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- [00:02]
A
Welcome to the Path to Exit, a podcast to help software and Internet founders understand the process to raise capital or sell their business.
- [00:19]
B
Hello and welcome everyone. I'm Mike Lyon, founder and Managing Director at VistaPoint Advisors and this is the Path to Exit. This show is dedicated to helping founders of software and Internet businesses understand what it takes to raise capital or sell their business and how to do it well. My guest today is Jeff Koons, managing director and founding member at VistaPoint Advisors. In today's episode we will discuss selling to a competitor. What are the risks, rewards, and should you even consider it? Please enjoy my discussion with Jeff. One of the most anxiety inducing parts of a process for founders is interacting with a competitor as a buyer. This is a concern for pretty much all of our founders we work with. How do you think about the risks and rewards of including a competitor and how do you protect yourself and the company during the process? Jeff, to get us started, just talk a little bit about the risks and maybe what founders are worried about when including a competitor in their process.
- [01:06]
C
Absolutely, Mike. And nice to be here with you today. I think there's a couple ones that naturally come up and honestly are founded. They're not unreasonable, but things along the lines of providing competitively sensitive data or information that is proprietary to your own company. Another big one is if customers or potential customers find out that you are in a potential sale process or talking with them, does that impact the business performance today because you can't close that sale? Is the buyer who's a competitor actually trying to buy your company or are they trying to get competitive information so they're shady in their intent for even entering the conversation? And then anything around future plans, whether it's product roadmap, innovative technology might be coming out with that outside of this M and a discussion they would never be privy to that obviously could be viewed as an advantage to them.
- [01:55]
B
Great points. And I think sometimes when a founder is working with a banker, sometimes the banker tries to minimize these concerns and I don't think that's necessarily the right path. I think you have to go through this analysis of do we want to include competitors, which one, and be really thoughtful about why you would include them or exclude them. But I would just say if someone isn't taking your concerns seriously, I would continue to push on this because it's a really important topic. You talked a little bit about some of the risks which sound pretty serious of including a competitor. Can you talk maybe a little about why would you even want to talk to a competitor? Like is there A never reason or what are the pros of talking to a competitor?
- [02:30]
C
The first and the biggest one just frankly comes down to sometimes a competitive bidder can pay the highest price. It's not only sometimes, it is oftentimes. And there's a couple reasons for that. And really it comes down to synergies. The first is on the revenue side. So if it's a competitor, maybe it's not a direct overlap from a product standpoint, but it's in the same ecosystem or category that could represent a really attractive cross seller upsell opportunity. If this competitor had your product, normally the buyer is going to be the bigger entity, so they might have a bigger resource base or sales team already so they can actually use your product and really generate revenue. Synergies with cross sell upsell, that's one reason why competitors can pay a lot of money for somebody. Another reason is things around like time to market and product expansion. So maybe your product is already best in class and this competitor is working on it, but it might take them 18 to 24 months of dev work. A lot of time, a lot of money, and it's no guarantee it's going to be as good as your product. When you're thinking about that and kind of a build versus buy decision, sometimes the buy can be overwhelmingly valuable. And so you can pay a lot of money for that shortcut time to market. And then the other thing would be around leveraging existing sales and marketing spend. I hit on this already. But if your product is tangential or related, then that buyer, when they're looking at this acquisition, their whole unit economics might be better. You could increase their ACV by 20% because everybody's going to buy your product along with their core product suite. So that revenue synergy side is really valuable for some competitors and they can pay money for it. The second one tends to be around just cost synergies. So not just finance, admin, hr, which are relevant in all transactions. But let's say your dev team is all working on building out the same product suite. You probably don't need that same level of headcount to deliver the product and you can do it for cheaper. And then the final one I would highlight would be pricing leverage. And so if there are two parties that are actively competing against each other on price, if they do come together, obviously that pricing pressure goes down, which means they can charge more money and increase their revenue via pricing leverage. So that's overall synergy value. And when people are modeling out deals, those things really can move the needle. In terms of what they're willing to willing to pay. There's some other ones as well. So there are things like marketing, category diligence, risk. So let's say you're in a space that everybody perceives there's this one big risk about maybe let's just use AI right now because it's all the rage. If you are selling to a competitor who has that same market risk, they are going to underwrite that risk very differently because they already have it and they've already gotten comfortable with it, whereas a third party outside the industry might just view it totally differently. So there's definitely some advantages there and how they underwrite the end market risk. And then the final one here I would highlight Mike is true category leaders, market leading companies oftentimes are built via M and A and so they'll go and acquire all the best of breed point solutions and ultimately roll them up. And so it's very possible that if your company is the acquisition that really does create a unified market leader, that value again goes outside of revenue multiples, EBITDA multiples and really speaks to this is now the dominant company in this space and there's real value there.
- [05:35]
B
Yeah, one point you made, I just want to double underline. You mentioned market risk and how competitor would view that differently. A really good example of that would be an industry where maybe you're in a small tam. And so in theory there could be all these buyers for your business. But once you get a little bit further in diligence, a lot of the PE firms are going to back out because they feel like they can't build a big enough business. By definition your competitors in that TAM and has accepted that tam. So it's really the only way for them to grow. So I think there's some great points in there. There's a lot of positives to selling to a competitor and usually it just comes down to these are the competitors we don't want to include because we know they'll be bad buy.
- [06:11]
C
And then a little bit later we're.
- [06:12]
B
Going to talk about how to protect yourself when you are dealing with a competitor. But if we're trying to do the first part of that funnel, which is okay, who are the guys that could be good buyers and bad buyers? Talk to us about what does a good competitor look like as a buyer? What's their profile? When should you pay attention to them and maybe lean towards including them?
- [06:30]
C
The decision here is do we want to provide this sensitive information, have detailed conversations with them? The companies that it makes sense to do so for even if they're a competitor first is they're larger and well capitalized. So it could be a public, public buyer who trades at a very high revenue multiple or it could be a very highly backed, PE backed company. Maybe you know something about their valuation or not. But there's certain investors out there where if let's say Insight does the deal, chances are they paid a good price for it. They invest in highly attractive growing companies. You can feel really good that they are going to be able to pay at least as opposed to a company that might not have that kind of backing or might not trade at those elevated multiples. So that's one Number two, and I think this is often underappreciated. But do they have a track record of premium M and A? So do they consistently go and pay good multiples for good companies? Because if a competitor, let's say it's a legacy company, it's older, they've done one deal in the past five years that is probably not going to be the company that's going to get excited about paying 15xrr for your business. They haven't done it. They don't have the M and A muscle and chances are they probably think a little too highly of themselves if they're never going to do M and A, that they don't need to do M and A. So I think do they have that track record of premium M and A? Another area that I think we historically find the best fits is when the product suite is complementary and it's not fully overlapping. So let's say that you're in a vertical and you do a really good job on the backend. Administration of regulatory compliance, employee scheduling, payroll, all the back office stuff. But you don't do anything on the front end stuff. So like revenue generating, like CRM, email marketing, things that are going to be generating revenue on the front end but you both sell into the same vertical. That's a really nice complimentary ideal and we often see those multiples being very attractive. And then the final one I would say, and these ones are always interesting for our client conversations is a strategic who meets some of the criteria above but who you're also taking market share from. So on these RFPs or on these competitive sales calls, it's you and this other competitor and you're consistently winning if they're large and well capitalized, whether it's public or private and they do a lot of good tech M A, that is a really nice profile because you're eating their lunch and they want to stop that.
- [08:49]
B
That's a great point. Hurting someone can be a good thesis for buying you. I also think that the customer overlap can be hard to understand, but there's a lot of different vectors for value. Like we worked on an edtech deal once where as you said, the products were more complementary than competitive. But there was an assumption that there was going to be pretty direct overlap in the customer base because it was edtech. But as we got a little bit further in diligence, the cool thing we found out is there was some overlap which you would expect, but there were a lot of net new customers for each of those businesses. And so the synergy values were much higher because now you were cross selling both products against each other's customer base. And so there's a lot of interesting things you can find out around synergies, around customers that sometimes surprise you that can drive a lot of value.
- [09:31]
C
Yeah, it's a good point, Mike. And one thing I think people don't often appreciate is having direct customer overlap. That's not super valuable because when you buy a company you just merge those two revenue streams and that's what it is. So if you're doing 5 in rev with this customer, the other company's doing 5 in rev. Congratulations. You have 10 in rev rev. Now you have 100% wallet share versus I have 5 in rev. Of these five companies you have 0 in rev and vice versa. There's a lot more cross sell and upsell future revenue available to them.
- [09:58]
B
Great points. So we talked a little bit about what makes you a good buyer. We're going to dig in now to what makes them in particular a bad buyer. And why this is important is all this risk we talked about up front, this is where you really want to minimize it. So you don't even want to include these buyers in your process. You don't want them to know you're on market. You don't want to talk to them or give data. So this is where I think you did a lot of bang for your buck and that first insurance policy, if you will, around protecting yourself. So maybe talk a little bit about buyers who are not a good profile.
- [10:26]
C
Yeah. So the flip of what makes them a good buyer. If it's a legacy provider that's valued at a discount, so it could be public or private, let's say it's a public company that's trading at 2 times ARR, they are not going to pay 15 times ARR for your business. That is just unlikely to happen. And if, let's say a company has raised money, maybe it was eight or nine years ago, they didn't raise a lot of money. And it's not a private equity firm firm who's a big fund or has a track record of doing really attractive M and A. All signs point to them not being a premium buyer in your process. And then there's also a follow on to this which would be what's their access to capital. So if it's like a small cap public company with $40 million on their balance sheet and a market cap of 500 million, they're probably not going to be an ultra premium buyer here, just given they have capital constraints. We also see this where if you have a very small VC or a VC, somebody maybe has written a $4 million check and it's a 200, 300 million fund, their ability to do big transformative M and A is just inherently limited. And we would not expect them to be able to actually execute a kind of deal that our types of clients would find attractive. And then the final thing I would think of would be this reputational risk that our clients are just always aware of. They're competing all the time. Everybody knows the scuttlebutt around every other company and it'll get out if, hey, this company's a tire kicker. They look at a lot of things, they never close deals, but they're in every process and they submit bids even occasionally to get more access to data room. That reputation, if you've heard that or been able to validate that from other founders or entrepreneurs, don't discount that and really take that to heart.
- [12:04]
B
Absolutely. A couple of points I would highlight there is the multiple that your potential buyer traded at is probably the single most important factor in whether they could be a good buyer. So if they were purchased for four or five times ARR, and you're this really high growth business that you think is going to trade at 10, 15, 20 times ARR, there's a chance they could do it. But there's a very small chance a business that trades at the low multiple is going to get there whether it's public or private. And a lot of times the private multiple isn't public, if you will. But if you know who the investor is, you have a very good idea of whether it could be a premium or not, or whether it's definitely a low multiple. So I think that's something just to focus on. And one other category I would add here that we hear a lot from founders is I would call it the bad people risk this competitor. They're just bad people. I don't like them. I would say be very careful about what I would call the normal competitive tension, competing with your competitor. Not all your competitors are bad people. And sometimes good competitors have some bad people that work at their organization. I'd say the biggest risk I see is the sales guy of the acquirer. So if you feel like they're a company big enough that their M and A does not include the sales team, that's a real positive because the salespeople are the most leaky at any organization. So really professional buyers won't even include the sales team because they know that's a problem. They have a dedicated M and A team. But I would say just give some thought to are they really bad people or are they just tough competitors? We worked on a deal once where our client was just dead set on not talking to a competitor. And we felt mixed because they were a private company and they hadn't raised a ton of money. But we convinced them to let us talk to the investor because we knew they were getting ready to do another round. And it turned out it was getting valued at a really high multiple. They had access to a lot of capital, they became an amazing buyer. And in the end, our client ended up loving his competitor. Once he got to know him, they came together. So just be on the lookout for, I would say, what's real shadiness and what's just competitive shadiness. Right. You're competing with someone so you think poorly of them. Okay, so let's say we've went through that rubric, Jeff, where we weeded out the buyers that we thought didn't make sense and weren't a good fit. And now we have a few that we want to include in our process. But we want to be really careful with them. Talk us through some steps we can take that will help us get to are they serious, are they interested and how we stage that out to protect ourselves.
- [14:22]
C
Yeah, there's a couple different approaches here and how you engage the process is really key. One of the easies and obvious ones is let's say it's a private company, but they've raised a ton of money and it's from an investor who pays good multiples, big funds. We've qualified them based on our criteria. We just talked about go to the investor first because companies are pretty good at understanding the competitive landscape. And if you give, even on a no names basis, a little bit too much info, they might be able to figure it out. However, if you're going to the private equity firm, so you find the partner at private equity firm X, hey, we have a deal coming to market, can't tell you who it is. Here's what they do, here's the financial profile. Nobody has a better sense of these, the M and A roadmap or the M and A applicability of any one deal, frankly, then the investor who's ultimately going to be doing the diligence of writing the check, likely. And so they can give you a really quick read without the names like, oh look, with that growth rate, we would never do this deal. Or hey, we're shut down for M and A because we're going to go look to run a process in 18 months. You've never told them who it is. You've given them high level categories, high level financials and if they pass, no blood loss at that point, if they say, oh this is really interesting, I want to know more, then again, you can go qualify them based on the other criteria and do some things we'll be about to, to get into. But you've created that first off ramp. If it's not going to be a good use of time in protecting yourself.
- [15:38]
B
Yeah. At one point I want to dig in on something you said. There's also some things they can say that may disqualify them immediately. And I think one thing founders are not aware of, if a PE firm has made an investment in an attractive company and they've held it for four or five years, that likely means they're looking to exit in the next year or two and it will significantly drive down the amount of cash they want to put to work in your deal. Deal. So for example, I think of a deal we worked on a couple years ago, it had a great buyer, they looked like an amazing buyer, but when we got their bid, the structure was horrible. The valuation is fine, but they only wanted to give like 50% of the deal in cash and 50% in rollover equity. And the reason why is they were going to sell that portfolio company, just like you said, in a few months. And they can't really put that much cash to work because it's not really going to accrete in valuation in that short period of time. And that's just the math of impacting their MOIC or their irr. It just crushes that number and so it really artificially limits what they can pay. So that same buyer, if we were talking to them four years ago, I think would have been an Amazing buyer, but they were going to market soon, which frankly made them a terrible buyer in that situation.
- [16:44]
C
An easy way to think about the math is investor puts X dollars in and those X dollars generate a return. If they're going to put x plus Y dollars in and the Y dollars are at a one X because they're going to sell this thing in six months, then the whole weighted average of the return comes down out and that's.
- [16:58]
B
How they're measured, that's how they're compensated. That is their game is the return game. So they won't do things that really mess with that, particularly on a deal that's already a winner. Right. They're not going to turn it into a middling deal. All right, maybe talk about the next step around protection. So we've talked to the investor first, maybe we've made it through that screen. It feels like a good fit. What are we doing now?
- [17:16]
C
The next thing to do is to basically bifurcate or have different versions of your process materials and data packs. So there might be the general non competitive version that's going to be explicit. You're going to provide a lot of the key underlying data that they need to make a proper underwriting decision, which is still important to make sure the bids you get are adjusted and people know that they did the bad and the ugly. However, with a competitor, you very much so are going to change that. So of course you're going to redact customer names, but you might take out the product roadmap, you might take out quota attainment so people can understand, oh, there's three good salespeople here. Let's just go try to poach these three. You don't need to provide them with that level of data. You might be a little bit cageier about the text schematic that you put in your material. So people don't know some of the more interesting technology development decisions you made. And they could look at that quickly and say, oh, that's a great idea, we should do it that way. So the modified data and materials, you are in total control over what you share and don't share. And the advice we give our clients is if you would be uncomfortable with the competitive CEO reading this in front of you, take it out. There's no reason to take risk. If ultimately they prove to pay a good price, be a serious buyer, all that, that great, we can always show it to them later. But they don't need to know all of that data in order to come to a first round sense evaluation.
- [18:35]
B
One thing to think about. There is the information that may be public that you haven't necessarily thought that's public. Like a common one is an org chart. I don't want my org chart in the materials. You can basically get 80% of your org chart from LinkedIn for most tech companies. The other thing is sometimes around pricing, pricing or the other common one I think is you think they haven't seen your. Typically your competitor has been in your software before. That just happens. I do think the product roadmap is one of the more sensitive things like where you're going with the product or how you're evolving it. That's something I would definitely keep till late. And then obviously any customer diligence. You already mentioned some of that. That's going to be really important. Talk about maybe the most protective thing you could do to deal with the buyer and we can talk a little bit about the upsides and downsides of doing that.
- [19:19]
C
Yes, there's another different approach which is basically I am hypersensitive about my competitors. Maybe they're good buy tires, but they do have a history of being tire kickers or there's something about it that makes it very uncomfortable sometimes. What we'll do is we'll run our process. We'll actually get first round bids and if we, let's say get 15 bids on an asset, we have four that are really strong that we're going to move into the second round. We feel very good about closing risk, we feel very good about price. At that point we're going to have a really good deal here and then there is value and can we get a better deal? Is there an option value associated with. Well, let's bring some of these competitors and. And the message there is much different, which is, hey, we haven't reached out to you yet due to competitive sensitivity. People understand that we have a ton of interest in this asset. If you ultimately want to be involved, you have a more explicit level of deal price turns to get to. And if they're not able to hit that, then you haven't given them any information, you haven't spent any time with them, you're protected. If they are able to get aggressive with that understanding, then again you go back to that first decision point we talked about. Protect your information, make sure they're qualified, all that. But you don't even talk to them until you get pricing and initial interest confirmation from the first part of your process.
- [20:33]
B
Yeah, I think that strategy to get a deal done almost and then call them is the most protective I don't see it work out that much. Usually the timeline is just too late for that buyer or too quick. And they just know that they don't really have a solid chance of the deal. So you rarely see them engage. So if you think that competitor could be a top bidder, that's not the value maximizing way to do it. It could be a way to go about it if you're worried about other concerns. But something to think about. And one other thing I just wanted to in also think about the interaction of PE firms and their portfolio companies. So for example, we recently worked on a deal. Our huge private equity fund. They have a big fund that does really big deals and then they have a smaller fund. We were talking to the smaller fund about a minority investment in our client and our client really liked these guys, thought they'd be a good fit. But the bigger fund was an investor and a pretty big strategic who wanted to buy the business. Our client really had no interest in that. But over a period of about three weeks, that strategic went to the big fund investors and complained a lot about the small fund's involvement and basically shut that interest down, which obviously was disappointing to our client and us. But just be on the lookout for some of those interactions between PE firms and the strategic companies in their funds. That can be a positive or it can be a negative. But you should be aware that there are some dynamics there you need to pay attention to.
- [21:50]
C
Absolutely, you're exactly right. When we come to a competitor and say, hey, we have a ton of interest and we're on this aggressive closing timeline, all that it is really hard and oftentimes they will pass past. The one reason why they are a little bit different than just a general outreach is they're in the market, they know you, they understand the market and what to diligence so they can move quick if they want to, which is why we even bother giving them a chance. But as you said, like, normally the pressure is too high, but at some point there is option value in going to them. So I just wanted to add that one.
- [22:20]
B
Absolutely. So something to think about. And I think if they did respond to that quick timeline, that tells you something about how much they feel like they need you and could be a sign there's a lot of valuation upside down there. We talked about what are called strategic steps in dealing with competitors. Let's talk about some more tactical things you can do to protect yourself during the process.
- [22:37]
C
So the first one starts with the NDA and having a very tight non solicit and a very tight definition of damages. So again, you would want to work with your lawyer on this. Normally the NDAs are pretty basic. They end up in the same spot when you're dealing with a competitor that should be a heavily evaluated and thought through red line and document and ensuring you have the non solicit and a clear line on damages if somebody was divided violate the NDA is really important. Another one that we've done before is you can actually, if there's an investor involved and sometimes you can do this at the bigger public companies, but in the documentation or NDA you can actually insist on a firewall. So simply put, even though they might be two parts of a similar organization, let's say it's a private equity firm and their portfolio company, you actually write in the NDA that the documents and data will be shared with the private equity firm. They cannot share them with the portfolio company company. And I understand a lot of people out there right now are thinking, yeah, but they're probably just going to call their buddy, right? You would be surprised at how seriously, once some general partner's signature is on a document that states how damages will be calculated, they will actually keep that stuff private and confidential. It's not perfect, but that is a mechanism that you can ultimately deploy. And again, the goal here is to keep the sales guy out of the process. So that's another one. We touched on this quickly, but data redaction. So customer names, keywords that are bid on, salary, info, information, those kind of things, you can just black line those out in the materials and the data sets that you're sending to folks. We had a deal one time where it was a direct competitor. It was a little bit more of an Internet business and we basically provided redacted keyword bidding information until close. So this party ultimately closed the deal without ever seeing the keywords that we bid on. Because a lot of our secret sauce was on it. They did not need to know what those words were. They need to know they weren't infringing on trademarks or brand or illegal or anything like that. But they didn't need to know the specific special sauce. And we just held that until close and it was fine. And then the final thing I would say is around customer calls. So when you're closing a deal in deep diligence, any buyer and investor is going to want to talk to some of your customers. And one of the things you can do is have that buyer or investor reach out under the guise or employ a third party market. Research firm. So it's not. Hi, this is Competitor A calling to talk about Competitor B.
- [25:02]
B
It's.
- [25:02]
C
Hi, this is Mike Lyon Research Inc. And we want to talk to you about Competitor B. Right. And so again, just trying to provide as much protection as you can, knowing it's not perfect, it's still the right thing to do in order to ensure that you're as protected as possible.
- [25:18]
B
I also just want to say be creative here about how to do this. So I'm going to give you the most extreme example of a deal we've ever worked on. There was a sector where basically the strategic buyer public had bought a lot of the IP in the sector and their M and A strategy was basically as follows, Sue Competitor A based on violating their patents and then buy them very cheaply as the litigation strung out.
- [25:41]
C
Which then goes away.
- [25:41]
B
Which then goes away. Yeah, that's part of the deal. So we had this one client who was interested in selling and for whatever reason wasn't on their radar yet in terms of a litigation target. They probably just didn't know how big they were. So we actually knew this buyer pretty well and actually thought the buyer was fine. This was just an aggressive strategy they had in this particular vertical. Cause they did own the ip. We went to the buyer and said, here's what we're going to do. We're never going to tell you the name of the company. I forget exactly how we did the NDA. Maybe it was just with VistaPoint. And we said, we're going to supply you all the data you need because you buy so many of these, you know how to value them, got them all the data, they did all their diligence on a fully redacted basis and we got bids and got to the closing. Now, the day before the deal closed, unfortunately, our client looked at them on LinkedIn and they were able to see that. So they did actually find out the day before it closed. But I think we probably got like a 15% premium because they weren't exactly sure who it was, but they wanted to do a deal. So this was just a way of protecting our clients client. Now we've only done that once, but I just mention it, you can be creative in how you deal with this and it may turn some buyers off, but it may also buy you the protection you need. And obviously that was like an extreme case. Today we talked a little bit about what are the risks and rewards of engaging with a competitor if you're selling your business. We talked about what makes a good potential buyer and a bad potential buyer that you don't even want to include at all. And then we also talked a little bit about some protections of how you engage with the buyer to put them through their paces before you give them the detailed information information Jeff, thanks for joining us. Great discussion.
- [27:08]
C
Absolutely. Thanks Mike.
- [27:11]
A
VistaPoint Advisors is a founder focused investment bank that advises software and Internet founders through M and A and Capital Raised transactions. We are a fully unconflicted investment bank who only works for founders on the sell side, so you know that we're always representing your best interests. Security is offered through VistaPoint Advisors member Finra Sipic. This has been provided for informational purposes only. It is not intended to address all circumstances that might arise. Testimonials from past clients may not be representative of the experience of other clients and there is no guarantee of future performance or success. Clients are not compensated for their comments. If you have any questions about the process of selling your business or raising capital, reach out to a member of our team or check out the four Founders section of our site by visiting four Founders Guide.