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“The duty of privilege is absolute integrity -
towards ourselves, towards our possibilities and
to live to the full the life that we’d love.”
John O’Donohue
2007
Positioning Your Company
For Exit
SBIR Phase II Conference
June 2017
2
Disclaimer
I am not an attorney
I am not a financial advisor
Please make sure you get advice from excellent paid professionals
3
Crossing a threshold
BEFORE AFTER
4
Thank you: National Pharmaceutical Council, American Pharmaceutical Association, Merck
Today’s Presentation
Part 1: Avoid founder frustration
Part 2: Begin with the end in mind
Part 3: The M&A Process
5
Part 1: Avoid founder frustration
6
What people say:
7
“The investors
screwed us”
“Venture
capitalists are
evil”
“Why don’t they
understand – it’s OUR
money.”
“It was my
idea”
“This is SO
unfair”
BUSINESS & TECH.
Tuesday, May 31, 2016
Mr. Nord says, “Then founders look around three years in, and they have 45 people and no real business model and own 4.5% of their business and are asking themselves what happened”.
8
Avoid Founder Frustration:Know the rules
Willett wins with the lowest score Giants win with the highest score
Both sports are played with a stick and a small ball.
9
Liquidation Preference:
Which is better 1x or 2x?
It depends.
Make sure you have the right experts
on your deal team.
10
Avoid Founder Frustration::Know who is at the table
Understand their incentives
YOU
Directors
Investors
Management team
Employees
Advisors
Acquirer11
Avoid Founder Frustration:Understand how you can
add value
• What is the job of the acquirer/investor?
• What is your job?
– “Advance the science”
– “Publish papers”
– “Build the company”
– “Generate (superior) return for our
investors/limited partners/shareholders”12
Avoid Founder Frustration:Manage Conflicts
There will be conflicts.
Figure out how to manage them.
Figure out if it is time to recuse yourself.13
Avoid Founder Frustration:Understand Business Value
Idea versus Execution
What is your relationship to the company?
Pick your role carefully:
Founder
Employee*
Officer
Director
Investor
Advisor*
Consultant14
http://www.sportingnews.com/nba/
~2003 - Charlotte Christian High School 2015 – NBA MVP
Stephen Curry Rookie (2009): $2.7m
Stephen Curry MVP (2016): ~$22m
https://en.wikipedia.org/wiki/Stephen_Curry
15
Avoid Founder Frustration:Understand Business Value
Idea versus Execution
Avoid Founder Frustration:Understand the Business Value
$1b of sales potential versus $1b in sales
16http://www.bizjournals.com
$2.8B
Valuation
Avoid Founder Frustration: Avoid envy
You don’t need to be envious of someone who won the lottery or had an IPO that went up. You have to figure out what makes sense and follow your own course.
Warren Buffett, April 30, 201617
18
Part 2: Begin with the end in mind
The M&A Process
19
Investor Math – Founder Math
What do I/We get?
Two things:
What percent of the pie do I/We own?
What is the pie worth?
(Valuation)
20
Investor Math – Founder MathThe Cap(italization) Table
The start-up book.com21
Investor Math – Founder Math
The Cap(italization) Table
What percent of the pie to I/We own?
CSE: Common Stock Equivalents
15%
YOU
Everybody else
85%
22
15%YOU
Everybody
else85%
Investor Math – Founder Math
What’s the pie worth?
What do I get?
Pie is worth I/We get
$50 million $7.5 million
$250 million $37.5 million
CSE: Common Stock Equivalents 23
Avoid Founder Frustration:Understand the specific scenarios
15%YOU
Everybody
else85%
YOU
Everybody
else
2%
98%
Pie = Even a penny below
$50M
Pie = “$50M or above”
CSE: Common Stock Equivalents 24
Avoid Founder Frustration:Understand the intricaciesof YOUR liquidation stack
25
THE NEW YORK TIMES BUSINESS THURSDAY, JUNE 2, 2016
ENTREPRENEURSHIP
In their haste to get financing, start-up founders often fail to read the fine print and later discover that they have signed away huge shares of the profits.
26
Liquidation Stack
Where do you sit?
Sale Price: $400,000
Mortgage: $150,000
27
Liquidation Stack
Where do you sit?
Equity
Debt $150,000
$250,000
Valuation: $400,000
28
Liquidation Stack
Where do you sit?
Sale Price: $130,000
Mortgage: $150,000
29
Liquidation Stack
Where do you sit?
Equity
Debt
$150,000
$-20,000
Valuation: $130,000
30
Investor Math – Founder Math
Series A
Exit
2016 2018 2023
Define Key Milestones
or
Key Financing Milestones
Capital required/financing need for Series A
Total capital required/total financing need
Series B
DebtSeries
C
Debt
Preferred
Common
Other
Liquidation
Stack
Where do
you sit?
32
Liquidation Stack
Where do you sit?
Series C
Common
Series B
Series A
Series C
Common
Series A,B Pari Passu
33
Liquidation StackWhat happens when there IS
enough to pay out the whole stack?
Series C
Common
Series B
Series A
Series C
Common
Series A,B
34
Liquidation StackWhat happens when there is NOT
enough to pay out the whole stack?
Series C
Common
Series B
Series A
Series C
Common
Series A,B
35
36
Avoid Founder Frustration:Gains and Losses
Plan for Your Transition
What is your role (if any) in the surviving entity?
Founder
Employee
Officer
Director
Investor
Advisor
Consultant
37
38
Part 3: The M&A Process
The M&A Process
Close
Plan Shop Bids Term sheet Diligence
39
Plan: Assess the state of the current market
• What is more likely – IPO or sale?
• What were the multiples in recent transactions?
– Industry specific
– Stage specific
• Assess the risk of now versus later:
– Take the bird in hand
– Hold out for a higher valuation later
• Past results or previous offers are not comparable
40
Plan: Sale versus IPO requirements
• Product “complete”
• Revenue
• Path to profitability
• Full management team
• Developed salesforce
• Growth story
• SOX-compliant systems
• Audited financials
� �
�
�
�
�
�
�
��
�
�
�
�
�
�
Needed for Sale Needed for IPO
Nice to
have
In most situations, M&A is the more attainable exit
41
Plan: Understand Markets Dynamics
42
43
44http://www.wsj.com/articles/the-cloud-deal-wave-hasnt-crested-yet-1465143376
June 5, 2016
New York Times45
2015: Biggest M&A Year Ever
46The Wall Street Journal
New York Times47
48http://info.kpmg.us/ma-survey/index.html
Valuation
49
50http://info.kpmg.us/ma-survey/index.html
51http://info.kpmg.us/ma-survey/index.html
Valuation
An art and a science
52
53
“The whole process
was crazy-making,
because it was
imprecise. The was no
right number. It was all
a matter of opinion,
feeling, selling.”
Understand Valuation MetricsWhat is Your Company Worth?
Many Valuation Methods:
• Price/Sales Multiple
• Price/Earnings Multiple
• Tops down meets bottoms up
• Industry specific
54
Understand Valuation MetricsWhat is Your Company Worth?
55
Use many methods and develop a range
Be realistic
Investor Math – Founder Math
Series A Exit
2016 2018 2023
Define
Key Milestones
or
Key Financing Milestones
Capital required/financing need for Series A
Total capital required/total financing need
Series B Debt Series C
57
Company
Name
Series A
Req’d
Series A Milestone Total
Capital
Req’d
Long-term
revenue
potential
Potential
valuation
$500K Three contracts: to
establish “track record”
$1.0M $2.25M $5.0M
$1.5M Commercial readiness $1.5M $2.5M $5.5M
$2.3M Two contracts:
“proof of concept”
$2.5M $40.0M $100M
$2.5M Demonstrate efficacy –
(xx) indication
$87M $2.1B $8.0B
$5.0M Two collaborations +
identify own compound
$125M $1.0B $4.0B
$1.5M IND filed for resistant
(xx) cancer
$4M $35M $200M
Investor Math – Founder Math
58
Plan/Prepare
• Know your ecosystem:– Most likely acquirers, alternative targets (your
competitors), existing alliances, consolidation
– Assess the potential buyers for cultural fit
• Know your company’s situation:– Cash out date, burn rate, ability to raise more capital,
money and team to get to the next milestone
• Consider type of sale– What: Asset sale, stock acquisition, merger, tender offer
– How: Targeted sale, auction
– Transact for cash or stock?
59
60http://info.kpmg.us/ma-survey/index.html
Avoid Founder Frustration:Understand You are Part of a Pipeline
61http://info.kpmg.us/ma-survey/index.html
Business Day
62
SATURDAY, JUNE 4. 2016
The sharpest attack came from Greg Duffy, the founder and former chief executive of
Dropcam, the home video camera and cloud-computing service that Nest acquired for $555
million in 2014, about six months after Google bought Nest. Mr. Duffy clashed with Mr.
Fadell, remained at Nest for eight months and briefly moved to another post at Google
before departing last September.
Writing on Medium in late March, Mr. Duffy said he regretted selling Dropcam to Nest and
noted his “extreme differences on management style with the current leadership at Nest.”
63
Which factors are most important when evaluating a target?
Target Valuation and Investment Return
Strategic Fit
Growth Potential
67%
56%
44%
Cultural Fit 15%
http://info.kpmg.us/ma-survey/index.html
Plan/Prepare
• Assemble the deal team– Lawyers, accountants, bankers
• Prepare due diligence materials– Organize the books and records (legal, contracts, IP,
financial statements, NOLs)
• Document the operation– Product description, roadmaps, employees, sales pipeline,
customer listsDocument the operation
• Develop Presentation/Pitch Deck– Non-confidential
– Confidential
64
Documentation for a merger
65
Plan/Prepare:Get Stakeholder Alignment
• Understand the transaction implications
– Change of control provisions
– Vesting, who gets what at different valuations
– Executive compensation
– Retention of key employees
– Effect of recaps or restructurings
• Understand the terms for different “series”
66
Plan: Evaluate the constituencies
Acquirer
� Acquiring business unit
� Executive Management
� Board of Directors
� Shareholders
� Customers
� Wall Street (if public)
� Current Employees
Target - YOU
� Management
� Board of Directors
� Shareholders – by series
� Advisors
� Employees
� Customers
…who are involved at various levels and often have different motivations.
Management needs to understand the shareholder dynamics and proactively influence.
67
68http://info.kpmg.us/ma-survey/index.html
Plan: Before you go
• Establish one spokesperson
• Set fallback plans and walk away points
69
The M&A Process
Close
Plan Shop Bids Term sheet Diligence
70
Shop
• Do’s and Don’ts
– Confidentiality
– Keep the business going
– Management shows concern for employees
– Be able to back-up your forecasts
– Focus on the whole transaction, not just the price
– Robust documentation
71
The M&A Process
Close
Plan Shop Bids Term sheet Diligence
72
Term Sheet/Due diligence:
Process Steps
• Letter of intent/term sheet
• Due diligence
• Definitive agreement
• Board approval
• Shareholder approval
• Regulatory filings
• Closing
• Post-closing filings
73
Terms and Conditions:
What do they mean for you?
• Escrow
• Earn-outs
• Recaps, management holdbacks
• Tax considerations
• Representations and warranties
• Indemnification
• Termination conditions
• Closing conditions74
Considerations
• Federal Securities Laws
• Antitrust Laws
• State Corporate Law
– Fiduciary duty
• State Contract Law
• Tax
• International
75
Fiduciary Duty
• Duty of Care
• Duty of Loyalty
• Duty of Good Faith
• Business Judgment Rule
• “Entire Fairness”
76
The M&A Process
Close
Plan Shop Bids Term sheet Diligence
77
Other Resources
79
80
81
Presidential Summit on
Entrepreneurship
Representatives from 50 countries, five continents
http://www.youtube.com/watch?v=uhLpFtpfeWY
84http://info.kpmg.us/ma-survey/index.html
85
http://www1.american.edu/academic.depts/ksb/finance_realestate/rhauswald/fin673/673mat/KPMG%20M&A%20Survey%202001.pdf
“83% Of Mergers Fail”
86https://tobyelwin.com/mergers-acquisitions-project-failure/
Personal Partnership: Marriage
87New York Times: 12/02/2014 – Claire Miller: http://www.nytimes.com/2014/12/02/upshot/
Business Partnerships: 80% fail
88http://www.forbes.com/sites/amandaneville/2013/03/01/why-partnership-is-harder-than-marriage/
Entrepreneurs 3/01/2013
Why Partnership Is Harder Than Marriage
“But the truth is that partnership is far more difficult to
maintain than marriage. In fact, whereas 50% of marriages
end in divorce, the number is closer to 80% for business
partnerships. And it’s exponentially more difficult if you
happen to have more than one partner.”
89
Key deal terms
90
91