In 2003 through 2005, when I was in my pre-investor, CEO role, we bought three companies and through this process we learned a lot about what to do differently, what to do better, and what just not to do in start-up M&A. One company in particular taught us a majority of the lessons. The company was a venture backed business that had raised over $40M. It received an offer for a large exit that was turned down by the board (because it was 1999 and things only went up). We bought the business four years later because its technology solution moved us from a point solution offering to a platform, its customers more than doubled our existing base, much of the company’s revenue was SaaS, and because we were able to buy the company with stock and at a value that was a fraction of the capital invested. One founder planned to leave at the time of the acquisition, but the CEO planned to stay on and was key to our integration plans. I liked him a lot and really respected him and I was truly looking forward to partnering with him. It took me by sudden surprise when the former CEO called me two weeks after the deal closed and resigned. While it blindsided me then, it doesn’t surprise me now. A pilot who successfully crash-lands a plane is pretty unlikely to want to stay on board for the next leg of the flight. Walking away from the crash may be the only thing that the pilot or a crash-landed CEO can be expected to do.
When I went through this experience as an operator, I thought it might be a one-off. What I have seen as an investor is that this situation was not unusual. There are three types of exits – great ones, good ones, and disappointing ones – and this is especially true for management teams given how committed they tend to be to the start-up effort. A lot is written about great exits and good exits, but the disappointing ones are often the most difficult and are the exits that require the greatest amount of heroism, fortitude, and personal integrity from the leadership. Think about it. People have been with the company for five years or more. They have worked unusually long hours and often for below market pay. They started the company with a vision and there was a period of excitement and growing expectation as external capital was raised and expectations rose further. Then something happened, setbacks occurred, and finally the company was sold with the management team / founders receiving possibly, at best, a percentage of the proceeds in a carve-out. And they take a job offer that they feel they need to accept because not doing so could kill the deal.
These disappointing exits are often the types of businesses that are targeted by our portfolio companies, which see the opportunity to acquire talent, technology, IP or customers. So when our portfolio companies are considering “tuck-in” acquisitions what should a they, as a buyer, expect when buying a crash-landed business? Which people will stay and which will go? What do we recommend that our portfolio CEOs think about to make the combination successful?
My experience with the acquisition described above turned out to be a great one. Certainly there were challenges but the technology was solid, the customers were relatively stable, and we got some great talent, some of whom became key members of the leadership team. There are thousands of distressed venture backed businesses, many of which have some great core assets in terms of technology and people. The secret is knowing what you are buying and what to expect so you can have a similar experience.
Potential acquirers have the chance to buy something valuable for cheap and to really gain some extremely talented employees. Startups (and especially distressed start-ups) are often less like jobs and more like tumultuous relationships. People are emotionally drained and have committed extraordinary levels of effort and mental energy to an idea that has failed. Often they have also made financial sacrifices that are taking a toll. Toward the end, leadership teams often work for discounted salaries or defer compensation. Bonuses most likely have not been paid. Stress and uncertainty and discussions of the “zone of insolvency” have likely been daily realities. The key for retaining and motivating these people is to offer them stability and opportunity and over time many will get excited about the new vision. Remember to be patient and let them recharge their emotional batteries – it takes time but it will be time well invested. In then end this will buy you the loyalty and passion you are counting on from the new team. Finally, have a going away party for the CEO and other departing leaders. Let them leave with pride, but let them leave. The transition is complete once the CEO has left the building.