It seems to happen every week: A tech startup barely out of infancy gets bought for millions of dollars by a deep-pocketed company intent on growth by acquisition.
The latest Canadian example is Halifax-based GoInstant, acquired in July for a figure reportedly north of $70-million. It's the second east coast startup and the fourth Canadian company acquired in the past two years by California-based Salesforce.com.
Other serial acquirers – including Google, Microsoft, Oracle and Facebook – are ramping up their efforts. According to a list compiled by Techvibes.com, there were at least 75 acquisitions of Canadian tech companies between 2007 and 2011.
As dazzling as the multimillions of dollars raining from the computer clouds may be, entrepreneurs who set up businesses with the intention of selling them need to ask themselves serious questions before signing a deal, experts say.
When Salesforce made an offer to buy Toronto's cloud-based human resources company Rypple last winter, co-founder David Stein grappled with some issues. "No. 1 was 'do you have a shared vision?' No. 2, 'does Salesforce.com have an entrepreneurial culture?' And No. 3, 'do you have a large and loyal customer base to expand the market for our solutions?'"
Mr. Stein also wanted assurances that the company could continue to maintain its identity under the Salesforce umbrella. He'd seen other Canadian entrepreneurial companies gutted for parts and he had watched Canadian talent get shifted to foreign headquarters.
"We started our company because we saw a problem and found a way to address it. We get a lot of satisfaction and pride when we build products that customers tell us they like. That's the entrepreneurial feedback loop that gets you excited," he explains. "We didn't want to lose that excitement and independence."
Mr. Stein said he and Rypple co-founder Daniel Debow got the assurances they needed. Salesforce CEO Marc Benioff told them, "you guys have a good base of knowledge of the market, so stay in Toronto."
Another thing that made them comfortable, Mr. Stein added, was the growth of Salesforce's other Canadian acquisitions: Radian 6 in Fredericton and Halifax, and Sitemasher in Vancouver. "It's not just what people say but what they do, and we saw evidence of people being able to grow their roles in the company and still having an entrepreneurial go-getting spirit."
Salesforce buys companies for their technology and the reputation they've built as well as their leadership, said Renny Monaghan, vice-president of marketing for Salesforce.com in Canada. For that reason, when it takes on a new company it wants to let it run in its own location, the way it's been running.
When Salesforce bought Sitemasher in 2010, the company had 25 employees. In late July, it opened a Vancouver office with space for 100 employees (for its new product called Site.com). Across Canada, "Salesforce plans to add another 500 new jobs over the next two years – high-tech engineers, designers, marketing and sales people," Mr. Monaghan said.
"It's exciting to see innovation happening all over Canada, from coast to coast. As part of Salesforce they can grow much faster that if they were stand-alones."
Becoming part of a company that's rapidly expanding through acquisition may be the smartest move for tech startups, said University of Alberta professor of finance Randall Morck, who does research on mergers.
On the one hand, there's always danger in acquisitions, he conceded. Past studies by PricewaterhouseCoopers and BusinessWeek have concluded that at least half of the mergers and acquisitions in North America end up diminishing shareholder value by leaving the combined firm worth less than the pre-merger value of the two companies.
However, Prof. Morck pointed out, "my research shows that very rapid expansion via mergers and acquisitions can make more sense in high-tech sectors than in traditional industries. That's because a firm that suddenly acquires a technology edge can scale up production faster – to make as much out of its tech advantage while it still can."
Speed is the key. "Technology leads can evaporate suddenly, so you want to work them to the max while you can. Added production capacity and expansion of staff can be critical to this," Prof. Morck noted.
Aside from any assurances, there are also practical considerations that need to be in writing during an acquisition, said Albert Luk, a lawyer at Devry Smith Frank LLP in Toronto, who specializes in small and medium-sized businesses. "The offer may be temptingly large, but there are often strings attached.
"I rarely see the purchase amount actually paid on the closing. Typically it is in installments that have conditions attached. Most offers have adjustment clauses that reduce the amount paid by a dollar amount or percentage if results of the acquired company fail to meet expectations."
That means it's in the best interests of the seller to insist on having continued control of how the company will operate after the sale, Mr. Luk advised. "You want to at least limit any exposure you have to any downward adjustment of the price."
Fortunately, buyers are likely willing to negotiate. "My experience is if the acquirer is entering into a new product or business area, it's not in their interest to gut the operation."
But if they're buying a company with a plug-and-play application, there is a risk that's all they want to acquire, Mr. Luk cautioned. "Sometimes an acquisition is just intended to eliminate the competition. In those cases, people could be shown the door."
There have also been cases where a purchaser's offer is a sham, intended merely to learn proprietary information, Mr. Luk said. It's important to have the offer in hand before revealing information in the due diligence process.
One risk mitigated by the current tech-merger boom is that publicly traded technology companies have profits and the wherewithall to pay at least some cash rather than shares, Mr. Luk said. "In the 1990s, they were promising shares of paper that had nothing behind them, and when the company went down, it all went down."
Mr. Stein said Rypple's growth has been nothing short of amazing since the deal closed in February. "We've grown in each quarter. We had 30 employees last winter and now we've got over 60 and still have positions we need to fill."
He attributed the growth spurt to the international attention Rypple has received in big sales meetings organized by Salesforce, including Cloudforce in Toronto, which attracted 8,000 people, and a similar event in Australia.
He's looking forward to the biggest Salesforce event yet: Dreamforce, 2012, taking place in San Francisco starting Sept. 17. It's expected to draw 70,000 participants, and it is said to be the biggest technology conference in the world hosted by a single vendor. Guest speakers will include the CEOs of General Electric and Burberry, U.S. General Colin Powell, Sir Richard Branson and Tony Robbins. Among the entertainers are The Red Hot Chili Peppers.
"There are very few companies that have grown as quickly as Salesforce has: from its start in 1999 to $3-billion today. To get inside the company and see how that happens is an exciting opportunity," Mr. Stein said.
"It's almost like being plugged in to a massive generator of business."