Random Thoughts – Randocity!

CEO Question: Should I sell my business to a Venture Capital group?

Posted in botch, business, howto, tips by commorancy on February 5, 2022

person with keys for real estate

This may seem like a question with a simple answer, but there’s lots to consider. The answer also depends on your goals as CEO. If you’re here reading this, then you’re clearly weighing all of your options. Let’s get started.

Selling Anything

A sale is a sale is a sale. Money is money is money. What these cliché statements lack in brilliance is more than made up for in realism. What these statements ultimately mean is, if the entire goal of selling your business is to make you (personally) some quick money, then it honestly doesn’t matter to whom you sell.

Selling your company to your brother, a bank, another corporation or, yes, even a Venture Capitalist group, the end result is the same: a paycheck. If your end goal is that paycheck and little else matters, then you can end your reading here and move forward with your sale. However, if your goal is to keep your hard built business, brand and product alive and allow it to move into the future, I urge you to keep reading to find out the real answer.

Selling your Company

Because you are here reading and you’ve got some level of interest in the answer to the question posed, I assume, then, that you’re here looking for more than the simple “paycheck” answer. With that assumption in place, let’s keep going.

Companies are complex beasts. Not only does a company have its own product parts that makes the company money, companies must also have staffing parts, the people who are hired to support those product parts and maintain those new sales.  Basically, there are always two primary aspects of any business: product and staff. As a CEO, it’s on you to gauge the importance levels of each of these aspects to you. After all, your staff looks to you for guidance and they rely on you for continued employment. There’s also your legacy to consider and how you may want to be remembered by the business (and history): positively, negatively or possibly not at all.

Reputation

Let’s understand that in countries like China, reputation or “face” is the #1 most important aspect of doing business. I don’t mean the business’s reputation. I mean the person’s own reputation is at stake. If the person makes a critical misstep in business, that can prevent future opportunities. In the United States, however, “face” (or personal reputation) is almost insignificant in its importance, especially to CEOs. Short of being found guilty of criminal acts (i.e., Elizabeth Holmes), there’s very little a CEO can honestly do to fail their career.

Indeed, I’ve seen many “disgraced” CEOs find, start, and operate many more businesses even after their “disgrace”. It’s even possible Elizabeth Holmes may be able to do this after serving her sentence. As I said, in the United States, someone’s business reputation means very little when being hired. In fact, a hiring business only performs background checks to determine criminal acts, not determine whether the person has a success or failure track record at their previous business ventures.

Why does any of this matter? It matters because no matter what you do as a CEO, the only person you have to look at every day in the mirror is you. If you don’t like what you see, then that’s on you. The rest of the industry won’t care or even know what you’ve done in the past unless you disclose it.

Venture Capitalist Buyouts

At this point, you’re probably asking, what about those Venture Capital Buyouts? Are they good deals? That really all depends on your point of view. If you’ve put “blood, sweat, tears and sleepless nights” into building your business from literally nothing to something to be proud of and you still hold any measure of pride in that fact, then a Venture Capital group buyout is probably not what you want. Let’s understand the differences in the types of buyouts.

  1. Direct Business Buyouts — These are sales made directly to other businesses like Google, Facebook, Amazon, Apple and the like. These are sales where the buyer sees value in not only maintaining the brand and products under that brand, but building that brand as a sub-product under the bigger buyout company. With these kinds of buyouts, your product will live on under that new company. Additionally, the staff have the option to remain on board and continue to maintain that product for the new company for potentially many years. This kind of buyout helps maintain the product and maintains “face” among staff members. This kind of buyout rarely involves resale and, after the acquisition dust settles, is usually seen as a positive change.
  2. Venture Capital Buyouts — This kind of buyout is an entirely different beast. Venture Capitalists are in the purchase solely to make money off of their “investment” as a whole. The business itself is the commodity, not the products sold by the company being purchased. No. Venture Capital buyouts are a type of investor who buys a “business commodity” to “fix up” then “flip” to make their investment return. Thus, Venture Capitalists don’t honestly care about the internals of the products or solutions the company offers, only that those products / solutions become marketing fodder for their sales cap. Venture Capitalists do weigh the value in the products prior to the purchase, but beyond that and once the purchase completes, the business is treated not as an ongoing concern, but as a commodity to be leaned out, fixed up and made attractive to a buyer. This kind of buyout always involves resale. This fact means that remaining staff must endure acquisition twice in succession, probably within 1-2 years. This kind of buyout is usually viewed by staff (and the industry) as a negative change.

Thus, the difference between these two types of purchases is quite noticeable, particularly to staff who must endure them.

Undervalued

[Update 2/8/2022] Everything up to this point has only implied what this section actually states. I’ve decided to explicitly state this portion because it may not be obvious, even though I thought this information was quite obvious while writing the initial article.

Bottom Line: If a Venture Capital group is considering a purchase of your business, know that what the VC group is offering is only a fraction of what your business is actually worth. They can’t make money if they pay you, the seller, the company’s full value. Keep in mind that the VCs consider the business a “fixer upper”. That means they will invest “some” money into the business to “dress it up”. How that “dress up” manifests isn’t intended to turn your business around, however. What “dress up” means is investing money to make the business look pretty on paper… or, more specifically, so the books look better. That means they’ll pay an accountant to dress up the numbers, not pay to make your business actually better. Though, they will cut staff and then pull out the whips to make sure everyone sells, sells, sells so the business appears to have better year-over-year profits. When a prospective buyer looks at the books, the buyer will notice improved numbers and, hopefully, be willing to fork over double (or more) what the VCs paid to buy the “company” from you, the original seller.

Even the smartest, brightest, most intelligent CEOs can be taken in by the lure of a Venture Capital Group company purchase offer. Know then that what VCs have offered you isn’t what your company is actually worth.

Ultimately, it also means that you as the seller are being taken for a ride by the VCs. You can dress up your own company and do exactly as the VCs. Then, find a direct buyer willing to pay double what the VCs offered, which will make you twice as much money AND remove the VCs entirely from the picture as an unnecessary profiting middleman.

Acquisition Woes

Being the acquired company in an acquisition is hard on staff. Lots of questions, few answers and during the transition there’s practically silence. It’s a difficult process once the deal closes. It only gets worse. Typically, the then CEO becomes a lesser executive in the new firm. However, most times the CEO changes position not because they want to, but because the buyout contract stipulates a 6-9 month transition period and obviously most companies don’t want two CEOs. Though, I have rarely seen transitions that agree to co-CEOs. It’s an odd arrangement, though.

This means that the newly demoted executive is only on board to complete the transition and receive 100% of their contractually agreed buyout payment. In fact, most buyout contracts stipulate that for the CEO to receive their 100% payout, they must not only remain on board in a specific position for a specified period of time, they may also be required to meet certain key performance indicator (KPI) metrics. So long as all goals are met, the contract is considered satisfied and the former CEO receives 100% payment.

However, if some of the goals are only partially met, then reduction of payment is warranted. Such other metrics may include retaining key staff on board for a minimum of 6 months. If any general staff have ever gone through a buyout and have received a special bonus or incentive package, that’s the reason. The incentive package is to ensure the CEO’s KPI is reached so that the contractually defined buyout payment is paid at or as close to 100% as possible. This is also why these acquired executives can get both grumpy and testy when they realize their KPIs are in jeopardy.

Trust

Let me pause for just a moment to discuss a key issue, “trust”. While contracts stipulate very specific criteria, such as payment terms, not everything in a buyout is covered under the contract. For example, the acquiring company’s executives can find anything they wish wrong with the KPIs to reduce payment. Contracts usually do not contain intent clauses that hold the acquiring company execs accountable if they “make up” flaws in the agreement that don’t exist. It is ultimately the acquiring executives who decide whether the KPIs have been met, not the incoming CEO. If you trust these people to be morally and ethically sound, then you have nothing to worry about. However, because Venture Capitalists aren’t always practical in what they do and are driven by the need to see a return on their investment, they could find faults in the KPIs that don’t exist, solely to reduce payments. Basically, you’ll need to be careful when extending trust. Meaning, you must place full trust in those VCs willing to purchase your company. This means, doing your homework on these people to find out where they’ve been, who they’ve worked with and, if possible, get references. Let’s continue…

Buyouts with Strings

Every buyout has strings attached. No buyer will purchase a company outright for straight up cash without such strings. Such strings ensure the company remains intact, that key staff remain on board and that the product remains functional. These are handled via such stipulated “insurance policy” clauses in the form of KPIs applied to acquired CEO and executive team. These KPIs, when reached, allow the business seller to receive payment for reaching those KPIs. Were key staff to leave and the product have no knowledgeable or trained staff left to operate the product, then the purchase would be useless and the product would fail. For a buyer, requesting such insurance policies in the contract is always a key portion of buyout contracts. Expect them.

Saving Face

Circling back around to Venture Capital group buyouts, it’s important to understand that the point of such a buyout is for those “investors” to return their investment sooner rather than later. The sooner, the better. That means that their point in a company purchase by a Venture Capital group is not to take your business into new and bigger directions by dumping loads of money in and growing it. If they dangle that carrot in front of you, know that that’s absolutely not how these deals work. Don’t be deceived by the dangling of this carrot. This carrot is absolutely to get you to sell, but will almost just as definitely not pan out… unless it’s contractually obligated.

On the contrary. They’ve spent loads of money already simply buying the company. They’re not planning on dumping loads more cash into it. Instead, they plan to lean it out, get rid of stuff that wastes money (typically HR, insurance and such first), then move onto erasing what they deem as “useless” staff and wasteful costly third party services (ticketing systems, email systems, marketing systems, etc).

As for staff cuts, this means asking managers to identify key staff and jettisoning those staff who aren’t “key”. This usually comes down in the form of a mandate that only X people can be kept on board out of Y. For example, 10 people may be employed, only 3 may stay. Who will you pick? That then means jettisoning 7 people from the staff roster.

You won’t know this aspect going into the deal because they won’t have made you privy to these “plan” details. It also likely won’t be in the buyout contract either, unless you requested such a buyout stipulation. It’s guaranteed you’ll find out this plan within 10-20 days after the deal closes. As I said, the Venture Capitalists don’t look at it as an ongoing business to help flourish, they look at it as commodity to lean out, pretty up and hope for a high priced buyer to come along.

Venture Capitalists understand that it does cost some money to make money, but they’re not looking for a money pit. The purchase price is typically where the money pit ends. You shouldn’t expect an infusion of cash as soon as the Venture Capital firm closes the sale, unless such investment has been stipulated in writing in the purchase contract. Of course, you are free to take some of your own sale money and invest it into the business, but I don’t know why you’d do that since you no longer own the company.

What this means and why this section is labeled “Saving Face” is that eventually you’re going to have look into the face of not only the 7 people you had to fire, but the 3 people left and explain what’s going on. These situations are extremely hard on morale and makes it exceedingly difficult for those 3 who stayed on to remain positive. Surviving a huge layoff cut is not a win. In fact, it’s just the opposite. It’s also not simply a perception issue, either. Such a huge layoff places an even bigger burden on those who remain.

The 3 who remain feel as though they’ve lost the lottery. Now those 3 must work at least 10 times harder to make up the work for the 7 who are no longer there. Honestly, it’s a lose-lose situation for the acquired company. For the venture capitalists, it doesn’t matter. They’ve leaned out the company and the books now “appear” way better and the business also “appears” far less costly to operate in the short term. “Short Term” is exactly what the VCs are banking on to sell the company. This makes the “business” look great on paper for a buyer. As I said, the quicker the Venture Capitalists can flip their investment and make their money back, the better. The VCs are more than willing to endure hardship within the acquired company to make the company appear better for a buyer. As the saying goes, “It’s no skin off their noses”.

Technologists vs Venture Capitalists

Being a Venture Capitalist and being a Technologist are two entirely separate and nearly diametrically opposed jobs. It’s difficult to be both at the same time. As a technologist-founder-turned-CEO, the point is to build a business from scratch, allow the business revenues to help grow the business further and expand and build a reputation and customer base. Building a business from scratch is a slow road to a return on investment, which typically takes many, many years. That investment takes years to accrue, but can make an executive a lot of ongoing money. Just look at Jeff Bezos and Amazon. It can and does work.

As a Venture Capitalist group buying companies, the point isn’t to build a business. It’s to buy already built businesses as “commodities”, lean them out, make the books look great, then sell them for at least double the money, usually in months, not years. If the VCs dangle a “five year plan” in front of you, claiming to grow the business, please re-read the above again. To spell it out, there’s no “five year plan”, unless it randomly takes the VCs that long to line up a buyer. That’s more of an accident than a plan. The VCs would prefer to line up a buyer far sooner than 5 years. The “five year plan” rhetoric is just that, rhetoric. It was told to you, the seller, to keep you interested in the buyout; not because it is true.

If the “5 year plan” carrot is dangled in front of you, then you need to have the VCs put up or shut up. What this means is, make them write the “5 year plan” investment explicitly into the purchase contract. If they are legitimately interested in growing the acquired company, they should have no problems adding this language into the buyout contract. This will also be your litmus test. I’d be highly surprised to actually see VCs contractually agree to adding such “5 year plan” language into the purchase contract.

As I said above, these two types of jobs are nearly diametrically opposed.

One method slowly builds the company as a long term investment opportunity, the other uses the existing whole company itself as a commodity to sell quickly as a fast return on an investment. As a CEO, this is what you must understand when considering selling your business to a group of Venture Capitalists.

If you want your business and brand to continue into the future and have a legacy listed in Wikipedia, then you want to keep your business going and growing. Once you sell your business to VCs, the brand, product and, eventually, staff will all disappear. Nothing of what you built will remain. Selling to a Venture Capital group likely ensures that this process happens in less than 1 year.

Selling to a direct business, the brand naming may hang around much longer than 1 year. It’s really all about whether you care about your legacy and your resume. You can’t exactly point to producing a successful business when nothing of it remains. Selling the company makes money, yes, but has a high chance of losing everything you’ve spent loads of time building. Unfortunately, Venture Capital group purchases almost ensure the fastest means to dissolution of the brand and of that time spent building your business. Still, a paycheck is a paycheck and you can’t argue with that in the end.

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