Jan 25 2006

Some follow up to “When should you sell your business?”

There was a lot of traffic on my recent post on the best time to sell your business (comments link here), including a few points that I wanted to highlight. Chris Zook sent me a graph with the following note that I think sums up the underlying driver of what I was describing in that post.

Company_value_spikefocusing more on the idea that while companies generally increase in value as they grow in size/revenue/customers (per your chart), there is often a period of accelerated value that diverges from the standard trajectory as a function of “strategic value perception” or “buzz” about a specific segment or product. The thought being that a given  company would optimally want to sell at or around the peak of the buzz period, as it would take them some time to get to a point where they could realize the same value after the buzz wears off. I’ve always thought this effect is particularly evident in acquisition activity within certain technology segments where a few dominant players are in a continuous battle to stay on top with the next new thing – thinking not only in relation to GYM but also security software (Symantec, McAfee, Computer Associates) or networking (Cisco, Juniper, Nortel). Always tend to see those companies scrambling for the same new technologies, and thus bidding up the other remaining technology providers, which tends to increase the value of public and private offerings for the rest… at least for a time. function of a normalized value curve (perhaps it looks more like a I agree, although I think that this is a cycle that repeats itself over time (i.e., there are several times in a company’s life where their perceived value accelerates away from some more linear stair step, but generally runs in the up and right direction for businesses that are executing reasonably well). Sometimes this acceleration is driven by external factors (i.e., buzz around Web2.0 technologies), sometimes its driven by internal factors (i.e., technical validation of a product, signing of certain new customers, etc.). If you’re a seller, the key of course is to try to figure out how to create that buzz around your company (Brad refers to this as ‘becoming a bright shiny object’) either with a specific partner or more broadly in a market such that potential buyers see you as unique, scarce, critical to some aspect of their business, likely to be bought by someone they don’t want to own you, etc. In this way you can accelerate your deviation from the normal slope and sell for maximum value. Along a similar thought process, Nate Redman pointed out in an email exchange that: as a company moves from proof of technology to proof of business, valuation metrics shift from “strategic value” (which equates to an internal business case and defensive maneuver) to more classic multiples.  In between is no-man’s-land. The other piece to this, of course, is the buy-side.  $25-50MM is an amount that can be initiated, if not approved, by business units.  Once you close in on $100MM and above, the CEO/Board and staff get involved; even Wall Street takes a critical eye.

So, what does this all mean from the perspective of a VC? Certainly there are trade-offs to selling a company early in its lifecycle vs. holding on for a more substantial (but much later) outcome.  While going for broke can bring the big return that most funds rely on to anchor their portfolio, a large number of smaller returns can be equally attractive. To steal one more quote from Nate:

Implications? Increases the importance of low capital intensity, choice of market, and timing.  A portfolio of 3-5X returns leads to a great outcome, but if you are only spending $2-5MM each, it makes it difficult to put $500MM to work.  Teams may be smaller but you need to work with high-leverage entrepreneurs (previous relationship, market experts, etc.) in order to increase the number of boards that you can effectively manage at any one time. I’m going to expand on this last concept as the subject of another post – as it really goes to the heart of the economic model of being a successful VC.