Thanks for reading Intelibilia! Subscribe for free to receive new posts and support my work.
One of the biggest lies in the entrepreneurial world is that the only exit for a company is binary: to either sell big or die big. Sell big to a more prominent company or go public and sell it in little pieces to thousands of investors. Or die big because no company is interested in you enough to purchase it, and you run out of investors' cash to burn. Kaput.
That is not true.
We live in times where only the companies that go big and get more than x10 returns of the money invested -by Angel investors and primarily Venture Capital- make the headlines. We have to accept that Venture Capital succeeded with this narrative; They are the builders of an ecosystem where big money comes from them taking huge risks (only 10% of startups survive more than ten years), and the only way they can raise more funds to invest is to get x10 results.
That is the narrative they want us to believe, but there are mainly two alternatives they are not interested in:
make the company profitable and return dividends to the investors, or
Sell the company to an industrial competitor or partner to gain access to the talent of team members—the acquihire.
A profitable company sounds like a good outcome for any investor, but not for the Venture Capital if the company is not sellable. Sometimes, a profitable company cannot be sold for the multiples desired when a VC accelerates a company. There are multiple reasons (market maturity, stalled growth, a toxic founder, etc.). Venture Capitalists need to cash out their investments to return the profits to the fund's investors, and dividends are not part of the equation.
The other option is the acquihire. An acquihire is the combination of the words “acquire” and “hire”; the acquisition of a company by another to gain talented employees. I was acquihired once, and I took part in other acquihired experiences, so let me explain why they can be a good option for Founders and Angel investors, but not always for VCs.
When a company wants to acquire another company, the amount in the check will be the sum of different reasons. Some of them are qualitative, and others are quantitative. Quantitative reasons are metrics like enough maturity to keep sustained growth and increasing revenue, user acquisition, a reasonable P&L balance, and Cash Flow. Qualitative reasons could be brand recognition, influence in communities, and of course, the team's talent.
Hence, an acquihire can also be defined as an acquisition where the team's talent outweighs the quantitative reasons.
Because quantitative causes are not the reason for the company's acquisition, its value is significantly lower. Goodbye to the tenfold expected by Venture Capital investors. Welcome lower ratios ranging from two times to five times. And this is the main reason why a VC will not accept an acquihire as an option unless that’s the only option or lose the money invested.
Now we know the position of the VCs, but what about the Angel Investors and Founders? Angel Investors play a different game than VCs. First, Angels invest with their own money, and VCs don’t. Second, Angels’ costs are significantly lower than a VC firm. Finally, Angels and VCs play the investment game differently. I think Angels are Poker players: you have to be smart and be lucky. If they have enough resources, VCs know they will get an x10 every X times they invest. So probably, an Angel investor will be happy with an x5 return while a VC won’t be thrilled if they consider the company still has a long run.
Founders usually are the main target of an acquihire, especially technical founders. Companies are willing to recruit talent, and they can pay good money. So if there is a small company with talented people around that could fit into their organization, they will go for it. An acquihire is an excellent option if the company struggles to gain traction, the relationship between the founders starts to deteriorate, or they realize that entrepreneurship is not for them.
Regarding how the buyer will pay for the company, the standard approach combines cash and shares. Most companies will try to compensate by exchanging their shares and not including cash. This is usually the main friction point, especially for Angels, VCs, and non-founders with equity not joining the acquiring company. Once the deal is done, and the company will suspend operations, they will need cash to pay the severance to the workers, the debts, and more. Also, giving shares of the acquiring company to non-founders sometimes is not feasible or desirable if the company is not public (anyway, the scale-ups secondary markets are maturing very quickly).
The rest of the cash now should pay back to the investors and terminate the relationship. Can the acquiring company compensate investors with shares? Yes, if the shares are in a public market without restrictions and they can avoid extra costs due to taxation.
So the Founders don’t have any cash, but they can sell the shares and buy a Lambo, right? Not so fast.
When a company acquihires you, they want you to stay in the company to accomplish the missions they have in their minds. That’s why the shares are vested during a period ranging from one year to four years (the de-facto standard in the tech industry). Share vesting is the process by which an employee is rewarded with shares but receives their rights over a period of time. Every month the Founders will vest a percentage of the shares agreed in the acquisition until they become fully vested four years later. The vesting has a cliff to avoid people leaving the company too soon. Cliff vesting is the process by which an employee earns the right to receive the shares at a specified date, rather than gradually becoming vested over time. A typical cliff in tech startups is one year.
Not all companies can be candidates for an acquihire. The best ones for the Founders, Angels, and VCs are companies in a very early stage of development. When a company grows and starts to recruit employees and create a structure, the less likely an acquihire. Also, the most desired Founders are the technical ones. If the acquirer does not want any of the Founders, it can be a problem. And it’s not strange to pay in cash to the leaving Founders just like Angels and VCs.
The Music Snippet
Selling a company of any size can be challenging. So Welcome to the Jungle, baby!