\n<\/p>\n
My previous article<\/a> summarized the exit \u2014 when investors, founders, and employees can turn their shares in your startup into cold, hard cash.<\/p>\n Since investors are investing not to donate to your company but to make money, in the end the only thing we actually care about is the end \u2014 the exit. But we care about some exits more than others because some types provide better returns.<\/p>\n For venture-backed startups, there are 3 successful exits:<\/p>\n The IPO is the best exit since the valuations of public companies are highest. But outside of pharma and fusion energy, a listing on Nasdaq or NYSE generally requires a company to be hurtling towards if not already leaving the $1B ARR milestone far behind.<\/p>\n If you\u2019re a leading rocket launch company, an EV manufacturer, or a developer of GenAI, an IPO is the clear path to the highest value exit. If you\u2019re a test tool maker or AI for bowling, an IPO is unlikely. Though IPOs make big headlines, there are only a handful each year.<\/p>\n At the other extreme is a private equity exit. PE will buy up any company generating healthy profits. It\u2019s the usual exit for a smaller, bootstrapped business with consistent earning. That rarely means venture-backed startups, and exits are a small multiple of operating profits, leading to a low-value exit. It\u2019s not the exit venture investors hanker for when they write you a check, but one we too-often have to settle for when the company\u2019s growth stalls. Stay tuned for full details of PE exits in my next article.<\/p>\n The usual exit for venture-backed startups, the end goal of 95% of startups, is an acquisition by a strategic acquirer, usually an industry giant.<\/p>\n If your valuation at pre-seed is $10M, you need to reach an exit in the $500M \u2014 $1B range to be a successful venture investment. At a $20M valuation, that\u2019s $1B \u2014 $2B exit.<\/p>\n Who has a billion dollars on hand to acquire a startup? Not me. It\u2019s usually one of the companies in the S&P 500. Not only do most of them have healthy bank balances, but public companies have tradeable stock that\u2019s just as good as cash.<\/p>\n While there are exceptions, a successful<\/em> exit is almost always an acquisition by a large, public company.<\/p>\n Why will giant Acme Corp snap up tiny Zstartup? There can be many reasons. In fact, each strategic acquirer will have unique strategic requirements and constraints, so every deal is unique. But we can put most of the reasons into the following general buckets:<\/p>\n In some cases, the answer will be a combination of these reasons.<\/p>\n The exit investors are hoping for, the ones that make the headlines, are when an industry giant pays billions for a startup.<\/p>\n That usually means two things: (1) you\u2019re stealing market share from a giant and (2) there\u2019s multiple potential acquirers looking to get their hands on the business.<\/p>\n Nobody wants to pay more than they have to. Your job as startup CEO is to make them have to pay more than they want.<\/p>\n An initial offer to acquire the business will usually make business sense for them. If you\u2019re doing $100M in revenue and losing money at it, they might do an analysis that says they can increase revenues to $200M and generate $40M in profits. So they\u2019ll offer $150M.<\/p>\n Since the VCs have valued the business at $1B, you\u2019ll laugh at their offer (until the following year when VCs stop funding you and you run out of cash and are desperate for that $150, which is now reduced to $50M.)<\/p>\n If you\u2019re growing quickly and stealing their market share, they might come back with a slightly higher offer like $200M to protect their existing multi-billion dollar cash cow. Meanwhile you reach out to their big competitor and offer them a way to grab market leadership. For a price. A steep price.<\/p>\n Suddenly there\u2019s a furious auction between two giants with more cash than brains, fighting over your startup that unlocks leadership of a critical market for them. Now the price starts climbing into the stratosphere.<\/p>\n How much will a strategic acquirer pay? The answer, of course, is it depends. It depends on the acquirer, depends on the type of deal, depends on the industry, depends on how quickly you\u2019re growing, how big the potential market is, and how desperate they are.<\/p>\n So it seems a bit absurd for investors to ask even before you\u2019ve finished developing the product how much the company will be acquired for. But they will. I guarantee it.<\/p>\n Investors need to know there are industry giants that care about this problem. Industry giants that make acquisitions and aren\u2019t afraid to pay big bucks. If your startup is an obvious acquisition target for Meta, Google, or Amazon, that\u2019s guaranteed to get investors excited.<\/p>\n A decent rule of thumb for a successful strategic exit is 5x revenues. But you need to do better than that. Create a spreadsheet of startups similar to yours that have been acquired and find out the acquirers and multiples. The ranges will be wide, but patterns should emerge. Show investors the range and the mean value, while highlight the big successes.<\/p>\n The challenge is that both acquisition prices and startup revenues are rarely disclosed except for the biggest deals. So finding the acquisition multiples can take detective work. Often they will have to be estimated or guessed at based on anecdotal discussions.<\/p>\n For bigger industries, the investment banks often publish reports listing recent M&A activity. Reach out to the analysts who wrote the reports as they might be able to discreetly mention some additional non-public information.<\/p>\n The best way I find to get acquisition multiples is to talk to other founders, especially ones who\u2019ve been through previous exits. They know the numbers and though they\u2019re supposed to be confidential, you can usually get enough partial information to piece together some reasonable guesses.<\/p>\n Though there can be exceptions, S&P 500 giants rarely buy startups with revenues under $100M. It just doesn\u2019t make sense for them.<\/p>\n An acquisition will cost the company millions in legal and M&A fees. It will consume valuable time of top executives. It will have to go through multiple layers of approvals, all the way to the board. It\u2019s not worth the hassle to buy up a budding startup with only $10M in revenues, even if it\u2019s a tenth of the cost they\u2019ll have to pay when the startup reaches $100M.<\/p>\n Just an important, giants don\u2019t want to build a startup. They want to buy a finished product that they can sell immediately to their big customers. A $10M startup is still an experiment. It\u2019s still iterating. It\u2019s still developing the core feature set. It\u2019s still dependent on the founders and a few key employees who are likely to leave after a year or two.<\/p>\n So $100M in revenues is widely considered the key milestone. Startups who haven\u2019t crossed that hurdle are considered too immature. They may watch you and reach out to you for periodic updates, but are unlikely to bite. Once you reach that $100M mark, then you become a legitimate, high-value acquisition target. This is why every venture-backed business plan has to be about reaching $100M and getting acquired by an industry giant.<\/p>\n Our goal as startup founders is to reach an acquisition. And yet, depending on your definitions of failure and success, somewhere around 75% of corporate acquisitions fail. (HBR estimates 70\u201390% failure rate in this report<\/a>.)<\/p>\n A few companies know how to do acquisitions and integration well. The vast majority are a disaster.<\/p>\n Strategic acquisitions are highly dependent on the goals and incentives of the acquirer\u2019s executive team. But big corporations are constantly changing their goals and shuffling executives. Integrating a small (by industry giant standards) startup is a far lower priority than the daily feeding and care of the company\u2019s cash cows.<\/p>\n To provide incentives for the employees to stay, a significant fraction of the deal value may be structured as earnouts. These can be as simple as a requirement to remain at the acquirer for 2 or 3 years to earn large yearly bonuses or vest shares. Or can be paid upon reaching milestones such as hitting product release requirements or revenue targets.<\/p>\n Especially in smaller, earlier-stage deals, earnouts might account for all the payout to the founders and executive team. And that leads to obvious problems.<\/p>\n Can you meet those goals when the resources that you need \u2014 developers and sales team \u2014 are no longer under your control? Promises sound great during the honeymoon phase when both sides are dedicated to making the acquisition work.<\/p>\n But what happens when the company changes strategy? Or the executive championing your product within the company leaves? Or it becomes obvious that you won\u2019t hit those optimistic goals?<\/p>\n Then the finance team comes looking for ways to save money. Cuts to staff. Cuts to marketing. Then the legal team might come looking for ways to grab amounts being held in escrow or even clawing back stock or bonuses already issued.<\/p>\n\n
Why An Industry Giant?<\/h3>\n
Why Does a Giant Want You?<\/h3>\n
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Get that Auction Started!<\/h3>\n
Checking out the Comps<\/h3>\n
The $100M Milestone for Strategic Acquisitions<\/h3>\n
Pitfalls Of a Strategic Acquisition<\/h3>\n