7 Things to Consider Before a Startup Acquisition

Originally published in ReadWrite.

Startup acquisitions often don’t go as planned—often because the founders don’t know what to expect and how to ensure they’re getting the right deal.

While getting acquired is something many young startups hope, dream and sometimes even plan for, the actual deal doesn’t always follow the script. One reason startup acquisitions often don’t go as planned is that the founders may not know what to expect and how to ensure they’re getting the right deal. That’s especially true if it’s an early exit—before the company has fully matured.

So we asked seven young founders from the Young Entrepreneur Council (YEC)—many of whom have been through the acquisition process—to share reasons why an early-stage exit might not work out, along with their best advice for making sure things do go as planned:

1. Prepare Records And Documents

When there are different perspectives on how a company should be valued, it’s hard to reach a price agreement. Different visions about where the marketplace is headed can impact perceived value. And investors who want an unrealistic return on their investment can prevent deals from getting done. Practical and personal issues can also bring an acquisition to a halt, including technology differences that make integration difficult and key team members who don’t want to work for the acquiring company. Proper acquisition preparation can help. All your accounting records should be in order, prepared in accordance with generally accepted accounting principles (GAAP). Your corporate governance, legal records, HR and employee documentation should also be in order and easily shareable.

2. Avoid A Funding Gap

3. Build Cash

One big reason early-stage exits go south is that as part of the due diligence process, there is an intense focus on the company financials. The debt you have and the cash you have in the bank matters. Oftentimes, entrepreneurs try to focus on keeping their tax burdens down by minimizing their taxable profits. While this strategy may make sense early in your business life, when you begin thinking about exiting, you want to have at least two years of higher profits. Get ready to write big checks to the IRS if you are thinking about exiting.

Second, investors want the company to have cash in the bank and debt to be low; this shows great company health. It makes it easier to justify getting a valuation at three to five times annual revenue.

4. Align Expectations

I’ve sold two companies, and both have had different outcomes. The main thing I would suggest is ensuring that your expectations and theirs are aligned. Many times, founders are so eager to get the deal done that they fail to consider “life after acquisition,” and how this change will affect their happiness. The top three things to consider:

• Operational roles, responsibilities, and expectations: Will you maintain your freedom to create?

• Product road map: Where does your product fit into the acquiring company’s overall strategy, and what happens if things change?

• Earn-outs and changes to the company What happens if the earn-out is tied to a result that you don’t have any power to affect? What if the acquiring company gets acquired? It happens.

5. Practice Due Diligence

Whether a startup or Fortune 500 company, people looking to sell should practice due diligence on their own companies before handing things over to a prospective acquirer. Mistakes and oversights can be corrected, and if they cannot, the damage can be minimized. It will be very bad for your asking price if you are sitting at a negotiating table and your prospective buyer informs you that the contract for your biggest customer cannot be assigned, and that contract will have to be renegotiated. It will be even worse if doubts about your IP ownership arise as you are looking to sign the deal.

These sort of issues, and many others, are going to come to light one way or another. Make sure that when they do, you are the one in control of the situation by doing your homework ahead of time.

6. Avoid Under-Valuations And Mismanagement

Your company could be undervalued. If you wait a few more years and continue to grow your revenues, you will get closer to your maximum valuation. Keep in mind that acquisitions are often mismanaged, or the new leadership falls apart and hurts the brand. All the hard work you put into building your business could go down the drain.

7. Find A Culture Fit

Most important is a culture fit. Whether you’re getting acquired or merging with another company, it’s equally important. We’ve acquired another company, and getting both teams to integrate and act as one under a mutual value set was crucial to the transition. We walked away from an acquisition opportunity because the cultures were not aligned.

Things to discuss and look for in action at a company are values, beliefs, outlooks and expectations. Other things I’ve found to be important are the company’s risk tolerance, as well as its ability to change and adapt. As entrepreneurs, sometimes we forget not all companies are comfortable testing and pivoting.

Related Posts:

• 6 Reasons Acquisitions Derail—and How to Get Them Back on Track
• Preparing Your Startup for Acquisition
• Is Your Startup Dangerously Rushing to Scale?