When a Strategic Sale is not the Right Sale

A capital-efficient, bootstrapped business can be a formidable presence to larger vendors in a market. It is a bit of the David and Goliath story: smaller competitor takes what is rightfully theirs from a sizeable peer. Except instead of a rock and a slingshot, these founder-controlled businesses are armed with customer centricity, agility, service quality, and a mission-driven workforce (vs. a workforce filled with mercenaries).

A common response by larger players is to make a “Strategic Offer” – to buy out these nimble and high-quality companies and make the problem go away.

While strategic offers can create significant returns for founders in certain scenarios, it is these rare, outsized outcomes that we typically see in the press. For most sellers, strategic offers come with obstacles to navigate: mirage-like valuations, onerous founder lockups, and often the deterioration of the business post-close as measured in customer satisfaction, employee retention, and dare we say the company’s spirit, as nebulous as that may sound.

Below we unpack some of these elements further.

Headline Price: This is the number any buyer throws at you. Whether it is for 100% of the business, or just 5%, you get an Enterprise Value (EV) figure that assesses the entirety of the business. In Strategic Offers, the structure is almost always for a super majority (2/3rds+) of your company, and often, 100%. Headline price is the most emotionally charged aspect of any offer, and Strategics use this to lure Founders into a period of exclusive negotiations. While these prices come to fruition in certain cases, too often Strategics use a large headline price to get you to the table, only to grind down EV through the course of diligence. This grind-down (which high-volume software aggregators are famous for too), looks like:

  1. Headline price reductions.
  2. Shifting more of the price into contingent outcomes around growth, EBITDA performance, or strategic outcomes (e.g., winning 10 new customers in anew market).

The main challenge with contingent outcomes here is that Strategic buyers often squelch the ability for your company to achieve growth or profitability due to: centralized decision making, layers of bureaucracy, and strategy designed by external teams (most of whom have never actually worked in a software company). This makes these variable, contingent outcomes described above very unlikely to be achieved.

Upside: As noted, when a strategic makes an offer the most common structure presented is a 100% buyout. With this structure comes several economic, emotional, and philosophical questions to grapple with. On the economic front, one of the trade-offs for this max headline price described above is the missed opportunity to participate in future growth. It is rare that a founder is invited to “roll equity” and re-invest back in the business alongside new strategic ownership, parting ways with any investment or involvement in what they have built.

For founders who believe deeply in what they have created and are energized by the thought of what is to come, headline price can be supplemented by this opportunity to participate in continued growth. Expanding growth rates can come from the continued professionalization of sales and marketing, market tailwinds created by operating in a portfolio of adjacent companies or, completing some M&A of your own, all while maintaining economic and emotional ties to the business.

Legacy: From the carefully cultivated customer base and the staff that helped build the business, to the community it sprouted out of and the intangibles of brand reputation; the notion of legacy can take many forms. When a Strategic acquires a business, the end-goal is “integration.” Integration typically looks like: moving customers off existing contracts, re-platforming products, restructuring/downsizing teams, and assimilation into existing processes. Change of this sort can be distressing for Founders as they watch investments in their clients, people and processes undone.

Process: Most Founders only sell one business in their career. This process can be fraught with challenges, both logistical and emotional. Strategic buyers are not known for their speed and efficiency in execution. As a result, be prepared for longer discovery, exclusivity, and diligence periods, marked by third-party involvement and a lack of expediency towards executing on-schedule. Strategic acquisitions always have a ‘deal-risk’ overhang from a potential change in corporate strategy by the buyer. There are many stories of Strategic buyers backing out at the last minute due to unexpected changes in corporate strategy, stock price sell-off or reshuffling of executives.

Every Founder will weigh these factors differently when considering whether to sell their business to a Strategic buyer. We believe Arcadea presents a distinct alternative for those that operate high quality businesses and who prioritize upside and legacy over headline price.