How to prepare for M&A, your most likely exit avenue

Despite the plentiful headlines about mega billion-dollar M&A transactions, record IPOs and the rapid growth of SPACs, small deals will continue to be the most likely exit for the vast majority of tech startups. In the over 30 years I’ve worked on M&A at White & Case, Barclays and my current firm Ascento Capital, I have seen too many startups that are not prepared for an exit via a merger or sale. This article will provide specific recommendations on how to prepare your startup for M&A.

While it is good to strive for a billion-dollar-plus sale, a successful IPO or a SPAC deal, it is practical to prepare your startup for a smaller transaction.

Global M&A hit record highs in the second quarter with a total deal value of $1.5 trillion, but smaller transactions vastly outnumber mega billion-dollar deals. The U.S. saw a total of 16,672 deals in the year ended June 31, but only 583, or 3% of that number, were valued at more than a billion dollars (FactSet). The IPO market is healthy again, but M&A still represents 88% of exits: So far this year, there were 503 IPOs and 5,203 deals, according to the CB Insights Q2 2021 State of Venture Report. After the SEC announced in early April that it was considering new guidance on SPAC IPOs, the rate of new SPAC issuances fell by around 90%.

While it is good to strive for a billion-dollar-plus sale, a successful IPO or a SPAC deal, it is practical to prepare your startup for a smaller transaction.

Here are a few recommendations that will prepare your startup for an M&A exit:

Track M&A in your subsector

Set up an alert on Google News for M&A activity in your subsector. For example, if your startup is in the IoT subsector, search for “IoT acqui” and this will pick up news stories on acquisitions in the IoT space. Save the search so you can go to Google News on a regular basis. Also track your closest competitors on Google News, particularly to see who is selling their company.

Prepare a list of likely acquirers

Prepare a list of the companies or firms most likely to buy your startup. This list should include domestic and international companies, businesses in non-tech industries, private equity firms and their portfolio companies, as well as VC-backed companies. Track these likely acquirers on Google News as well.

Consider executing a parallel track

Consider approaching the top 10 likely acquirers when you are raising the next round of capital. If your startup gets M&A offers and VC term sheets at the same time, this will provide your board of directors choices on the path ahead. Knowing the M&A activity in your startup’s subsector and the 10 most likely acquirers will impress VCs and increase the chances of being funded.

Having the option to raise funds rather than selling will increase your leverage with potential acquirers, too. Executing a parallel track, exploring an M&A exit and the next round of VC financing in parallel are mutually reinforcing.

Increase M&A value with strategic moves

Opening an international office, such as in London, will signal to potential acquirers that you have international ambitions, helping to potentially increase the M&A value of your company. Also review the customer and vertical concentration in terms of revenue. If your company is highly concentrated in a customer or vertical, or both, you may suffer from a lower valuation since the risk is concentrated. Consider focusing on other customers and verticals to lower the concentration.

Also review the intellectual property of your company, especially the patent portfolio, as this can be valuable to an acquirer. If your company has software products, make sure that the code is fully documented.

Prepare for in-depth due diligence

Startups often underestimate the rigor and detail of due diligence by acquirers. Set up a data room on your company’s internal drive and keep it current. A sample data room index can be found here.

The financials should be kept in GAAP and maintained in perfect condition. Review the capitalization table to make sure it is up to date. Any verbally “promised” equity should be fully documented in writing.

Legal documents should be in order and kept up to date. Review customer and vendor “change of control” sections in contracts to make sure these do not require you to seek approval, which can slow down or derail an M&A transaction. Make sure there is no exclusivity clauses in resale agreements.

Get smart on the M&A process

How well the M&A process is conducted will determine a significant portion of the value for shareholders. Take the process seriously and hire a brand name law firm and accounting firm for the process with specific experience in tech M&A. Hire an investment banker that has experience working on deals in the tech sector who can coordinate the process and add value in negotiations, deal structure and valuation.

Study working capital requirements and earnout structures, as these can have a large effect on the ultimate value to shareholders in an exit. Research the current market standards for representations, warranties and indemnification clauses (Global M&A Intelligence Report 2021, DLA Piper).

Don’t miss the M&A window

Typically, the first company to sell in a subsector will achieve the highest valuation and the last company will get the lowest. More generally, this frothy, over-the-top VC, PE, IPO, SPAC and M&A market will not last forever. SPACs are already cooling, and the M&A market is sure to follow. If the market slows significantly, be prepared to wait for it to heat up again, which generally occurs a few years after the general economy recovers, since it takes awhile for large acquirers to get their confidence back on the M&A front.

Ascento Capital’s latest deal closed a few weeks ago. It represented Proant, a small Swedish IoT company that was acquired by U.S.-based Abracon, which is backed by private equity firm Riverside Company. The valuation significantly exceeded my client expectations due to the high level of M&A activity in the IoT sector and a robust auction process. This is an excellent example of selling in the M&A window for optimal results.

Consider the benefits of a smaller transaction

For a startup, the right M&A partner can massively speed up the development and distribution of its product. Raising round after round of capital is a slower route than M&A to seeing your product adopted on a global scale. From a career perspective, a founder successfully selling a company is a rare event and will open career doors at the acquirer or have investors knocking for their next startup.

Best of luck on whatever path you choose and be prepared.