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The exit dave litwiller - jan 31 2012
- 1. Leading the Exit DaveLitwiller Executive-in-Residence, Communitech Jan. 31, 2012
- 2. Overview • Exit Vehicles •When to Sell • How to Get Started • Investigations and Activities to Maximize Value • Establishing the Valuation Target • Selling Methods • Process Structure • Typical Timeline • Post-Sale Considerations • Earn-outs • Partial sales • Q&A Copyright, David J. Litwiller 2012 2
- 3. My Background • Twentyyear trajectory of R&D, marketing, finance and general management roles in early-, growth-stage and scaled-up tech companies in Waterloo region • Governance • Spent a number of years heading M&A, divestiture, turnaround, and corporate venture finance activities in semiconductor and enterprise software businesses, as well as work in instrumentation, automation, med/biotech, and components Copyright, David J. Litwiller 2012 3
- 4. A Few Facts •Early- and growth-stage tech companies are acquired at a rate of ~1% per month • 85% of funded technology start-ups achieve liquidity through acquisition or LBO, rather than IPO. In certain sectors the proportion can be much higher, such as clean tech, where the exit vehicle is an acquisition as much as 98% of the time • A substantive IPO (tier 1 exchange, liquidity, analyst coverage) now requires: – Revenue moving fast toward $100M – $250M market capitalization – $75M on the cover (float) => IPOs today are usually out of reach as a means of liquidity for founders, investors and early shareholders Copyright, David J. Litwiller 2012 4
- 5. Signals that it’sa Good Time to Sell One or more of: • Business is strong, growth is rapid, and there’s a compelling case that things look like they will just keep getting better • Motivated buyers are active in the market. Especially so if a land grab mentality takes hold by larger companies to stake a claim in a technology or market space where there are diminishing number of good properties available, and yours is one of an increasingly scarce few • An offer comes in from a credible buyer in the top quartile of benchmark valuation ratios • The industry is consolidating and maturing; technology prominence or go- to-market innovation as the primary basis of competition is giving way to scale or scope efficiency, channel access, critical supply control, and geographic reach Copyright, David J. Litwiller 2012 5
- 6. More Signals • FirstOrder: Others are better positioned to achieve or maintain the #1 and #2 market share positions in the industry which is consolidating • Second Order: Lanchester dynamics suggest competitive advantage favours others in the competitive ecosystem • Founders or funders need liquidity, or, are running out of ideas, agreement, or execution capacity to keep the business moving forward as quickly as the environment demands Copyright, David J. Litwiller 2012 6
- 7. Getting Started • Performa SWOT analysis on your business – Be candid with yourself • Do a SWOT analysis of the larger players in your competitive ecosystem • Then, map your S&O onto their W&T Copyright, David J. Litwiller 2012 7
- 8. Identify Strategic Buyersand Rationale Qualitative • Understand why they need you • Build a marketing story about how they can maximize your company’s opportunities • Explain why you shore up their shortcomings • Rationalize why they can overlook your weaknesses Quantitative • Five plausible buyers is a bare minimum to start the selling process • Forty is preferred practice, and strongly so. More on this later Copyright, David J. Litwiller 2012 8
- 9. Vendor Structural Considerations •Strategic Planning • Financial Planning • Audit and Tax • Legal Copyright, David J. Litwiller 2012 9
- 10. Sell-Side Due Diligence •Run your company through the same due diligence filter that a prospective buyer would – the long-form checklist • Unearth any significant shortcomings to be able to proactively remedy them, or position the sale in such a way to diminish the impact of those weaknesses • Pay particular attention to: – IP provenance, integrity and documentation – Continuity plans for key team members – Continued access to funding and tax incentives – Corporate governance – Major contracts – Resolving disputes Copyright, David J. Litwiller 2012 10
- 11. Common IP SoftSpots • Founders didn’t make a clean break with their former employers (took more than memories) • Inability to show clean ownership and chain of title for the IP • Lost patent rights due to filing delays or disclosures • Overly broad technology licenses granted to early customers – Exclusive – “No better deal” clauses – Change of control provisions Copyright, David J. Litwiller 2012 11
- 12. Valuation • DCF isusually the gold standard for valuation of mature businesses – Can be tuned to the exact conditions of each – But, the subjectivity and wide variance of required assumptions in early- and growth-stage technology companies weakens its utility • Benchmark valuations and transactions tend to have more significant weight, both for objective value cues as well as the social proof they offer Copyright, David J. Litwiller 2012 12
- 13. Tempering Risk andGrowth Factors • Risk – Relative size – Breadth of customer base – Diversity of product offering – Diversity of geographic footprint – Dependence on a few key people – Leverage – Extent to which the IP is foundational and protected • Growth – Industry outlook – Reinvestment requirements – New products in the pipeline Copyright, David J. Litwiller 2012 13
- 14. Comparables Analysis Company Multiple AB C D Mean Median EV/EBIT 10 52 15 20 24.3 17.5 EV/EBITDA 6 22 8 10 11.5 9.0 EV/Revenue 4 3 5 4 4.0 4.0 Price/Book 3 14 3 4 6.0 3.5 Price/Earnings 17 90 49 33 47.3 41.0 EV/Employee 1 2.3 0.9 4.2 $ 2.1 $ 1.7 EV/Patent 2 4 1 3 $ 2.5 $ 2.5 • Build a statistically significant database of benchmark company valuations • Use M&A transactions, public companies, and private financings data • Be careful about publicity bias of the highest value and highest multiple deals • Generally, a database of about twenty comparables best counters selection bias • Builds basis for objectivity and defensibility in the exit decision, as well as negotiations Copyright, David J. Litwiller 2012 14
- 15. Realistic Expectations Copyright, DavidJ. Litwiller 2012 15
- 16. Keeping it Real– Part II More detail about high value, high IRR deals, based on a five year exit horizon from start: • 50* to 100* growth in value 1.1% of the time • >100* growth in value 0.4% of the time => Headline grabbing valuations and multiples occur in <2% of exits Copyright, David J. Litwiller 2012 16
- 17. Keeping it Real– Part III • Financial buyer will typically pay 3* to 6* EBITDA • Strategic buyer will typically pay 6* to 12* EBITDA • To get substantially higher multiples: – Physical IP-based or Enterprise Software: >100% annual growth – Consumer Web and Mobile: >200% annual growth – The business is exceeding all of its internal and most peer key metric targets – No C-suite churn – Crystal clear accounting • Body shop services businesses will generally only command 3* to 4.5* EBITDA – Scale-able only as fast as people can be hired and trained – Most of the IP walks out the door at night – Key customer and delivery relationships tend to be strongly associated with owners • Valuation bottom line: Establish your price target, including a go/no go number Copyright, David J. Litwiller 2012 17
- 18. Three Sale Methods •Bilateral • Limited Number of Participants • Competitive Auction • The choice is a trade-off among: – Time required from management – Erosion of confidentiality – Competition for the deal – Fiduciary duty risk Copyright, David J. Litwiller 2012 18
- 19. Timeline Duration (Weeks) Preparation Fourto Six Develop Financial Projections Conduct Internal and External Diligence Map Path for Management and Key Employees Identify and Engage the Sale Team Start Three Prepare Collateral Documents and Data Room Contact Prospective Suitors through Appropriate Channels Execute NDAs with Interested Parties Appraisal Three to Four Suitor Review of Offering Memorandum and Data Room Suitor Investigation of Target's Competitive Environment Suitor Transaction Benchmarking Management Meetings Active Pursuit Two to Three Receipt of Initial Bids Initial Bid Selection Term Sheet Negotiation Best Offer Selection Final Due Diligence Six to Eight Complete Investigations Negotiate Definitive Purchase Agreement Establish Transaction Schedule TOTAL Time to Reach a Signed Agreement Sixteen to Twenty-Four Weeks Closing Any time After Executing Definitive Purchase Agreement Sometimes Synchronized to Achievement of Major Milestone or the End of a Fiscal Reporting Period to ↓ Accounting Overhead Copyright, David J. Litwiller 2012 19
- 20. Suitor Funnel • Activity-basedmetrics during early stages provide leading indicators • Crucial importance of at least two high quality bids • In case negotiations with one bog down, to have a hot standby • To keep up competitive tension to drive favourable valuation and terms Activity Number of Remaining Players Stage to Stage Reduction Ratio Criteria Candidate Suitors Forty Plausible Means and Strategic Interest, Contacted to Solicit Interest 50% Active Appraisals Twenty Sign back NDAs and Spend Time in Data Room 75% Active Pursuits Five Indicative Bids Submitted 60% Suitable Bids Two Reasonable Offers to Select One for Exclusive Negotiation 50% Executed Purchase One Deal Done Copyright, David J. Litwiller 2012 20
- 21. During the Sale •Nothing is done until everything is done. Continue to vigorously execute at an operating level • No financial or strategic misses – Revenue – Margin – Major account wins – Loss of key customers Copyright, David J. Litwiller 2012 21
- 22. A Few IntegrationConsiderations • Tuck-in or stand-alone – Extent to which the soul of a start-up needs to be preserved – Credentials of management – Whether there’s a clear path to self-sufficiency, profitability, and self- perpetuation • R&D team apprehensions – Provide clear objectives about revised goals in the new setting – Be up front with people • Catalytic technology overlap between target and acquirer – Generally occurs when inbound overlap is in the range of 15% to 40% – This provides enough similarity to have common language and issues to collaborate post-transaction – Different enough to retain individual identity without devolving to NIH conflict Copyright, David J. Litwiller 2012 22
- 23. Earn-Outs • Contingent paymentsbased on future performance of the business • As a broad average, only 15% of maximum formula value is obtained by the seller, so use them cautiously and have moderate expectations when you do • Advisors working on a contingency fee tend to dislike them. They’d rather price the risk in to a single $ value up front and get paid in full immediately • Be clear about budget and managerial authority with the acquirer to retain the freedom of action to be able to deliver earn-out targets • The longer the earn-out horizon extends, the less likely it is the acquirer can continue to provide entrepreneurial freedom to the acquired unit’s management, despite intentions at the outset – For growth-stage businesses, twelve months is common, eighteen gets to be a stretch – Difficult to work well beyond two years Copyright, David J. Litwiller 2012 23
- 24. Partial Sales toStrategic Buyers • Typically requires a provision for the acquirer to be able to later purchase 100% – As time goes on and your business grows, the acquirer can’t be in a position that it is increasingly dependent upon a small company over which it can’t get full control – At the same time, if your business ends up being not as important, it can be cast off, often in a weakened state • Partial acquisition by a strategic buyer can scare off certain customers and partners that your company independently would likely be able to access, especially if the acquirer is a competitor of theirs • Additional delicate issues that can arise: – Extent of and mechanisms for coordination and control – Exclusivity provisions – Commitment to a particular technology platform and marketplace approach in an environment of uncertainty – Reduced entrepreneurial motivation for founders and employees holding equity rights Copyright, David J. Litwiller 2012 24
- 25. Using i-Bankers • Ingeneral, it is difficult to get the A-team from an investment bank to work on a transaction size of less than $20 million • Below that level, use of i-bankers often imposes high fees in exchange for mid-grade talent and so-so rolodexes • Smaller deals are typically better served by management acting as its own prime contractor to handle the sale, calling upon skilled lawyers, accountants and other advisors as needed Copyright, David J. Litwiller 2012 25
- 26. Other Thoughts • Sellingyour business is a time consuming process for six months or longer • CAs/NDAs notwithstanding, word will get out that you’re for sale once more than five people know • Identify key employees, especially team players, re-recruit them and accommodate them – Corollary: It is also the time to part ways with any unproductive renegades Copyright, David J. Litwiller 2012 26
- 27. Takeaways 1. An exitscenario is not a business model. Build a great fundamental business. Everything else follows to create and capture value 2. Nail the numbers early in the financial projection preparations to put forward to potential buyers. The qualitative aspects of representing the company can then be done much quicker and better 3. The better the preparation at the front end of the sale process, the faster it goes, enhancing value 4. Competition for the deal, real or perceived, is usually the way to reach the best value, transaction terms and flexibility Copyright, David J. Litwiller 2012 27
- 28. Takeaways 5. Get helpfrom advisors who have been there before when selling. You are an expert in your business, honing your skills relentlessly. But, selling a business is a rare event. The process follows its own set of conventions in which many entrepreneurs, even great ones, have little experience. The boundless energy and optimism of the successful entrepreneur can be helped at sale time from a more dispassionate perspective about the decision, strategy and tactics of sale 6. Do as much due diligence on a prospective buyer as the counterparty does on you. Really dig to build a detailed picture of the good and the bad of the potential acquirer. Investigation of the buyer informs the go/no go decision, negotiating tactics and optimal form of transaction 7. At every step of the process, keep revisiting how to maximize value for your business in the new prospective ownership setting 8. It is far easier to react to advances than to try to turn a buyer on! Copyright, David J. Litwiller 2012 28
- 29. Follow-up Discussion Contact: dave [dot]litwiller [at] communitech.ca © David J. Litwiller, 2012 29