ESD Alliance Tutorial: How to Prepare to Be Acquired

The best part about the ESD Alliance event last evening at the Cadence Headquarters in San Jose was that the topic material – how to prepare your enterprise to be acquired – is applicable to all manner of tech startups. And as the conversation was taped, the discussion will be available straightaway on the alliance website.

Of course, if you’re prepping for an acquisition you’ll need far more pointed advice than just this recorded conversation – you’ll need to hire experts to address your specific situation. Nonetheless, yesterday’s panel provided a great starting point.

Carefully moderated by Attorney Mark White [White Summers, Caffee & James LLP], who had clearly done his homework, each panelist added essential information to what was effectively a tutorial on pre-acquisition best practices.

Speakers included IP/Patent Attorney Dennis Fernandez [WhiteSummers], Tax Attorney Tom Maier [Fudderman Dupree], Investment Banker Neil Shroff [Orion Capital], Moodwire CEO Manu Chatterjee [founded Lampdesk, sold to Palm in 2007], and Silvaco GM for IP Warren Savage [founded IPextreme, sold to Silvaco earlier this year].

The conversation between these five gentlemen – two attorneys, a banker, and two CEOs who have survived acquisitions – was not at all glamorous. Instead, it was honest, calm, factual and amazingly short on hubris of any kind.

Turns out being acquired is a very humbling experience, that acknowledgment being one of the most important take-aways from the evening. Don’t go at the process with pretentiousness, because pride goeth before the fall, was the message.

Mark White advised his audience to be knowledgeable enough to know when to exit and savvy enough to ask for the maximum price, but also wise enough to know that attention to legal, financial, and corporate-governance issues prior to and during the acquisition are absolutely crucial to success. He called on each panelists to expound.

First, you’ve got to figure out which one of your beloved business units is going to be acquired. It’s a bit of a Sophie’s Choice whether you’re going to throw one or more overboard to make the other units more attractive and salable.

Warren Savage acknowledged, when prompted by Mark White, that he was relieved to learn that Silvaco was interested in all parts of IPextreme – the IP licensing products, IP packaging products, the Xenia Platform, and the company’s foundational leadership of the Constellations IP vendor collective. He said he took comfort in knowing all of IPextreme was being acquired by Silvaco, and considered that situation to be ideal, but never guaranteed.

Of course, breaking the company up “is always on the table as an option,” Warren said. “Every entrepreneur has to have this discussion [with investors], because these are the things that often help to move an acquisition forward.”

Neil Shroff agreed and added, “If there is a clear reason to break the [company up], you can do it. But you should always let the market decide.”

Second, you’ve got to be brutally honest about your current financial profile way in advance of shopping your company around. Do you have too many investors, too many different classes of stock, too many loans, too many funding rounds, too many bossy pants sitting on your board?

In the case of Manu Chatterjee, he found restructuring Metavana [now Moodwire] has been important to the company, although the effort required was huge: “The company had 100+ shareholders, and we called each one and said: Hey, we need to hit the pause button and reset several things.

“We had three different classes of shares, three different classes of loans, and four different classes of debt. [With eventual consensus], we were able to restructure capital to raise more money, and get some debt off the books.

“To one of our creditors, in particular, I said: We need you to help us. We will come up with a formula for what the shares and debts will be worth in the new company [and he agreed]. The restructuring has created a new entity with new shares.”

Despite his experience selling Lampdesk to Palm, Chaterjee acknowledged his technical expertise is inadequate for navigating myriad pre-acquisition business issues.

He encouraged the audience to engage with financial and legal experts to guarantee everything is done correctly. In the end, he advised, when it comes to selling your company you will benefit.

Third, there’s the patent problem. Patent early and often if you plan to be acquired, was the advice of Attorney Dennis Fernandez. Although, if you’re well down the path of creating IP and patents in your company, you may be too late.

Nonetheless, Fernandez said, look at your patents and pat them down for validity and strength. And be especially alert to patents you might establish early on that will compromise the ability of your competition to succeed.

“If you patent what your competitors do before they realize they need it,” Fernandez said, “in addition to protecting what you’re shipping, you will also protect what your competitors are doing. If you then have a patent the acquiring company needs, their fear will drive the acquisition.”

“Of course, it’s even better to patent the standard,” he added, noting that these strategies are important to pursue prior to looking to be acquired. Patent portfolios are vital assets that are always evaluated closely when you want to sell your company.

Fourth, there’s the problem of the investment bankers you don’t want to engage with. Yeah, their services are very pricey, Neil Shroff acknowledged, but in the long run, you really need somebody to serve as a go-between between you and your potential buyers.

Hiring an investment banking organization to handle those discussions can more than pay for itself in the long run, as the bankers work to avoid time-consuming hassles.

“Even a couple of years before an exit,” Shroff said, “we can identify a complementary fit for your company. Helping you to focus on a segment in the market that a potential acquiring company is not focusing on, so you can start to develop a portfolio position to complement [that of] a possible acquirer.”

Fifth and finally, there’s a whole world of potential hurt embedded in the tax implications of your corporate structure.

As an example, per Tom Maier, it’s clever to consider issuing QSBS, Qualifying Small Business Stock, which has advantageous tax consequences.

But QSBS comes with stringent rules: It must be held for 5 years, it has to be a domestic corporation – “Caymen Islands don’t qualify” – and the corporation can not be an S Corporation even for a single day, which is tricky because an S Corp is a “good place to be” as a startup to protect the personal assets of the founders.

Maier’s point was not about QSBS, per se, but about the caution one must take to establish a quality, legally defensible tax structure for the corporation from the very first day.

Nothing puts the chill on an acquisition faster than when the acquiring company discovers irregular business practices within the company that hopes to be acquired.

He also warned of the pitfalls of exercising stock options at the wrong time. Caution is always the better side of valor, he admonished. Know what you’re doing, get professional accounting and legal help, and when it comes to stock options, “Read the fine print!” Maier warned.

He reminded the audience that business registrations and tax filings must always be current and correct. “We started small in Mom’s garage,” is not a defense, he said.

Failing to go out and register your company in every single jurisdiction where you’re doing business, and failing to pay the appropriate taxes in that jurisdiction, are never acceptable.

Tom Maier actually had more advice for the audience, but the discussion had been underway for almost 2 hours at that point and Mark White called for an adjournment. Nonetheless, the audience on Tuesday evening felt well served, as the topics were so diverse and the speakers so knowledgeable.

Clearly, the evening’s conversation was not so much about technology, as about the business of technology and there were few in the audience who did not have at least some familiarity with these things – including the single most important preparation any organization can make if it hopes to be eventually acquired.

Expressed emphatically by Warren Savage: “You better know your customers before you start your company. I see a lot of companies and my best advice to them is, don’t talk to the VCs unless you have at least three customers.”

“If you have one or two friends, they will always be your customers,” he added, “but nobody ever has three friends. Have three customers before you approach the VCs.

“And have enough experience in your market to know what people will actually buy!”

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Addendum …

Moodwire CEO Many Chatterjee offered this laundry list of items to help determine the competitive value of an organization.

* Plumbing – What you have to do to build product, though the end result has no value in eyes of customer. But if you drop the ball you will have to spend time on it, whether it’s the battery, the connector to battery, or something else.

* Table stakes – The product must compete in the present market. If you’re making a phone today, it has to have Bluetooth and LTE. Customers use these features and they have value, but everybody has to have them just to get into the game.

* Differentiator – Know why somebody will buy your product rather than your competitor’s. Is it a large screen size for a phone, or a sports car like a Tesla that doesn’t use gas?

* Just being different is not enough – A different color, a 3D camera. It all may be cool, but may not have any actual market value.

* Subtracting features may result in negative value – Your phone doesn’t have a headphone jack, but everybody else has one. You better be pretty confident about this, because only a company like Apple may be able to get away with it.

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Tags: Dennis Fernandez, ESD Alliance, Manu Chatterjee, Mark White, Neil Shroff, Tom Maier, Warren Savage

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