC: That’s the understatement of the year. Being in a startup is an emotional rollercoaster, which only gets worse when you are in M&A mode. Most veteran entrepreneurs will tell you that within any M&A transaction, there is always the point where you think a deal is completely done, but it falls apart and everyone walks away. Somebody isn’t willing to compromise on the last few things. As a founder, you think, “Wow, I’m going from ramen to nice cheese and back to ramen again.”
VB: If you’re considering an acquisition, who should you talk to?
JM: I can’t stress this enough. This should all be compartmentalized between people on a need-to-know basis. You don’t want to have it broadly known that your startup is for sale, particularly to your employees in front-line jobs. We’d bring in the CEO and CFO — maybe one or two others — and we do the meetings off-site.
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