With a near shutdown of IPOs and SPACs, tech companies are increasingly considering whether they should be looking at another capital raise, a merger or a sale. As the world's leading seller of software companies, we'll admit to some bias. We've seen a number of horror stories and missed opportunities when companies decide to raise capital and not explore their M&A options. Let's compare the two approaches and explain why you should look at M&A early.
Doing a Raise
If you are going to do a capital raise in today's market, here are some considerations.
- You'll give up equity without getting any liquidity. In other words, you normally would not be able to take out cash. Raising a round will change your cap table; if you're raising an A or B round, you would normally expect to give up to 30% or more of equity. Any investment will involve dilution for current shareholders. While there may be a promise of a 'bigger pie', your slice will become smaller and smaller with every investment round.
- Dilution has a cost. We often encounter CEOs who, after 3-4 funding rounds, retain less than ten percent ownership, with little incentive left to exit. The CEOs are carrying the heavy load, running the company, and may get little from an eventual exit.
- You may lose control. Most entrepreneurs Corum works with are less sophisticated when it comes to working with a Board of Directors. New investors may want to add board members to your current group, shifting the dynamics of the board and impacting voting percentages. This could have a significant impact if the board is not aligned on going to market for an M&A event. With a new investor in the mix, they may have different financial goals than you as CEO. We often see this with companies that have heavily backed venture boards.
- Different emphasis on growth. In the case of VCs, most will drive an early-stage company to spend their investment on growing, quickly creating the need for more working capital. In uncertain economic times like now, they'll be the first to tell you not to worry and that they'll provide additional capital when needed, but forget to add that it could come at a significantly lower valuation (what we call a down-round).
- You may end up with nothing. Most investment terms have preferred liquidation rights and preferred stock rights, favoring the last investors in. They get paid first. This isn't a concern when the ultimate sale price far exceeds the preferred threshold, and there's plenty left to divide among the other shareholders. However, we've seen scenarios where a large VC or Private Equity firm forces a sale, is made whole through the preferred liquidation rights and leaves little or nothing for the CEO and other founders.
- You may miss your optimal M&A window. Some CEOs think they will do a round and sell later, but that takes a while. The last round in wants to get the value up, so you won't be able to sell right away. From the 2000 and 2008 recessions, we learned that tech companies can quickly lose 80% of their value when the market turns and take 4 to 7 years to regain their peak valuations. Many CEOs and founders missed their most opportune exit window then and never recovered. Is this a risk that you are willing to take? If you are a baby boomer, do you have time to wait for a recovery? Be realistic. The answer is no.
- The time burn. Raising money is time-consuming, especially for smaller companies. Unless you have a significant war chest to survive a couple of years of turmoil, you can become a prime target for vulture capital. At a minimum, you should raise enough capital, so you don't have to go back to the market too soon.
The M&A Route
There are several benefits of running an M&A process. Remember, the decision to accept an offer is up to you.
- Immediate Liquidity. Most deals have a large cash component these days. There is an immediate opportunity for CEOs and founders to take money off the table—no need to wait through more years of work and risky promises that may never materialize.
- Higher Valuations. Running a global process and targeting strategic buyers and PEs will almost always yield higher valuations because of the auction process. Your share price is not pegged to a specific valuation but to what the market will pay. On average, if you go through a well-managed, global search process, you'll improve offers at least 40% because of the competitive tension created.
- Harnessing your full potential. Acquiring strategics will always offer a significant value advantage for early-stage companies. They are looking for global sales, a marketing footprint and operational resources that VCs and other capital sources cannot provide. If you go to the market too late, there is little premium paid to the last standing. You don't want to miss the window.
- A second bite opportunity. A common scenario with private equity firms is a 70-90% PE recap where you get a first significant liquidity event and later a 'second bite from the apple' when the company is resold again by the PE firm. The payout of the second event is usually much higher than the first one. For example, we have a case study in our Selling Up Selling Out boot camp where a company sold 90% of the company at a $40M valuation but kept 10%, then later sold again for $100M (6x).
- Several Benefits of the process. Running a global, professional process can yield benefits, including improving your business model, strengthening your strategic position, collecting invaluable data and insights that improve value, opens doors to new business, and, of course, a merger, sale or recapitalization. Any one of these benefits will justify the time and expense of a global partner search.
Even with the continued market uncertainty, tech M&A has proven to be resilient, with strategic buyers holding $1T in cash and PE firms holding another $3T. This does not include family funds, angels or sovereign funds. They are all competing to invest in or acquire good companies.
Before you decide on doing a raise, talk to us about exploring the M&A option and calibrating your value in today's market.
You may be surprised by how much you are worth.