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Tuesday, May 11, 2010

How Do I Structure My Startup For Investment And Acquisition?

I recently attended one of the usual Silicon Valley conferences where a group of startup CEO's, lawyers, bankers, VC's and entrepreneurs get together to keep the dream of the holy grail sale or acquisition of a startup company alive. It was interesting because one of the newly minted entrepreneurs immediately asked the question "How do I structure my startup for an easy exit?".

I will have to admit that I chuckled under my breath and thought to myself "wrong question". You should be thinking about how you are going to keep your company above water to survive long enough to get to the point where someone actually cares about you and your company. With that said many entrepreneurs do make decisions early on in the life of their company that impede their ability to sell or go public.

The following are approaches that entrepreneurs can take in the early formation of their company that will make the company more attractive for sale or investment.

LLC Versus Incorporation - Many entrepreneurs start out forming their companies under the LLC form of business organization. Frequently, entrepreneurs are driven to this approach because they have concerns about the reporting and expense associated with incorporation. They also harbor the hope that their company will be profitable one day allowing them to distribute those profits(profit interests) to the founders. These are all good reasons to start a company as an LLC. However, they are not good reasons from an investment and exit perspective.

Realistically, revving up your startup to profitability is no easy task. Secondly, even if you get there you are more likely to plow those profits right back into your company to keep it growing. For investors or potential acquirers the reinvestment behavior is what they are looking for in an entrepreneurial company.

From a structural perspective investors and acquirers do not like the LLC format because it is inconsistent with the format they are accustomed to investing in and purchasing. They prefer the vanilla corporate structure because it is well understood when it comes to merger and acquisition.

Yes, you can convert your LLC over to a corporation if a sale or investment is imminent. However, why go through the hassle and expense. Start out as a corporation to make your company more attractive to potential buyers.

The Team - Unfortunately investors are subject to being influenced by impressive resumes. This is unfortunate because many successful companies are started by people that have great ideas and good business skills that never went to designer label schools or worked for Fortune 500 companies. Despite this well known fact, investors and potential acquirers may overlook your startup and even pass on an acquisition if they do not see well known labels attached to team members. If you or your company fits this description I suggest you add someone to your team that has "credentials". Even if the credential holder is an adviser it will help your cause.

Investment Categories - Interesting enough investors and acquirers are not that creative when it comes to the investments and acquisitions that they make. Even in the high flying Tech/Internet world investors have a tendency to only invest in areas that they deem to be "hot". This means that even if you have a great idea, good growth and even some profits to prove it investors may overlook you because you are not in a space that they care about. Before you pick an idea, product and or service to form a company around determine what investors care about. This is easy enough. Take a look at their portfolios and track recent IPOs. Granted, this may be difficult if you are looking for an exit two or three years away. However, most investing trends have a history and a trail you can follow and extrapolate from to determine where investment is headed.

Conclusion - Asking the questions how do I structure my company for exit at the start of a business may not be the best thing to be thinking about at that stage in your company's history. However, there are actions you can take early on in your company history that will make you more attractive to investors when the time comes to cash out.


Dennis Garlington said...

I've been through this enough times that I've written some rules. They include, "Worrying about stock will make you go blind," making it the mental equivalent of that thing blindness inducing thing your mother warns about.

The best advice I have is do as little as possible, e.g.,

1) use a simple corporate structure, especially if you're serious about private equity funding;

2) build a realistic capital acquisition plan based on 40 million shares, but only issue 1 share to each founder …and remember that lenders and investors will assign a $0.00 NPV to sweat equity;

3) don't promise anything to anybody until you've got an interested investor;

4) never promise "no-dilutions" (except for the employee stock-option pool);

5) accept the Golden Rule, i.e., "He who has the gold rules;" and,

6) then get your focus on to the real work of developing a product with a strong value proposition and getting to market as fast as you can.

hyip said...

Nice post. This is good information for me. Thanks for sharing.