Fmr Livemocha Co-founder on How to Plot Your Exit Strategy

Most companies don’t explicitly plan on getting acquired. By the time that they decide to sell their company, it is often too late as they have run out of money. How can you have the upper hand on a possible acquisition if and when the time comes? Fmr Livemocha co-founder Shirish Nadkarni talks about his experience with exits and how to plan your exit strategy and build relationships with potential acquirers.

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On steps to plotting your exit strategy

When thinking about your company’s potential exit strategy, you want to be bought, not sold. Shirish shares how you should be an active player in the acquisition process.

“It’s important to figure out who are potential acquirers for whom your technology, your revenue stream, your user base, can be strategic for them. As you think about your company and potentially what kind of exit strategy you might have, it could be through an acquisition or it could be through an IPO. One of the things that I’ve done in the past and one of my board members used to insist is that we keep a list of companies of would-be potential acquirers, even though you might not be looking to sell your company at that point. We felt that we had to keep a list of companies that would be potential acquirers, and then during our board meetings, we would keep that up-to-date and update our board members on any changes in strategy or changes in that list. 

What we did was explore business development relationships with these potential acquirers. So you might, for example, have a solution that would be a good fit with Salesforce, then you might want to join their marketplace, obviously, because it’s important for you to get customers, but also it’s a way that somebody like Salesforce can become familiar with your company. If they find out that you’re selling really well through their channels, then that gets visibility within the organization. Of course, you shouldn’t rely just on people to become familiar with your company on their own dollar. You should seek visibility with the right product organization, with the CEO, the top management team, so that they’re aware of your company, of your technology, and your user base. Hopefully, over time they may come to the conclusion that your company would be a right fit for that product strategy. 

One of the other things that is emphasized for founders is that the best time to sell your company is when revenue growth and economy are really, really strong as it is right now. Companies often make the mistake that revenues are really strong, the economy is strong, that growth will continue forever. Eventually, there’s a recession or downturn and funding becomes scarce. You’re forced to sell at that point, and that is not a great time to sell your company. As the saying goes, you want to be bought, not sold. When the economy is strong and your revenue growth is strong, you’re going to get much higher multiples for your sale. Then you look to hire an investment bank to help you manage that process.”

On tools for your exit strategy

The investment bank can play an important role in your acquisition. They can be the ones who can be aggressive with negotiations on your behalf, among other strategies. 

“The investment bank can play a very important role in managing your acquisition. They can provide you with a solid valuation range, backpack comps, comparables within the industry so that you have a good understanding of what is the potential valuation that you could be sold. They have contacts at multiple companies, typically through their corporate development arm, which is fine. Though obviously, you’d like to go to the product organizations where possible, but they can line up multiple suitors. They can manage the process so that all the suitors are valuing the company at the same time and then they can figure out who among those suitors are serious about the acquisition, and they can manage the deal and negotiate the deal with potential suitors and get the best possible price for the company. 

It’s important to have this because eventually, the management team for the company will join the acquiring company. You don’t want to upset the acquiring company by negotiating very hard, whereas an investment bank can do that on your behalf and work with the board to get the best possible deal for the company.

Typically, the investment banks will charge anywhere from 2% to 4%. They charge a retainer fee typically, as well, and then there will be an incentive for getting a higher valuation beyond the valuation range that they provided to you. So if they’re able to get you into the higher range of the valuation that they provided, then typically the fee will be higher, which is a good incentive to have. You definitely are motivated to get a higher price, and we don’t mind giving the investment bank a higher fee if they’re able to go beyond our typical valuation and to higher multiples for your company. The other thing to understand is that they have an 8-month to 18-month deal typically. So even if there is no immediate acquisition, let’s say for six months and kind of wind down the process, and you fire the investment bank or terminate that relationship. If there’s an acquisition within 18 months, you still have to compensate the bank for that acquisition. So you should keep that in mind as you manage any kind of acquisition for your company. …

Your board members are very critical to that process. First of all, they can help you identify potential investment banks because they’ve been involved with other M&A activity in the past, so they can help you identify the appropriate investment bank. You need to do a lot of diligence on the investment banks to make sure that the price range that you plan to sell at is a good fit with the investment bank. If you think you’re selling a $50 million range, you don’t want to go to Goldman Sachs and look because it’s too small for them, it may not get their attention. The board members can also be potential sources as they might have better contacts within potential acquirers, and they can get you the contacts that you need into the company.”

On criteria for going public

Devising your exit strategy as you build the company can be different for each one, with multiple options for each one. Some of these companies have more than $100 million in revenue, and this allows them to go public, among other aspects.

“There are a number of companies that will scale to $100 million and beyond, and that makes them prime candidates to go public. Typically the criteria for going public is $100 million or more in revenues, though, there are companies like Zillow, for example, that went public at a much lower revenue arrangement. They are growing very rapidly, you have to be growing predictably at a pretty high growth rate, 25% to 50% growth rate. You have to have a good ability to predict your future revenues and earnings because the last thing that you want to do once you go public is to disappoint your investors and analysts. Once you do that, it’s very hard to come back, and so being able to predict your revenues is critical for going public. 

Clearly, a lot of tech companies are not profitable when they are going public, but there needs to be a path to profitability that you can see within the next 18 months to two years. You need to have an experienced management team and board. There are times when the co-founder is like Mark Zuckerberg, is very young, and has no prior experience of going public. Obviously, hiring an experienced CFO who’s done this before and having a different board is all very important. Then the company needs to have very strong financial operations and controls well before going public. They need to be reporting internally on a quarterly basis so that they have the rhythm in place, once they go public because that’s what they will need to do, to report on that on a quarterly basis. The entire financial operations and management have to be a well-oiled machine by the time you go public.

There are a number of ways that you can go public. You have the traditional IPO process … but more recently, there have been two other mechanisms. One is SPACs and the other is direct listing. SPACs is the terminology that stands for special purpose acquisition companies, which essentially are companies that have raised money without any business plan except to take other companies public using reverse merger. SPACs became really popular in 2020. …The problem is most of the companies that have gone public using a SPAC have immature business models. … The companies that go public or traditional usually have much more mature business models, and so the risk is that they don’t have the revenue predictability and they missed their revenue guidance and earnings guidance. As a result, their stock loses value. …

Finally, you have direct listing as a mechanism to go public. Essentially, the complaint with the traditional IPO process is that it’s considered normal to have a big pop on the day of the IPO. It’s concerning to be successful that there’s a big pop, but what’s happening with the big pop is that you’re leaving a lot of money on the table. You could have priced your shares at a much higher price, but the investment bankers are conservative in pricing the IPO because they have their own clients to deal with who are buying those shares, the institutional investors. 

They want to see a big pop on that day, but it does leave money on the table. So direct listing is a different mechanism where you’re not really raising money, but you are listing your shares on the day you go public, and you let the market determine the price for your shares. A few companies have gone public using this mechanism. The traditional IPO process is still the most popular way of going public, but [direct listing] is starting to become more popular.”