Beware of Premature Merge Elation
There is a telltale sign of an inexperienced startup entrepreneur. They get premature merge elation. You know, they get so excited about doing deals all the time instead of doing the hard work of figuring out their businesses. I understand this. I was a premature merge elater once. Here’s what I learned:
1. As a startup you shouldn’t focus on buying other companies until you’ve figured out your own business
A close friend of mine in LA who is 3 years into his startup called me about 2.5 years ago and told me, “I just got offered the chance to buy this company because the founder doesn’t want to continue. It has awesome features that my main competitor doesn’t have. I can save tons of development time and I think I can buy it for all equity. How much dilution should I take for it?” My friend’s company was pre-revenue.
Me: “Zero dilution. Pass. Focus on your customers and don’t obsess about deals or keeping up with your competitors releases.”
I’m doing due diligence on a company of another entrepreneur in LA whose company was apparently doing very well. He had bought two companies and was eyeing a third. He had an ad-supported business doing about 1.5 million uniques. 500k had come through the last acquisition. He has raised (and spent) a ton o’ VC money.
My recommendation to our lead partner looking at the deal, “Pass. He’s talented. I’d like to work with him some day. That day’s not now. He hasn’t figured out his core business and he’s spending all of his time looking at ‘deals’ — that’s always a bad sign. He’ll learn the hard way and when we work with him he’ll be more focused.”
Two CEO’s come into my office (this sounds like the start of a joke). They want to merge with other and want to know if I’d fund the combined entity.
Me: Gag.
I lived through the era of companies doing premature mergers. It meant that the management teams hadn’t figured out a product / market fit for their own businesses. It’s far easier (and sexier) to spend your time working on deals — the chase, the negotiation, the secret dinners, the combination of assets, the PRESS STORY! — than it is to tweak features, A/B test products, crank out the next release, improve marketing copy, fly across the country to get a biz dev deal done or just pound the streets selling product.
That’s why immature teams spend so much time on mergers. Been there, done that, made the mistake. Please don’t relearn my lesson. Focus on improving your core business first. If you can’t just get it to work then one day you can focus on selling your assets. A merger is not the panacea.
2. There is no such thing a “merger of equals”
For some reason the industry of bankers who try to buy or sell businesses work in what is called the “M&A (mergers & acquisitions) Industry.” I’ve never understood this. There’s really no such thing as a merger — only acquisitions. I know, I know … technically they can be structured as mergers. But 90+% of all deals involve one company taking over the other.
Yes, they have grandiose statements to make them sound like mergers. Sometimes this involves co-CEO’s. Often senior people from one company are given senior titles at the other. They always have big lovey-dovey press releases. They often involve big hugs on stage. But to be clear the overwhelming majority of deals involve one company driving the cultural integration, establishment of uniform processes, hiring / firing decisions, etc.
This is a good thing. When there is a merger without a dominant buyer you have indecision and malaise.
3. Merging two weak companies is, well, weak
Another common scenario with inexperienced teams is when two struggling companies come together to create a stronger team.
We had a joke about this when I lived in England. We said it was like two people who couldn’t swim across the English Channel (21 miles) putting their arms around each other and trying to swim across together.
The only thing worse than your early-stage company buying another early stage company is you trying to pull off a merger of equals. Trust me — if you haven’t figured out your sh*t — neither have they.
4. Don’t trade your cat for somebody else’s dog
I was recently at the Greycroft Summit in East Hampton. During the weekend Alan Patricoff, the famed investor & founder of Greycroft said, “don’t trade your cat for somebody else’s dog” when talking about merging early stage companies.
I think we had slightly different definitions of this saying but since he coined the term I have to credit him. We both meant mostly the same thing. My version is, “you have a company with private stock. Somebody else is trying to convince you to sell to them in exchange for all stock. Assume they are not a hugely successful and growing company like Twitter, Facebook or Zynga. They’re a bit like you but slightly bigger and better funded. Don’t trade your company (cat) for their stock (dog).”
Why? Look, the chances of your making money out of your own startup are small. Most likely you’ll fail — most companies do. If you’re in the minority that succeed it’s possible that even when you sell you’ve raised too much money and taken too much dilution and your exit price isn’t high enough to warrant a big return for yourself.
BUT … it’s your company. You’re in control. Want to sell early? Your choice (obviously if you get investor consent). Want to double down and GO BIG? Your choice. Want to cut prices and go for market share? Choice, choice, choice.
The moment you sell, somebody else controls the exit timing, exit price, capital raising, etc. And your outcomes are tied to their moves and their stock. If they raise a bunch of capital little ole you isn’t going to be around to have your option pool topped up.
I know you think that you haven’t figured it all out and they seemed so polished. I promise they’re not. Remember that all companies sound great from their press coverage. If they’re early stage like you, they’re likely just dogs.
If you feel that you won’t be successful on your own I’d far rather:
- sell early and take real cash off of the table, even at a lower price than you had hoped for; or
- bring in management who can take your company to the next level and you stay on the board with some control
Neither of these outcomes is perfect. But IMO they are better than trading your cat for somebody else’s dog.
5. Deals are mostly for deal junkies
Deals are mostly done by deal junkies. You can tell who they are because when you want to talk about their business they’re always telling you about the three companies they’re trying to buy.
I confess to being a recovering deal junkie. I learned much about how to make post merger (acquisition!) integration work but the data says they still fail 70% of the time. And I’m convinced another 20% are liars.
6. Don’t do deals just because your VCs or board tell you to
VCs and boards are the worst at this. We can’t help it — deals are in our blood. But once somebody (even a recovering consultant or banker) has been through a post-merger integration and has had to deal with the mess that comes afterward they realize that it is more prudent to focus on your own business.
Still, I often hear about boards pushing teams into mergers. If it is right to buy a company you should consider it. But not just because your board eggs you on. Don’t assume they always have more wisdom than you on this front.
7. There are some times when buying a company (or assets) makes sense — there are especially good opportunities when tides turn quickly
I’m not saying there are never reasons to buy another company for cash and/or equity. It is preferable when you are in the dominant position so you can control the post-merger integration strategy. It is preferable when the other company clearly realizes this. It is best not to buy your competitors — they’ll always want an unreasonable price and think of the sale as failure. It is therefore often hard to culturally integrate them.
There is often a period of extremely good opportunities just after a big market correction. Many investors and management teams panic and get stranded without cash. Prices suddenly become attractive and sellers less cocky.
8. Eight, eight I forget what eight was for, but …
9. If you are going to start acquiring companies make sure you build a core competency for it
As I said there are times in your company’s evolution when buying other companies (or preferably their assets) makes sense. This is when you have already figured out your core business and you’re bolting on related companies in which you can use your company to scale that asset more effectively.
A classic case of a company killing it doing this is AdKnowledge. But they’re big and they have very experienced operators like Brett Brewer running things.
To make acquisitions work you need to know things like:
- how to structure deals
- how to incentivize management teams to stay / deliver value
- how to integrate technology, systems, people and culture
- how to avoid your team vs. theirs
- how to cut redundant costs
- etc.
So if you’re early stage and a first time entrepreneur and you’re bragging about all of the M&A deals you’re working on, just remember that some of us know that you’re secretly a premature merge elater.
