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In M&A the interests of Investors and Founders diverge

by on January 30, 2014

diverging railway

I read an interesting piece recently by Tomio Geron of ExitRound on Manu Kumar’s 4 Rules of M&A for Start-up Founders.  You can read it here.  Manu Kumar is a founder of seed stage venture firm K9 Ventures.  He focuses on investments that have a hard science or new technology focus.

Geron writes that Kumar is often actively involved in M&A negotiations for his startups and that  he often meets and negotiates with buyers on behalf of his startups.  I agree with a lot of the advice Kumar gives in this piece but I don’t agree with that position.

Use an Intermediary

In the piece Kumar explains that it’s important that the founders focus on building the company and for someone else to meet with potential acquirers on behalf of the company.  I agree with this statement.  For founders the company is their baby and emotions can run high.  In the M&A process it is very important to keep emotions in check.  An intermediary can be objective, act as a filter, and not see the potential acquirer as an adversary.

Build a Standalone Business with an Eye towards Selling

Kumar states, and I agree, that founders need to passionately build their standalone company but at the same time build a company that could be acquired by early identified potential acquirers.  Do not build a company with the intention of selling it. If you do that that’s setting it up for failure. Build a self-sustaining company. But at the same time you can do things to attract potential suitors. At the point of inception you can identify who could be potential M&A targets.

VCs’ and Founder’s Interests Diverge

Kumar goes on to state that his involvement in the M&A process, representing the company and the founders to corporate development departments of larger companies and even negotiating the deal terms, isn’t a conflict of interest.  Granted, he states that may be true for him because of who he is and the size of his fund, but I don’t believe this is true for most VCs.

In fact, most VCs interest will diverge dramatically from a Founder’s once the LOI is received.  That’s hinted at in the article.  VCs do not invest in companies to get a small return.  They invest to get a 10x return.  Yet a company could offer an amount that creates a good return for the Founder but the VC doesn’t make 10x so they refuse to sell.

VCs Control the Sale

I know of one company that took a large investment from a group of VCs at a pretty high valuation.  One of the founders told me after that happened that he was truly scared because he could work for the next 5 years growing revenues by 25%-30% each year, and ultimately sell at a valuation that would net him no more than if he sold today at a much lower valuation.

In fact, he got an offer from a very large company that he would have taken in a heartbeat but the VCs said “no.”  They wanted a lot more.  Another year later the VCs got an offer at the number they were looking for.  Ultimately it worked out for everyone, but there was a price to pay.  Yes, the founder made more money with the higher purchase price but there was a price to pay.  He had to work building and selling his company for another year PLUS he had to work at the acquired company as an employee as part of the earn-out for another two years.  That didn’t matter to the VCs at all.  They got their money and moved on.  Their interests were definitely not the same.

Founder’s and Management’s Representative

Kumar is likely an exception to the rule.  VCs’ and Management’s interests are not the same and that can become very clear in the M&A process.  That’s why I advise the Founder’s and Management to seek their own guidance, to get their own representative, to hire the intermediary that looks out for their interests.

Thinking about buying another company or possibly selling your own and want to learn more about making your deal a great one?  Contact me today for a complimentary, no obligation, initial consultation to determine if I am the right person to help you reach your goals.  No matter what, you’ll walk away from the meeting more confident about your future!

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