“A lot of companies wouldn’t share information with me. And then we would buy another similar company and they would be like, ‘Why didn’t you buy us?’ and I’d say, ‘Because we didn’t know anything about you.’ Keep that in mind. You don’t have to share everything, but if I don’t know anything, I can’t present [the best case] to executives and I can’t get a deal done.”

“Second thing, make sure there is someone who really knows the deal process, whether it’s a lawyer or a banker–this is not a pitch to get a banker. There were so many deals that I was a part of where they don’t even know where they can negotiate and where they can’t. You have to understand where there is room to negotiate on certain things. For example, there will be an escrow account.”

“A lot of entrepreneurs are going through this for the first time and they are trying to just figure it out. There are also some buyers who are new to it and are doing certain elements wrong. For example, a [startup] wanted to make sure that their engineers would be treated well in the new company and asked for the average engineering salary, including the salaries for interns, which left a bad taste in the acquiring company’s mouth.”

“The thing that I would want to know is the process that you will take me through. There will be certain unexpected things, but I want to know what is needed from the buyer for the deal to go through like Board approval, etc.”

Let’s talk about a specific situation: How do you find out the real value of a private company stock? How do you get comfortable about that?
“Sometimes you can expect that the value of the stock will go up significantly. For example with FriendFeed being acquired by Facebook, that stock has at least 10x’ed since. When you get an acquisition offer, you also have to look at how much is up front and how much is later. The company will prefer to pay more as a retention bonus and not worry about the cap table. Investors may have a very different focus. For you, as an entrepreneur, you may end up with a lot less. They will say we will acquire you for $30 million, but it is really $20 million and $10 million retention bonus.”

“See if you think there is a real chance of liquidity in 5 years. Also, [get a sense for] how much additional funding rounds will dilute your shares in future rounds of financing.”

“The real value in multiple bidders is that you can more easily walk away [from any one buyer/offer]. If you feel you can’t walk away, you are in a bad position.”

“Other non-financial values matter. There is actual real value in being in the right environment where you can be passionate about your work.”

“The more option value, the better. You’ve got to take that into account. Like how you are willing to take a lower valuation from a better VC, a better acquirer will be a better place for the company and can provide more financial value if the company grows.”

What have you learned about the process of negotiating? How can you know what is the most you can get or the least the entrepreneur can take?
“I think it is about writing a number on a piece of paper and sliding over that piece of paper with an offer. [laughter from crowd] It really depends on the type of relationship and how deep it is. It’s important to understand how valuable your company is to their business.”

“Prove that there is an ROI for the acquirer based on the value that you want to receive.”

“Depends on the type of acquisition that is being made. If you are acquired for a team, there is a range per person. If you are acquired for a specific asset, then ROI is key. If you are acquired for something that is unique and there is no substitute, than you have a lot more power in the negotiation.”

“Make sure that you have real options if the acquisition doesn’t go through. If you get a number initially that you don’t like, don’t start talking about terms…make sure you are comfortable with the overall number first.”

“We can do due diligence and do a build analysis, so we know how much it would cost to build internally. We have alternatives, too, and think about that. If you are truly a unique asset describe and present that [to us].”

“We develop financial models on your companies. It’s not an emotional decision. There is some method to the madness if you can look at it from that perspective. Each entrepreneur has a range, sometimes their range can be off.”

“An acquirer will look at how much they can earn with the asset they are buying–they can obtain additional revenue by putting it through their resources.”

“We’re not going to give all that value to that company, but some of it can be given to the company. Part of that is about what it means to be a ‘fair’ acquirer. We don’t want to be known for ‘raping and pillaging’ small companies. If it’s a small company that’s just winding down and has just a bit of IP, then, yes, a small acquisition is okay. But, if it’s a strong company that’s doing well, we’re going to pay for that value. Are we going to pay for the amount of value that can be created by pushing on all cylinders inside our own company? No, we want some of that value for ourselves.”

“There’s a bit of an art form and each company will handle it differently. The seller has a number in their mind that they need in order to make a transaction happen. I know it can come across strange if they don’t have a really good reason to justify it–that’s just the way it is. Also, if a deal doesn’t work for you, still be polite and say, ‘No thank you.’”

“I can think of two or three times at Yahoo! where on the second or third time around, we ended up acquiring the company. The deal didn’t align the first time around, but it made sense later on. If it’s not there, it’s not there.”

Do patents matter? Do they add value?
“Generally, no, but [acquisition name redacted] is an example where I’m wrong. Part of the stated reason why the acquisition was made was because of the patents. When I got started, I thought that patents would be a gold mine, but when I talked to our patent team, they think of patents as conventional weapons, not nuclear weapons. With [acquisition name redacted], they have hundreds of patents and one patent will rarely be very useful and valuable. We encourage companies to file for patent protection, but we have had real patents lawyers recommend against focusing on patents. Oftentimes, there is not a lot of value in patents.”

“On the flip side, you need them. You need them: I wouldn’t advise you to create a business without them. But, they most likely aren’t driving any value. The people and technology are the key drivers of value and the patents are usually just a little extra.”

“If some of the IP is unprotected and it is found out late in the process, that can really hurt a deal. Because the acquirer is a large public company, they want to make sure that they are protected. Don’t give them an excuse to not do the deal. [Patents are] not necessarily about how you create more value.”

“Make sure the patents are in the company’s name. I’ve seen it before where it’s not exactly clear [like when] the patent is in the name of one of the founders and the founder is no longer with the company. You have to be very careful with patents.”

“Even if you’re not applying for patents, taking the entrepreneur’s point of view, think of patents as an asset. Having a well-defined patent strategy and having answers about your patent strategy for an acquirer is enormously valuable. For first-time entrepreneurs in the room, a patent is valuable after you have defended the patent in court and have won. So it takes a really, really long time to prove that a patent is valuable.”

“As an early stage startup, focusing on patents can be hugely distracting. In certain markets where competitors are especially litigious, it can be more important to focus on patents. If you are trying to build a media company or something, in the short term they won’t matter.”

“Look at patent through the view that a potential public company acquirer would look at it–I recommend researching it. Spending the right amount on this can be important even if it means spending $25 or $30K on securing a patent with the right patent attorney.”

Earn-outs: panacea or deathtrap?
“Deathtrap, particularly for what we typically buy. Earn-outs are very tough. If you think about what you need for an earn-out, you need a very clear execution path. So, if we acquire a company and they have complete control of everything they’re doing with a sales force, what they are selling, then there could be an earn-out. But the reality is, is our sales force is going to sell it or is it going to be wrapped up into some other product that we are selling? Or, what if we change our strategy? What if the market falls apart? Things change with technology very fast, so we need maximum flexibility to change our plans. The minute we change things, it can mess up the structure of an earn-out.”

“I would add as well, if an employee comes on board with an earn-out it can cause the wrong behavior just in order to achieve that earn-out.”

“I would just add: As a buyer, I was never a fan of earn-outs. If it’s being used to bring down the true valuation of a company, then there is probably just a problem with the desired valuation of your company. I always encourage companies to come up with cleaner terms instead of having an earn-out.”

“When you look at the value of a deal, look at the value of a deal excluding the earn-out. You should be happy with the value of that deal.”

“To clarify there is a difference between a hold-out and an earn-out, a hold-out is a certain portion of the deal that is used as a retention tool. You get a certain amount for staying at the company. An earn-out is based on hitting certain business objectives [like achieving a certain number of] users or revenues. I think another way to pay the founders later on is to put some money into an escrow account and pay the founders later for retention.”

“Android was a very successful earn-out. One of those rare cases where there is a very large earn-out in comparison to the initial deal.”

“Even with Android, we renegotiated the initial earn-out. The hold-out is what we used to do with pretty much every deal but now we do in almost no deals. We will take the risk, from our perspective, that people will be excited and motivated to work for us.”

“I think the hold-out can be frustrating for the entrepreneur. They have spent all these years building this business and [if] they are clean from a customer perspective and IP perspective [then it shouldn't take so long for them to receive their due consideration.]“

Final words of wisdom
“Diligence the acquirer–check out other companies acquired by them”

“Build an independent business, not one built to be acquired”

“Be out there building relationships with the business side of potential acquirers”

“A good lawyer is not a place to skimp on”

“Choose your investors carefully”

Below are some of the questions discussed and select quotes from our panelists.

Below are some of the questions discussed and select quotes from our panelists.  This is part 1 of 3.

For the entrepreneurs, Why sell?

“Excitement of joining a large platform that affects hundreds of millions of people and being able to lead a small part of large part of the business. Facebook has a very good record of doing acquisitions and taking awesome talent and giving them a lot of responsibility.”

“Had plans to go public. The valuation was the key component. It had to be translated into a price that made sense for all of the years that we put in. We were also focused on making sure that the customers and employees would be taken care of well in the new environment. ‘What does the new buyer mean for the business?’ There has to be an emotional buy-in for the sale.”

“We were 9 people and were going to make up 10% of Twitter. Sometimes, a company is just running out of energy or is potentially going to get crushed (for real or it is just a threat). Sometimes, they will actually build the product (25% of the time) and may actually crush you, but, more often than not, it is just a threat during the negotiation process. Sometimes, the company is willing to pay up based on a year or two of expected growth, so it can be worth it from the financial perspective. Sometimes, you sell simply because the company is running out of money.”

“Thousands of seed funded companies out there and a lot of them may end up being talent acquisitions.”

“There are so many large companies where you can have a real impact by reaching all of their users.”

“Sometimes you are forced to sell by market conditions. Multiple bidders cause the price to go up. [The acquirer can help you] fulfill your a vision or help you better achieve your vision. They provide additional resources. Android was a great example of that. They needed Google’s resources in order to create such a valuable platform. Youtube as well.”

On the buyer side, Who is the decision maker?
“What the CEO wants, the CEO gets [laughter in the crowd]. Product teams decide the majority of what we see. The Corp Dev/Strat team may bring opportunities to the product teams to see if they are interested, but that’s just on occasion. Usually, it’s product-led.”

“It’s usually a collaboration between the GM of a business unit and the Corp Dev team. It’s less top down, where the CEO says who we are acquiring next, especially when the GMs have a better understanding of their particular business and are managing multibillion-dollar businesses. It’s important [for entrepreneurs] to be proactive instead of reactive. There’s a lot of inbound activity, but if the Corp Dev team is doing their job, usually they’re in front of the opportunities.”

On using a banker:
“Oftentimes, a banker isn’t necessary, but the bankers can help people not get too emotional. Try to separate the tactics and the reason why you want to sell. Usually, the Corp Dev team is the bad cop trying to get you to take the lowest possible price, while the product team is the good cop and the team that you will be working with after an acquisition. So, separating that out is important. Best advice: assume that at no matter which stage, the deal will fall apart.”

“After signing a term sheet, 1/3 of the deals didn’t go through at Google. [Even if] you have a signed term sheet, you have to keep working.”

“It has improved a lot since then.” (laughter in the crowd)

What should the seller do if a buyer is calling?
“First, think it is bs. It’s highly likely that they are full of crap. M&A is part of the strategy that a product group comes up with. You want to be optimistic and engage, but you want to limit the distraction and the number of people on your side that get involved. You want to quickly qualify how serious the opportunity is. Find out where this interest is coming from and how real the inquiry is.”

“Use the opportunity to build a relationship. Don’t involve anyone else. But, show them what you have built. We knew the Corp Dev folks for a year before the acquisition and building that relationship was helpful. Realize that the deal may not go through, but still build that relationship.”

“The only thing that I would add is: deals don’t just happen overnight. You foster the relationship over time. A number of deals that I have been a part of have taken a year. You have to be careful not to appear arrogant. Don’t want to seem ‘too busy’ to even talk to a Corp Dev person.”

“A year for a big company is a footnote. For a startup, it’s like a lifetime. Be aware that the timelines are very different.”

Should companies market to Corporate Development?
“No, and if you do, it should be a soft sell. Don’t say ‘we want to sell.’ Build a relationship with Corp Dev and the product teams, but I maintain ‘the best companies are bought, not sold.’ Just be on the ball and execute, and good things will happen. If you are too aggressive, the Corp Dev team may get tired of it.”

“Over 70% of the deals that start with one suitor, end with that suitor, assuming the company is sold. So, building that relationship and seeing where there is a cultural fit is important. You want to be careful with dangling one offer in front of a different company. Of course, a banker will want to make sure the best possible price is reached.”

“We see deals all the time where we have a term sheet from x company. Do you want to get involved? 99% of the time, nothing will happen if there is no relationship with anybody else in the company. Also, if we get the feeling that we are just being used to play off the other side, we aren’t going to play. It’s a hard game to play because relationships do have to happen over time. So, if you have deep relationships with multiple companies, than you can get involved in the process with multiple companies. It is harder to just play one company off the other, especially if you don’t have that relationship. It’s risky.”

“It’s tough to do anything in a compressed timeline. If your idea is you’ll just call up Corp Dev and see if something happens, it won’t. The key is working with the product team. Maybe partnering. Maybe just building a relationship. The product team will know if you are doing well in a market. Like with Postini and Google.”

“A company we knew very well had a term sheet from another company. We got involved and went from 0 to 60 and got to an LOI in 2 days and closed the deal in 45. Those things can happen on rare occasions when the relationship is strong.”

“On this panel, we have successful large tech companies. These are Corp Dev teams that represent tech giants. Depending on the company, Corp Dev can mean something completely different. If a company is not in a growth stage, they can be looking to acquire a team and product to renew growth and innovation. It’s different.”

Is it a distraction?
All the entrepreneurs agreed it was an enormous distraction.

“It’s a big distraction. You need to first figure out if you want to sell. Have the conversation with your Co-Founders and CEO. Don’t involve the team early on. Be careful with involving the team because they can find out that the company isn’t that valuable. In one case, an early employee left because they found out their equity wasn’t really worth much. Don’t call your investors. You can be in situations where the investors and you spend a ton of time going back and forth when the deal is still very early on. When the process starts to get serious, involve the lead investor but don’t involve them too early because they will drive you crazy.”

Stay tuned for part 2 in this series..