Research done by the Silicon Valley Bank shows that most UK startups are aiming to be acquired.
An acquisition is the most popular exit strategy for startups and has a lot of benefits for both the buyers and the sellers of the company. An acquisition can help expand the market and the resources of the selling company. On the other hand, an acquisition also has perks for the buying company as well. For example, a buying company can receive the intellectual property or software that they needed for their own company without going through immense legal work and patents if they buy a company that already has what they are looking for.
An example of this can be seen when Google acquired Wildfire, a company that creates software that helps brands manage their social media presence.
However, it is important to bear in mind that as a small company which is going to be acquired that you must go through the right procedures in order to ensure that you get the best possible deal when you want to sell your company. Therefore, it is important to know the fundamentals of what an exit strategy is, what acquisition is and why it is highly desired. Thus, it is also important to be aware of the implications of acquisition and the steps that are needed during the acquisition period.
What is an exit strategy?
The definition taken from Investopedia.com states that an exit strategy is a contingency plan made by a business owner to liquidate a position in a financial asset or dispose of tangible business assets once certain predetermined criteria for either have been met or exceeded.
An exit strategy is needed to limit losses.
An effective exit strategy should be planned for every positive and negative contingency regardless of the type of investment, trade or business venture that is entered into. This planning should be an integral part of determining the risk associated with the investment or business venture.
In the case of a startup business, good business people always plan for a comprehensive exit strategy in case business operations don’t meet predetermined milestones. If cash flow draws down to a point where business operations are no longer sustainable and an external capital infusion is no longer feasible to maintain operations, then a planned termination of operations and a liquidation of all assets are sometimes the best options to limit any further losses.
Most venture capitalists usually insist that a carefully planned exit strategy is included in a business plan before committing any capital. Business people may also choose to exit if a very lucrative offer is tendered by another party for the business.
Why Is Acquisition The Most Desired Exit Strategy?
Generally, mergers and acquisition refer to the consolidation of companies or assets through various types of buying and selling. Mergers and acquisitions can be done through many means, such as mergers, acquisitions, consolidations, tender offers, purchase of assets and management acquisitions. In all cases, two companies are involved.
In acquisitions specifically, the acquiring company obtains the majority stake in the acquired firm, which does not necessarily change the company itself or its structure but only the owner that it is under.
The main reason why small businesses want to be acquired:
- It is an honourable exit
- It is an effective means of expanding to new markets
- It may that proof the company has been successful and is profitable
- It increases exposure for the company
- It provides more security for the company
- It will lead to more growth for the company
The Implications Of Being Acquired
Generally, an acquisition is a good thing!
Six years ago Facebook acquired Instagram in what became one of Silicon Valleys best business acquisitions. At the time of the acquisition, Instagram had just 30 million users and zero revenue and it was considered to be a risk that Facebook bought the photo-sharing company for $1 billion, at the back of this information.
However, today Instagram has more than 600 million users and is a multi-billion dollar ad business.
Mike Hoefflinger former Facebook director of global business marketing, stated that
“And therein lies the priceless value of the Instagram story: proof of existence that Zuckerberg can turn visions of growth and impact into reality without undue meddling”.
He goes on further to state that it was “A clear message to the best builders in the world that if you want to play truly big, come work with Facebook.”
Thus, this acquisition was just as valuable to Facebook as it was to Instagram because it proved that Facebook could build multiple products at the same time, and it also sent a message to other entrepreneurs that Facebook was the best place in Silicon Valley to drive massive growth.
It can expand the market of both the buying and the selling company
Recently, DiDi a Chinese car service company acquired 99, a ridesharing company in Brazil, as a part of DiDi’s plans to expand its service into Latin America. DiDi bought 99 for $900 million.
This deal increased DiDi’s reach to 1,000 cities, as Didi also has partnerships with other companies like Grab and Lyft. This touches more than 60 per cent of the world’s population. Furthermore, it is said that DiDi app currently has 450 million users.
Chen Wei, Founder and CEO of DiDi, stated that
“globalization is a top strategic priority for DiDi. With enhanced investments in AI capabilities and smart transportation solutions, we will continue to advance the transformation of global transportation and automotive industries through diversified international operations and partnerships.”
Thus, buying 99 brings him closer to meeting this objective. Furthermore, the founder of 99, Peter Fernandez, recognised that being bought by a huge company like DiDi which has a lot of market power would help their company to reach new clientele.
“We feel privileged to be now a single organization with an even stronger purpose: improve the transportation industry and massively impact the lives of billions of people worldwide.”
However, if not done properly acquisition can have grave effects on shareholders.
This can be seen when Good Technology, a mobile software start-up was acquired by BlackBerry.
Workers that had bought shares in the Good Technology company were significantly impacted. Good Technology had abandoned its long-anticipated plan to go public which would have possibly made the employees value of shares in the start-up increase immensely.
Instead, when the sold their company to Blackberry, their shares depreciated drastically and they had to pay a high amount of tax based on the value of the company, rendering their shares in the company ultimately worthless. On top of that payouts to Good Technology’s investors and venture capitalists took priority.
One of the reasons for this unfortunate situation was because the company was evaluated at the selling price of $1.1 billion however settled to be bought for $425 million.
Hence, the statement made by businessman Dilip Shanghvi holds true for any company going through an acquisition.
If you are thinking about selling your company you should make your exit strategy/agreement as bulletproof as possible, this is why we have listed the 7 Things that you need to in order to sell your company.
7 things you need to do when your business is being acquired
- Use escrow
What is escrow?
- Escrow is used in sales of property and other high-value goods to protect both parties
- An escrow is an agreement between two people or organisations in which money or property is kept by a third person or organisation until a particular condition is met.
- The escrow agreement is governed by the conditions.
- Escrow is executed by both parties and cannot be recalled.
- When entering into escrow, the two parties write the conditions that govern the agreement.
- The conditions set out what happens in all situations. They should set out each possible outcome and what is to be done with the money/ property under each circumstance.
- Once both parties agree the money is transferred to the escrow agent where it is held until the conditions are met.
- An example of a UK government (FSA and HMRC) registered escrow platform is Transpact.
- Payment Services Directive 2009
Established low-cost escrow services, or ‘third party providers’, that are widely used in internet transactions today.
- Money Laundering Directive 2007 (2017)
Requires financial service providers with an annual turnover of £64,000 or more to take prescribed steps to avoid money laundering. The 2017 directive raises this to £100,000.
Escrow legal issues
- Money laundering risks
- Fraudulent escrow providers (scammers)
- Conditions must be comprehensive otherwise, the transaction will be voided
2. Do due diligence
The process of buying and selling a company usually takes 6 months. However, a lot of business owners get impatient and want the process to be hastened. Consequently, if a company does not do their due diligence it can be detrimental to the deal made in the acquisition
Due diligence is the process of examining a business before choosing to go through with an investment, merger, or acquisition.
Strict scrutiny is applied to the company’s financial records and any other relevant information.
Though it can be a contractual obligation, usually a due diligence report is voluntary.
Why is it necessary?
Due diligence allows for fully informed decisions on potential investment, mergers, or acquisitions.
Research has shown that doing at least 20 hours due diligence considerably increases the chances of a more positive outcome from the investment.
Compiling a due diligence report
Information on the following should all be included in a thorough due diligence report:
- Corporate records
- Financial information
- Labor/ employment/ suppliers
- Real Estate
- Customer Information
- Legal Reports
What happens if you don’t get a due diligence report?
- Without a due diligence report, you will be highly misinformed on the inner workings of the company with which you are not to do business.
- A due diligence report is the only way to fully grasp the type of company you are looking into.
3. Get Share Purchase Agreements
A Share purchase agreement is an agreement that sets out the terms and conditions relating to the sale and purchase of shares in a company.
The purchase of shares constitutes the purchase of a company’s operating business. None of the existing contracts with the company change. If a shareholder sells his shares in a company, then he achieves a complete break in the relationship between him and the target business. The buyer, however, will insist upon some contractual promises about the company (warranties), which will continue to bind the shareholder after the sale.
A typical share purchase agreement will deal with the following matters:
- Selling the shares
- Restrictive covenants
Advantages of SPAs
- No third party involvement
- No liability for debts
Disadvantages of SPAs
- Inheriting outstanding problems
A client will need a Share Purchase Agreement when:
- They are purchasing shares.
A Share Purchase Agreement includes:
- Details of the parties
- Purchase price and share allotment
- Deliverables when closing
- Timeline for transaction completion
4. Get Asset Purchase Agreements
An asset purchase agreement (or business purchase agreement), or “APA” is an agreement setting out the terms and conditions relating to the sale and purchase of assets in a company.
When will a client need an asset purchase agreement?
A client will need an asset purchase agreement when:
- They are purchasing an asset.
What is included in an asset purchase agreement?
Asset Purchase Agreement:
- Details of the parties
- Purchase price and the process of sale
- Intellectual property license
- Treatment of asset when the sale is completed, i.e. employees when a business is acquired.
5. Get your financial statements in order
Tips on how to get your financial statements in order:
- Use accounting software
- Know your income statement, balance sheet and cash flow statement inside out.
- Hire an accountant
- Open a task savings account
- Record every piece of money that enters and leaves the company
6. Fix your systems and procedures
According to mindtools.com, Processes can be formal or informal. Formal processes, known as procedures, are documented and have well-established steps.
For example, you might have procedures for receiving and submitting invoices, or for establishing relationships with new clients. Formal processes are particularly important when there are safety-related, legal or financial reasons for following particular steps.
Informal processes are more likely to be ones that you have created yourself, and you may not have written them down. For example, you might have your own set of steps for noting meeting actions, carrying out market research, or communicating new leads.
7. Choose whether you want to stay or leave
According to Noam Wasserman, if your company has done relatively well under your leadership the buyers or investors of your company would want you to stay on and run the company. Depending on how your acquisition is set up you may be able to implement an agreement that allows you to stay in your company in another role.
In conclusion, this year alone there has been over 23,000 acquisitions worth $2.5 Trillion worldwide. This proves how popular an exit strategy acquisitions are and why most small businesses aim to be acquired.
For further information on buying on selling your company please read the following articles:
Sources used in this article: