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Poor (unprofitable) but pretty: tips on selling your startup

From The Tech Entrepreneur’s Survival Guide by Bernd Schoner. Reprinted by arrangement with McGraw-Hill Education. Copyright © 2014 by Bernd Schoner.

From The Tech Entrepreneur's Survival Guide: How to Bootstrap Your Startup, Lead Through Tough Times, and Cash In for Success by Bernd Schoner, Ph.D. Reprinted by arrangement with McGraw-Hill Education. Copyright © 2014 by Bernd Schoner.

The chances that your startup is generating substantial profits by the time you are trying to sell it are unfortunately slim. Rather, most of us attempt to get significant economic return for ventures that continue to lose money, rely on ongoing investments for operations, struggle to pay the bills, and generally live on the edge of financial viability.

In the absence of stellar financial performance, you are forced to paint a pretty picture, spin a story, and seduce potential acquirers in other ways. You have to come up with credible answers to a set of impossibly difficult questions: Why would anyone spend money on an entity that has been trying to turn a corner for the longest time? Why would anyone buy into the value of a technology nobody is using yet?

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Why would anyone believe that next year will be big, when they know all too well that it was going to be next year ever since the company was founded?

As you put together your story, don't get carried away giving unrealistic forecasts and exaggerated prospects for the postmerger entity.

Your acquirer will make sure to hold you accountable for the expectations you create. Any disconnect between pretransaction promises and posttransaction reality will be flagged and held against the team.

Be enthusiastic, but realistic!

Strategic Value

When businesspeople feel the urge to go down a financially unjustifiable path, they typically argue that the activity will bring strategic value. A business development manager who is eager to go forward with a project but can't get the customer to pay will suggest doing it for "strategic reasons." A product manager who would like to develop a product but is unable to project sufficient revenue for it will claim the new offering is "strategically important."

If you are trying to motivate an acquisition with strategic value, spell out in detail what you mean. If the strategic value cannot be shown to result in future cash flows and financial results, what good is it? Of course, you can't predict the future, but you can anticipate and describe and model scenarios under which the combination of the two entities will make a strategic, that is, financial, difference down the road.

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The more detailed you are, the more powerful your argument will be. Use the opportunity to show off your understanding of the acquirers' business. Point out why the acquisition is good and strategic for their business. Startup management teams have a natural tendency to talk a lot about the value of their company. That is what they know best, and that is what they believe they need to promote. Yet, the important question for the acquirers is how the acquisition can improve their business, not yours.

Much has been written about improving sales success by asking pointed questions and putting oneself in the shoes of the customer.

Selling your company can benefit from the same idea. The acquirers need to see clearly that the acquisition will improve the value of their company. As the salesperson for your startup, you need to explain why that will be the case, much as a good product salesperson does the thinking for her customer.

Positive Trends

Startup valuations thrive on first and second derivatives! If the young enterprise can show a positive trend (that is, a positive first derivative) on any one key metric, it is in a good position to negotiate a favorable deal. Even though the current performance suggests a zero or negative company value, acquirers can be made to believe that the positive trend will continue and eventually result in profitability.

Even better, a positive second-order derivative on a metric suggests higher-order growth or exponential growth: now the entrepreneur can argue that the positive trend follows the infamous hockey-stick pattern and that the accelerating growth will fundamentally change the financial picture for the startup or its acquirers (Figure 12.1).

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Figure 12.1: Example for positive trends: linear growth (positive first derivative), quadratic growth (positive second derivative), and exponential growth (exponential first, second, and so on, derivatives). Note that the three curves are very similar in the first three years after the starting reference point. It is practically impossible to detect the difference between the growth patterns at that stage. Also note that in this example it takes four years for the exponential growth curve to overtake the linear and quadratic growth curves.

Exit Strategies

As you promote the value of your company, realize that it is easier to convince someone of a startup's bright future based on a small number of positive metrics rather than on a large number of mediocre metrics. Paradoxically, flat revenue with exponential growth in another dimension is worth more than a little bit of revenue growth and nothing else positive to say. As you are getting ready to prepare your company for an exit, focus your energy on a smallish number of metrics. While you should always put revenue on a growth curve if at all possible, it may be a lot easier to spin your story around other dimensions of your business including the following:

• Sales of development licenses (software business) or development kits (hardware business). At ThingMagic we used to brag about the increasing volume of development kits under the notion that those kits would translate into significant OEM product sales soonish.

• Customer profiles. One of ThingMagic's VPs of sales introduced the notion of a $50,000 club and demonstrated how the number of customers with revenue in excess of $50,000 had increased dramatically over the course of a year. Only 12 months later, that was no longer true, but we discovered that the $10,000 club was doing very well that year.

• Number of nonpaying users. You might argue that customers who don't pay for a service or a product aren't really customers. However, don't make that point when you are trying to look good to your future owners. Rather, argue how you will be converting nonpaying users to paying users.

• Growth margin. The growth margin of a product or business refers to the ratio of gross profit over sales price and thus is an important metric especially for hardware businesses. Product growth margin can be used to argue in favor of a positive and bright future, no matter what the situation is. If the growth margin is good–that is, you are manufacturing products at a small cost compared to its sales price–management argues that the company is positioned well for growth and profits when sales will be picking up. If the growth margin is bad–that is, product manufacturing costs you a large fraction of the sales price–management argues that the bottom line performance of the company will improve dramatically as soon as the manufacturing process can be optimized with the help of the new owners.

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