69. When to sell your startup? 🤷‍♂️ Equity and Valuation vs. Risk

If someone came up to you with a check and said, they wanted to buy your company. And let's imagine that check has many zeros on it. What would you say?

Would you immediately jump at the offer or refuse immediately? What would that number need to be to change your mind?

Today, I want to talk about how to think through that decision. I will also discuss when you might want to reach out for an acquisition proactively. As an example, I will share my experience selling Anonymizer.

Risk vs. Reward

If you're running a high-growth company targeting a big exit, there are two win conditions and two loss conditions.

One win is an IPO. That's a big win but exceptionally improbable. Alternatively, a company could acquire you, providing an excellent return to everyone.

On the loss side, you might just crash and burn, or you might limp along like a zombie for a long time. That's bad.

Given those four possible outcomes, how do you decide whether you should sell your company? Look at the immediate assured outcome from the acquisition against the potential risk and reward of continuing.

How much money are they offering, and how would that make you feel? Would it make you happy and count as a solid WIN, or would it be a disappointing outcome?

Weigh that against the range of likely outcomes if you don't sell. The best possible case might be an IPO netting billions of dollars. However, there is also a risk that your valuation could fall if not go to zero.

Some acquisition offers come with an earn-out, where the amount you get depends on how the company performs over a period of time post-acquisition. That can completely change the risk tradeoff since you would still be vulnerable even after the sale.

What are the odds of something catastrophic happing to your company in the next few years? What are the odds that a massive competitor might enter the market and crush you? Could you lose your biggest customer and see your revenues collapse? Do you have key people who might leave and leave you unable to execute effectively?

Against that, you have a known quantity, the cash from your sale.

This game is a bit like playing poker. When should you take your chips and leave the table? The difference is, as founders, we are playing  "all in" on every hand.

Selling Anonymizer

My startup, Anonymizer, specialized in consumer privacy. We were the world's first internet privacy company.

Over several years we grew to about one million active users and one hundred thousand paying subscribers. But then we hit a wall.

Fortunately, we discovered another opportunity and pivoted to selling high-end boutique anonymity solutions to the US Government. That quickly grew to eclipse the consumer business.

We had millions in sales and millions in cash with zero debt. However, once again, the growth slowed.

This time the problem was more fundamental to the business. While I knew everything about the consumer privacy space, I had no background with the Government or the big Three Letter Agencies.

We had done quite well, but we needed a profound understanding of our customers to excel, which was impossible as an outsider.

We considered trying to acquire someone else, but there weren't any companies with both the depth of experience in the government and relevant skillsets to be attractive targets.

Fortunately, we had only raised $2.5 million, all from angels. With minimal dilution, even a modest exit could mean a life-changing result for all the founders and excellent returns for the investors.

At the same time, we faced significant risks. Most of our income came from just a few major customers. In the government, you never know when a contract will go away because of a reorganization, a change in priorities, or when a new boss comes in and wants to change everything.

The odd of one or more of those contracts evaporating in the next couple of years, leaving us in a tough spot, were nontrivial.

We realized that the best way to maximize our return was to be acquired.

We hired investment bankers to put us up for sale, but we were unhappy with the offers we received.

Fortunately, there was no urgency to sell, so we decided to take a risk, reject the offers, spend the next two years extending our hockey stick growth.

We felt that the potential increase in valuation outweighed the risk of significant setbacks over the next two years.

We continued to hit our milestones, and two years later, we went back to the market and received much better valuations.

Critically, the one we accepted was an all-cash offer without any earn-out. We did not assume the risk of those customers disappearing. The acquirer bought the company along with any setbacks.

That was a lucky choice. Within the following year, our biggest customer went away. And the acquisition was only a few months before Lehman Brothers, and the whole economy collapsed in 2008, tanking everyone's valuations.

Sometimes you need to be lucky and smart.

Plan Ahead.

It's critical to think about this question now and revisit it from time to time. If/when someone does suddenly show up with a large check, your thinking will be muddled. It's difficult to see past those zeros with all the adrenaline coursing through your veins. It's far better to consider your options when you are relaxed and can think objectively. Confer with your investors and other stakeholders to agree on the range of values you would seriously consider. Decide on a valuation where you would happily hand over the keys and move on to your next dream, whether it be a life of constant travel, settling down with your vineyard, or funding your next amazing startup.

Perhaps you will decide that it is too early to sell at any price. The company is still embryonic, with the potential upside unknowable and potentially unlimited.

Be honest with yourself about the objective and subjective aspects of this decision. Know if the answer is NO, so you don't waste your or their time on pointless negotiations and due diligence.

Revisit this from time to time as your company develops, so you always know your ground when an opportunity comes knocking. You will understand your potential and risk position. With that, you can properly evaluate any offer or choose when to put yourself on the market.

Let me know how you think about selling your startup or suggest topics for other articles down in the comments.

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And until next time, Ciao.