Tactical vs. Strategic: How to Become Acquirable

How to Become Acquirable

They say there are three available exits for a startup. One of them is bad and, unfortunately, the path many startups take. One of them is to go public; great if you can get there, but in most cases these days is unlikely.

The more common path for successful startups, however measured, is to get acquired by a larger company. There are many variations to an acquisition, this article isn’t going to attempt to delve into those nuances. Instead I want to focus on what you, as CEO, should be focused on and what to pay very close attention to in order to increase your odds of getting to a successful acquisition.

First is what I call the Prime Directive.

Build Your Business to Last 100 Years

Build Your Business to Last 100 YearsThis needs to be your mindset every day. Build your business, not to make it acquirable but to be financially successful. The startup landscape is littered with companies that were built with the sole goal of getting acquired by someone, sometime by a specific company. While there are no absolutes, generally this is a failing strategy.

The harder you try to get acquired, the less likely it is to happen. You will find yourself making decisions based on what an acquirer might like as opposed to what will make the business succeed as a business.

If you follow the prime directive, generally good things will happen. It’s ok to have some target companies in your space that might have an interest someday, but it’s been shown time after time that the harder you chase, the less likely you are to catch.

There are several reasons why someone might want to acquire your company. They want your numbers and/or customers to add to their numbers/customers, or you are somehow strategic to their larger goals. Both of these reasons are good, but it’s rare to have both.

Grow Revenue

Grow RevenueThis ties into the Prime Directive above. If you can manage to grow your revenue into the $50MM+ range and be profitable, you have done a ton of stuff right. You have a solid customer base and you offer something they want at a price they are willing to pay.

The beauty of this strategy, of course, is it doesn’t matter so much if you get acquired, you presumably have a very viable company. Not always true, you could have reached a business plateau; many companies do. Revenues go flat, growth goes flat and the company suffers from the ‘walking dead’ issue. If this happens, don’t despair; you are likely still attractive to an acquirer, you just won’t get the same valuation. Let’s assume that’s not where you are.

Revenue-based valuations typically run in the 2X-4X trailing revenue range with a lot of variables (like current growth).

Since you have a very viable business, you already know who the likely acquirers are, and if you are really doing this right, they know who you are. While it’s beyond the scope of this article to go into the methods for establishing your availability, that’s what your seasoned investors are there for.

Become Strategic

Become StrategicThis is a very common reason why a big company acquires smaller companies. It’s one of the major reasons giant companies acquire other giant companies. It’s a great reason to sell a startup, but as all things, the path can be perilous. The great thing about a strategic acquisition is that it doesn’t require that your company is profitable. In fact, revenue-based valuations are generally thrown out in favor of strategic valuations.

Strategic valuations of 15X trailing revenues can be achieved. Another general rule is ‘replacement cost’. If they are wanting your company because of key technology you have, a good value target valuation is about 10X the cost of them recreating what you have.

The hard part of becoming strategic is knowing that you are strategic to them. The relationship to detect and avoid is a tactical relationship. A tactical relationship is one where you are just a checkbox on a list somewhere. (I will give an example of this in a moment.) Getting this wrong, pursuing a relationship that you think is strategic to them — but they view as strictly tactical — is both common and expensive. Avoiding tactical relationships requires difficult decisions but is usually worth the pain to avoid.

So, what do I mean by ‘tactical’?

Real example: Big Computer Company is interested in a piece of consumer software from small startup to put on their laptops to increase the consumer value of the laptop. Little company is working with the ‘Director of Stuff on the Laptop’ and his team and is enamored with the idea that their software will be on ‘millions of laptops’. It’s like a siren song to startups. Big Computer Company needs certain modifications and customizations to the software, which the startup gladly agrees to. Engineering is redirected to make the changes. The requirements become a moving target and the Big Computer Company keeps moving the ship date out. Nine months later the software is finally done and tested; Big Computer Company accepts the software and decides not to ship that laptop after all, citing market changes. Sorry.

This actually happened to me.

So, how do you tell if you are just tactical?

  1. You are involved with a small group within the big company. The world is full of product managers that have no problem getting startups to do stuff on their dime in return for lots of promises down the road. Make sure you have a VP in the loop somewhere.
  2. You are initiating most/all of the ideas. Make sure they are very involved and contributing. If not, it’s likely tactical and not that important to them.
  3. Lack of urgency on their part. In my case the tell was the constant changes in requirements and shipping schedules. They clearly weren’t in a hurry. Strategic deals have a palpable urgency to them.
  4. You are ‘one of many’ they are working with. In our case, there were 8-10 other companies providing software for the laptop. Definitely not strategic to them.
  5. Sponsorship is not at a high level. Same as #1 above, strategic deals will have very high visibility.
  6. It’s hard to get their attention. Do they return your calls? Do they call you? Do you have regular meetings to discuss progress? If not, it’s probably not that important to them.
  7. They have no ‘skin in the game’, no financial involvement. It is very common for the big company to get the startup to do all the work based on promises. One great way to test the strategic value of the deal to them is to require either some pre-paid royalties or some NRE (non-recurring engineering) fees from them. Tactical relationships will rarely provide this. If you’re strategic to them, there will be little hesitation to make the investment.

So, why is a tactical relationship bad?

Well, it isn’t always bad, just usually.

First, they can cost you a ton of money with little or no return. That’s always bad. They will very rarely lead to any kind of deeper relationship with the big company, they are just not that into you.

They can also create the impression of forward progress. ‘Look at all these deals we are working on!’. Having piles of non-performing contracts or ‘deals’ wastes your companies time and resources and can affect diligence down the road if you are acquired. I have seen companies that pay sales commissions on signed ‘deals’ whether they perform or now. You can imagine where that leads.

So, some warning signs to look out for in your thinking. First, believing that this deal will get your ‘foot in the door’ and lead to something bigger. Probably not. Second, believing that ‘deals = success’. Nope. Believing that having a Big Company logo on your web site as a ‘partner’ justifies the downside. Rarely. Customers don’t really care. Are you listening to your sales people and not your gut? Bad idea, trust your instincts. Sales people sell. Last, convincing yourself that the Big Company will ‘fall in love with you’ once they get to know you.

Best Way to Tell Strategic or Tactical

Tactical vs. StrategicOk, this is hard, but the absolute best way to get to the truth is to tell them ‘No’. You just aren’t interested in the deal as proposed. Rarely are CEOs comfortable with this strategy, but it works.

They most likely won’t walk away, but if they do you just saved your company a ton of money and headache. Telling them no to the deal as proposed forces them to show their hand and opens up the negotiation to get up front NRE, prepaid royalties or whatever you need to prove to yourself its strategic to them. Once you successfully get to this point, make your decisions based on what you see and hear. If they launch into a ton of reasons why this will be great for your company and nothing else, keep saying no until they either start negotiating or go away. Either way you win.

Lastly, seek help. Your investors can help, outside consultants can come in and provide a more unbiased and non-emotional evaluation of the situation. You don’t have to do it alone.

Jeff Erwin

Jeff Erwin has been a startup founder and CEO in the high-tech and software industry for over 30 years, with additional VP-level experience in a variety of public companies. Since 1989 Jeff has founded several venture capital backed startups, all leading to successful acquisitions. Jeff’s corporate employment history includes two years as VP of Business Development at Network General Corp, three years at Visio as VP of Enterprise Products and five years at Microsoft, where he served as General Manager for the Network Management Group & the Visio product line and was also the Director of Incubation for Microsoft Research in the wireless mesh networking space. Jeff has filed eight patents in the networking field, shipped numerous consumer and enterprise products for both Windows and Mac markets, and has board-level experience with multiple VC-backed startups. In 2006 Jeff assumed the role of President & CEO of Pure Networks which developed both Windows and Mac consumer software and successfully sold the company to Cisco several years later. In 2011 Jeff assumed the role of President & CEO of Intego, the leading provider of Mac security software. Intego was acquired by Kape Software in 2018. Jeff currently provides CEO-level consulting and mentoring. Connect with him on LinkedIn.