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One of the most frequent questions that we receive is, “What are my odds of a successful acquisition?” In analyzing our historical client results, we have found that there are two factors that have outsized impacts on success. While in aggregate the odds are 50/50, if you can answer ‘yes’ to these two questions, they move to roughly 80/20.

1. Are founders/employees still with the company?

   Our data show that if the company has no personnel (is effectively shut-down operationally) it only stands a 10% chance of being acquired. We used to think that there was a market for the tech of non-operational companies, but clearly that market is small.

2. Does the company have revenue?

   Companies with less than $50K in annual revenue stand a 15% chance of being acquired. Given our strategic acquirers have very little interest in preserving legacy revenues / business models, we suspect having some revenue is really just a signal for the software working with live, paying customers.

Answer ‘yes’ to these questions, and you stand a ~80% chance of successful acquisition. Answer ‘no,’ and your odds drop below 20%.

Although we are set up to take customers who face these long odds, we generally try to steer them towards alternatives such as our Strategic Partnerships product (currently private beta) or taking a few months, if possible, to put the company in a better position for a successful outcome.

Finding exits for sub-scale companies is more about finding visibility through the fog than envisioning opportunity across a big blue ocean. So when the fog set in a couple months ago across the broader economy, and we continued to market acquisition targets, it was second nature for us to start looking for clarity.

What we see is that acquisitions are still happening in specific sectors, though at a slower pace with lower valuations, with more focus on immediate returns.

Sector matters

When we market an asset, we usually do it across multiple acquirer segments, giving us a broad view of M&A interest. Obviously, today’s M&A appetite varies significantly by how COVID has affected the industry sector. Sectors like travel and physical retail are too busy with short-term survival to consider long-term strategic opportunities…at all.

M&A is not categorically dead

Consistent with previous macro crashes (i.e. ‘01, ’08 – see appended chart), we expect deal volume to go down 20-30%, but not to stop. We have found that acquirers in sectors that are only moderately affected by the crisis are eager to engage. Some of this likely has to do with the fact that we deal in sub-scale assets. Smaller assets are a way for acquirers to take advantage of their current leverage without taking on excessive risk.

The default is cautious diligence, but competition ultimately dictates urgency

We have had acquirers express their desire for a slow process given flux in the broader market.  Of course, once other interested parties come to the table, any individual acquirer no longer dictates the timeline. When there is competition, an acquirer that wants to take things slowly can either accept the consensus pace or drop out. That is also to say, if you have a single interested party, prepare for a long slog. No one likes to take a leap during a crisis if they have the option to wait.

Acquirers expect bargains

As with timeline, no individual acquirer dictates the price if there is competition. However, if acquirers are universally expecting bargains given the current environment, then sellers should be prepared to sell at a discount. As shown by previous downturns, acquisition value decreases more than deal volume.

Revenue matters more

Companies are in the process of mitigating their risks. Acquisitions are inherently risky, however, acquisitions with a short path to a positive return on investment are less risky. An asset doesn’t necessarily need revenue to be an attractive target, but if it can paint a very clear picture of how it will boost its acquirer’s revenue, it stands a much better chance at a successful outcome in today’s environment.

In short, M&A is still happening, but there is wide variance in the probability of getting to a successful outcome. Where any given asset sits along the probability spectrum depends on damage to its acquirer sectors, and its ability to create near-term revenue. And valuations are down. The fog has arrived, but at least we’re catching some glimpses through it.

Even in the best of times, most sub-scale startups treat documentation, process, and exit preparation as a chore to be done later. But as these companies (SellCos for rest of this article) look towards a potential exit, they will quickly realize how much work needs to be completed just to satisfy due diligence in an acquisition. Below is a list of steps every business should be taking now, and in the future, to ensure they are prepared.

Acquisition Structure and Why it Matters

Most sub-scale businesses will be acquired via an asset purchase. Rather than purchase the entire organization, including any past, present, and potential liabilities, the acquirer will pick and choose which assets it wants. For most SellCos this will primarily be the Intellectual Property (IP), but often customers will be included.

In an asset purchase an acquirer will not have as heavy a diligence burden as they would in a full purchase. But SellCos will need to ensure their assets are properly documented and compiled for the acquirer to review. Acquisitions are expensive for an acquirer and their bid will factor in expected diligence costs. A high cost of diligence, in either time or dollars, will lead to at best a lower purchase price, or more likely an acquirer not making an offer at all.

Intellectual Property Prep

Think of IP preparation in two different aspects – Can acquirers prove SellCos own their IP, and can an outside party easily review what SellCos have built.

Can SellCos prove they own their IP?

We ask this question to every client and every CEO emphatically states yes, confident they own their IP. But when we begin our review and ask for a list of all employees/consultants who worked for SellCo, including title, start date and end date few have a list prepared. When we ask for an electronic folder of all offer letters, non-proprietary agreements, and consulting letters, we get a mix of unsigned word documents and other forms. Very rarely do we find countersigned copies of these key documents. SellCos may believe that all employees sign these documents, but can they prove it. And if SellCos cannot produce countersigned documents, can they confidently represent to an acquirer that the software and processes are properly owned?

Now the good news – these are common issues even in the best run organizations. Even with great processes in place, physical signed documents can be misplaced, or countersigned electronic versions placed in the wrong folder. But SellCos can take a few simple steps to help limit this risk.

1. Create their list of all employees and contractors from the inception of SellCo. Note missing countersigned documents and begin the hunt to find them.
   • Once SellCos have exhausted their search, and if they are missing important documents, work with an attorney to determine if and how to remedy
2. Create an ongoing process to ensure everything is properly countersigned and filed
   • It can be a weekly or monthly process where an employee is assigned to update your employees list with all new employees or contractors, verify all their documents have been countersigned, and filed both physically and electronically.
   • Assign a second person to verify they can find the electronic copy
3. Keep a clean electronic folder of only final documents.
   • Every offer letter and consulting agreement likely has multiple versions in MS Word or some form of PDF. Those working copies are fine to keep, but store the final countersigned agreements in both the employee folder and a separate clean folder
   • This will make review and compilation significantly easier later

A few minutes of work each week or month can save time and money during an acquisition process.

Acquirer review

At some point in the diligence process, the acquirer will want to review the actual code and architecture of the software. SellCos should:

• Be prepared to demo how the software works and how users typically interact with the solution
• Have a full system map showing the architecture of the data and tables
• Be ready to share some version of the underlying code. We do not recommend sharing full code, but enough for the acquirer to understand that it is well built
• Identify any 3^rdparty software in the code

Remember that for the acquirer time = money. Better prepared SellCos that can quickly and easily share this information increase their chances of a completed transaction at a higher valuation.