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Business Development = Exit Planning

Most startups and emerging companies miss the opportunity for effective exit planning by not integrating exit planning into their business development activities. The most likely M&A partner is an existing partner, especially if you are making the partner successful. By understanding the relationship between business development and exit planning, you can utilize your partnership efforts to accomplish both objectives.

Startups are often told that exit planning is a dirty word, because investors (mainly venture capital firms) want the startups focused on building the next $1B company. Unfortunately, only .07% of the companies make it into this “Unicorn Club” (http://techcrunch.com/2013/11/02/welcome-to-the-unicorn-club/). Additionally, only 22.5% of venture back companies go public (although that number does seem high), according to The Venture Capital Cycle, 2nd edition, 2006. The remaining startups are left to contemplate a different future: bankruptcy, M&A exit or stagnation (also known as irrelevancy to your investors looking for a return). Of course, everyone knows that significant amount of investor returns comes from M&A exits, which creates a dichotomy between what your investors tell you and the realities that everyone knows. To deal with this dichotomy, startups should integrate exit planning into the business development activities.

Without exit planning, startups often lose significant value in their exit. The startups aren’t prepared for the worst-case and best-case scenarios. In the worst-case scenarios, companies wake up one morning to realize that their funding is drying up and they haven’t achieved profitability. There is the inevitable scramble to find an exit. However, the harsh reality sets-in for these companies when they realize that they haven’t built the necessary partner relationships to facilitate an exit. There is a mad scramble to figure out the potential buyers, who is the right person at the partner to execute on an M&A deal, and how to pitch an acquisition to each company. Often, companies face the terrible introductory phone call of having to introduce their company to a potential buyer and pitch a sale of their business in the same call. The success rate of such “fire sales” is low, and if the company can find a buyer, the valuation is usually pennies on the dollar.

In the best-case scenario, when your company receives its first unsolicited M&A offer, you want to reach out to other potential buyers to solicit competing bids. When companies aren’t prepared, they are forced to pay million(s) to advisors to find other potential buyers. However, if you have done your planning in advance, you should already know who the other potential bidders are, and can save significant fees. Additionally, the window for obtaining other bids is often short, and the other potential buyers are in reactionary mode. The internal process for potential buyers takes time. Many potential buyers can’t respond quick enough to make a serious competing bid.

To avoid these scenarios, you should integrate exit planning into your business development activities. With any business development efforts, you should start by understanding your ecosystem, including your competitors, inbound partners, alliance partners, go-to-market (GTM) partners, GTM alliances and other partners in your ecosystem. As you build your business, you will start forming partnerships with the key players in your ecosystem.

Layering exit planning over your business development activities only requires a slightly different analysis of your partners. You should understand (1) your M&A fit to their organization, (2) the rationale for a potential acquisition, (3) the partners M&A history, (4) the “M&A power structure” at the partner, and (5) the key decision makers to know for M&A activities. Once you understand these factors, you will have a roadmap for positioning your company for a potential exit.

Knowing When to Sell

Every startup begins with aspirations of being “the next” Google or Facebook or Amazon. This unbridled optimism is what drives an entrepreneur. Each new technology market has new success stories, and drives future entrepreneurs to chase after their dreams. However, the reality is that not every startup can “win” their market. With each new technology market, billions of potential entrepreneurs exist around the world as potential competitors.

As an entrepreneur, there is no reason to be ashamed if your startup doesn’t win the market. Every successful entrepreneur will admit that luck and good fortune play a significant role in deciding the winner. In fact, many successful entrepreneurs in a technology market are the startups that got out early, and avoided a devastating market crash or a market that never materialized.

To preserve their hard work and to protect employees and investors, entrepreneurs need to know when to turn the unbridled optimism into sober realism. They need to know when it is time to sell. At different points in a startup’s lifecycle, the management team needs assess the market and to acknowledge that the best strategy is to sell the company. Selling at the right time is the best way to preserve value.

Conversely, missing the right exit window will destroy a company’s valuation. In each new technology market lifecycle, numerous exit windows exist. A startup’s relative success and competitive positioning may dictate selling early. The competition may have clear (and potentially insurmountable) advantages early in the race, such as funding, key partnerships, technology advantageous or other related advantages. If you miss your right exit window, your valuation will suffer.

To illustrate the different exit windows in a market lifecycle, Gartner’s hype cycle is a good proxy for understanding the market dynamics.

Most startups are created and funded during the climb toward inflated expectations. Startups can achieve increased valuations by selling near the Peak of Inflated Expectations where established companies pay increased valuation to ensure that they don’t miss the next big thing. In this phase, valuations usually aren’t based on financial metrics, but some other metric is used to justify the valuation. For example, Twitch valuation discussion centered around having 55 million unique visitors, and AlchemyAPI’s valuation discussion centered around having 40 thousand developers.
Many startups crash in the Trough of Disillusionment as they run out of cash. The forced exit during this time period hurts valuation; however, if the company has some interesting technology or other assets, the startup can obtain a reasonable exit for the employees and investors. The investors may lose some value, but angel investors will appreciate receiving some of their money back, and the founders usually find value in having an exit on their resume.
During the Slope of Enlightenment, valuations begin to rise again. The remaining startups survived the downturn and presumably have customers and revenue. As more conservative incumbent companies recognize the new market’s threat and opportunity, they make acquisitions based on traditional financial metrics, such as multiple of revenue or earnings.
After entering the Plateau of Productivity, the hype is over and the clear winners begin to emerge. The winners’ growth begins matching or exceeding the overall market growth. Other startups begin to falter, although they may still be growing and profitable. The winners begin planning to go pubic. Currently, in the Hadoop ecosystem, companies like Cloudera, Hortonworks and MapR are emerging as the clear winners, even as they jockey for position to become the overall winner of the market. The valuation for the other startups begin to falter as their optimism and promise begin to falter.
On the other side of the Plateau of Productivity, the story doesn’t end. The market dynamics will determine if there is one clear startup winner (such Cisco, Google, Microsoft in their day), if the market fractures (the ERP market in the early 2000’s), or if the startups are crushed by bigger players via innovation or acquisition earlier in the cycle (Microsoft Office in its day). At this stage, unless your company is a clear winner, your valuation is based purely on performance without any premium for a promising future. Usually, private equity firms and opportunistic companies are aggressive in driving down valuations, as they execute on consolidation of the remaining industry.

On the other side of the Plateau of Productivity, one huge danger for entrepreneurs and investors is becoming a “lifestyle business”. Startups can remain with limited/no growth but sufficient profitability to say alive. This lifestyle business gives the entrepreneur a comfy lifestyle; however, it destroys value for the investors and employees as the startup becomes less valuable over time. The entrepreneur fears giving up the prestigious and comfortable lifestyle (CEO of a startup always sounds good at parties). In reality, the entrepreneur fails to see that this lifestyle business is bad for the entrepreneur as they spend years not doing much except for managing a non-growing business. If an entrepreneur sits too long in a stagnant company, it is hard to find their next job commensurate with their existing position. The entrepreneur can take a huge step back in their career when the startup eventually ends. The entrepreneur needs to recognize the situation, and to avoid the trap of a lifestyle business.

For an entrepreneur, there are numerous decision points for deciding if it is the right time to sell. The CEO and management team need to continually assess the market cycle, the likely market structure, the likely market outcome, their position in the market, their competitors position in the market, and numerous other factors. Most entrepreneurs lack the structural knowledge, experience and objectivity to make this ongoing assessment. More importantly, entrepreneurs can’t spend their days thinking about their exit strategy; instead, they need to focus on execution and becoming one of the winners. However, if they don’t have someone monitoring the optimal exit time, they will miss the optimal time to sell.

Focusing on Value Creation in M&A

50–90% of all Merger & Acquisition deals fail.1 The root cause is fairly simple: the M&A industry is focused on “getting deals done” and is not focused on value creation in deals. A majority of the time and expense are front-loaded into finding a company to acquire and executing the deal. Deal advisory and execution is only 30% of the battle.

Creating value from M&A requires a broader time commitment and understanding from a company. The time commitment required is years. After the deal is done and the 100 day integration is complete, most CEO’s stop actively tracking the deal. Most companies don’t realize that the hard work has only begun. Without continually managing value creation, companies move onto the next thing and only realize years later that the deal didn’t create value.

To understand value creation, a company must see it as a completely separate thread that must be managed throughout the entire deal lifecycle. During each phase of the deal lifecycle, companies must perform key activities and monitor deal execution to ensure the deal stays on target. Below are some of the key activities required for value creation:

M&A Strategy: the M&A strategy needs to be tightly aligned with the corporate strategy to ensure that any M&A deals are accretive to the company strategy, and are not distractions. Once deals become a distraction, they don’t receive the necessary attention, funding and management to achieve success.
Deal Sourcing: value creation requires defining clear criteria for the target. The list of criteria must include (1) strategic: your company’s target market, core competencies/DNA, culture and DNA and (2) tactical: deal size, location and other. Without clear criteria, the task of integration and realizing the strategy is much more difficult.
Deal Structuring: the traditional issue here is valuation and ensuring that a company doesn’t overpay or that the hurdle rate isn’t too high for the deal. However, creating a complicated deal to lower the deal price may be self-defeating. Beyond valuation, aligning incentives is very important, and ensuring anyone from the seller still involved is properly incentivized to perform.
Deal Execution: value creation requires getting a sense of the company and potential problems. During diligence, the buyer needs to start finding the skeletons and any potential landmines. From an M&A standpoint, every seller has some level of dysfunction or complications. Even the highly efficient purpose-built companies with a strong culture create significant challenges with integration.
Integration: this is where a buyer usually finds out “the whole truth about a company”. Many of the assumptions turn out to be wrong. The goal here is to be realistic about the situation, prioritize the value creating activities, and track execution. Usually, someone other than a project manager needs to manage integration. Value creation requires someone who understands how to make a deal successful take an active role in monitoring and tracking execution.
Deal Realization: in the 6 – 18 months after the deal closed, the real work begins: fixing problems, wrong assumptions, and poor execution. Value creation requires acknowledgement that it is normal that not everything goes as planned. Without this understanding, execs will hide potential problems.

For most companies, focusing on valuation may require a fundamental shift in thinking about M&A. However, once companies begin to identify the activities and required commitment for value creation, the success rate for M&A will improve.

1 http://hbr.org/2011/03/the-big-idea-the-new-ma-playbook/ar/1
http://www.relationshipeconomics.net/blog/to-improve-mergers-acquisition-success-rate-align-strategic-relationships/

A New M&A Role: Deal Manager

M&A deals are normally run like football team without a coach. Each specialist has a particular skill set, but each specialist is not positioned to understand how his or her activities relate to the ultimate deal success (value creation). Companies need to take an integrated view of the entire deal cycle. For example, M&A strategy decisions should be informed by integration experience (when things go wrong) so that the strategy assumptions have real-world validation, and can avoid sending a company down an unnecessarily difficult road.

Companies need to implement a new role into every deal: the deal manager. This is not project management. A deal manager has to be an M&A subject matter expert and a leader. The deal manager is more like a coach, conduct or CEO, because they need to have a vision for where the deal is heading, and need to lead the deal efforts.

Below are 5 keys deal management duties in a M&A transaction:

Big Picture View: Throughout the deal, the deal manager must maintain a big picture view of the deal and what it takes to make the deal successful. There are many handoffs between the teams and services providers (bankers, lawyers, due diligence teams, integration, management, etc.). The deal manager needs to understand how all these tasks interrelate and intervene when necessary to keep the deal on track.
Subject Matter Expertise: The deal management requires subject matter expertise across the deal lifecycle, not just in one or two areas. Just knowing strategy and M&A advisory is insufficient, or just know integration is insufficient. A deal manager needs to understand every role in a deal so that they can proactively monitor progress and intervene if someone is falling off the rails.
Feedback and Coaching: With subject matter expertise, the deal manager must provide substantive feedback to the stakeholders and coaching where the team members could use assistance. There will always be someone new to the team or lacking M&A experience. When this occurs, the deal manager must recognize this and provide coaching to the new members.
Collective Wisdom: As the deal transitions through the different stages, the deal manager must retain the collective wisdom learned in each deal stage and disseminates this information to other teams. If the sales team looks weak during the due diligence phase, the deal manager must ensure that the sales team is supported after integration and must set up specific KPI(s) to track their progress. With most companies, these learnings from diligence was lost in the handoffs and are never tracked, even though it was a known problem.
Deal Process: Finally, the deal manager must ensure that each step in the M&A process is completed and sufficient attention has been given to the relevant issues. This is the classic project management aspect and is an essential role in M&A. However, without the other 4 roles above, project management is a net negative to make a deal successful.

Once companies adopt the deal manager role, they will wonder how they ever lived without this role. The deal manager will lead to value creation in M&A and to making deals successful.

M&A: Optimizing for Value Creation

With M&A, most companies are focused on deal execution, and not enough time is spent on value creation. In fact, most companies aren’t optimized for creating value with M&A, which requires rethinking the approach to M&A.

M&A is a 4-quarter sport. M&A strategy and advisory is the 1st quarter. Deal execution is the 2nd quarter. Integration is the 3rd quarter. Deal Realization is the 4th quarter.

Companies utilize different coaches and different teams for each quarter without anyone overseeing the entire game from beginning to end. A consistent game plan and team management is required to keep everyone focused on the same end goal.

Below are 5 key ways that companies can begin optimizing for value creation.

Deal Manager: Companies need to empower a new role in M&A: deal manager. This is not project management; the deal manager must have the knowledge, experience and authority to make the deal successful. The deal manager must understand each aspect of the deal and how all the different activities relate to value creation.
Guided Deal Execution: A lot of time and energy is wasted in deal execution. Specialists are brought in to perform specific tasks, but each specialist is not positioned to understand how his or her activities relate to the ultimate deal success. For example, due diligence is handed off to associates and other junior team members to look at specific issues. However, the due diligence process is fantastic opportunity to understand how the target was run, the skills sets of team members and potential problems. Buyers need to optimize around deal execution to gain deeper insights.
Experience Driven Strategy and Advisory: M&A strategy and advisory roles need to be filled by people with proper deal experience. They need deal execution, integration and optimization experience. Any deal can look good in theory, but an experienced deal person will be able to identify and troubleshoot potential issues before deciding to proceed with a deal.
Focus on Deal Realization: Most companies only play the first 3 quarters, and lose the game in the 4th quarter. The 4th quarter is left to chance and is not actively monitored by the CEO or the deal advocates.
Acknowledge and Address Problems: Deals don’t always go as planned. This is the nature of M&A. The strategy may prove to be unsound; the execution may be poor; the competitor may have seized on customer fears of M&A integration. The important thing is to quickly acknowledge when things aren’t working out, trouble shoot the likely cause, and take corrective action.

Once companies recognize M&A is a 4 quarter game, they will start to understand that M&A deals must be managed across all 4 quarters and how to optimize for value creation. M&A is not about getting the deal done, but creating value through M&A.

The Masters Of Strategy: Lawyers?

Are lawyers the real masters of strategy? Maybe not from a substantive standpoint, but the legal analytical process appears to taking hold in the strategy world.

In law school, lawyers are drilled with IRAC (Issue-Rule-Analysis- Conclusion) as a means to organize their thoughts and provide a methodological approach to a client’s issue. When interacting with a client, lawyers are asked to listen a long set of facts and to figure out what legal issues are present and how the law applies to the facts. The same basic approach applies whether the client is talking about a car accident, a divorce, an M&A deal, or any other area of law.

Traditionally, in the strategy world, the approach has been fundamentally different. Strategy models are created, and sold to every client possible. New models were the “hammer looking for a nail”, or more precisely, “if you [the model] are a hammer, everything starts to look like a nail”. New models are shopped around as the latest innovation, where every company is convinced that it needs to buy into the latest strategy model.

This traditional made perfect sense when the strategy world was being created. Strategy as a discipline started in the 60’s and has been developed over the last few decades. Strategy models were the new “rules” being created.

We are now to the point where the strategy traditions no longer work. Companies have learned that not every strategy model applies to their situation. Also, companies have the scares from trying to implement strategies that don’t work for their situation.

Management consulting firms are now borrowing the IRAC analytical framework from legal community. Bain calls it Opportunity-Approach-Recommendations-Results1, which is IRAC under a different name. McKinsey calls it Diagnose-Forecast-Search-Finishing2 the Strategy, which is slight different but substantively similar to IRAC.

Lawyers	Bain	McKinsey
Issue	Opportunity	Diagnose
Rule	Approach	Forecast
Analysis	Recommendations	Search
Conclusion	Results	Finishing the Strategy

This change in approach will certainly benefit clients. The modern day strategist needs to be familiar with all potential models, and needs to listen to the client’s problems. After understanding the underlying facts, the strategist can decide (1) Issue: what challenges a client faces, (2) Rule: what models might help the client understand and address their issues, (3) Analysis: how the model applies to the client’s situation, and (4) Conclusion: the results from executing on the strategy.

While lawyers may not be become the masters of strategy, their analytical approach will certainly dominate the strategy world in the future.

1 See the Bain Website.
2 See The Art of Strategy

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