M&A and NBA? How the Two Are Oddly Similar
If you’re a basketball fan, then you would know that a typical NBA season takes 8 months to complete with games played almost every night (with 82 games in total). Teams have the pre-season to get their house in order, the regular season to get a record good enough to make it to the playoffs, and the playoff run to hopefully win the championship.
Similar to how basketball is structured, the preparation for M&A is something we get asked about a lot – when to start, how long it’ll take, how to prepare, etc. Given the uniqueness of the tech industry, there are some very specific things tech companies can be doing right now to set them up for success whenever that exit takes place. Let’s get to the drawing board and see what this would look like:
Get your house in order
For a team to win a championship, it needs to have great players. Notice how we said players (plural) and not player (singular) – it takes more than just one person to get the job done. Even Michael Jordan had Pippen, don’t forget that. For companies, this means leaning on different parts of your organization and making sure everything is in order.
Firstly, your accounting should be done properly on a regular basis (at least quarterly). This is especially critical for software companies given issues around things like deferred revenue and revenue recognition. Buyers are very focused on the right accounting of revenues and expenses and it’s important to have recent financials appropriately prepared and reviewed – we recommend at least the last two years plus any recent quarterlies for the current year.
Another area is that many companies are so busy growing and working on the business that they are not accurately capturing their Key Performance Indicators (KPIs). For software companies this would be Customer Acquisition Costs (CAC), Churn (Revenue, Seat, Logo), conversion ratios, Monthly Recurring Revenue (MRR) and a whole range of different metrics. You will need history of these metrics so you can demonstrate trends (ie CAC is declining and churn is improving) and tell the story through these leading indicators. It’s also helpful to have these metrics to run the business along the way and provide early warnings of any issues or to demonstrate what initiatives are having a positive impact.
Know the market and your end goals
“If you fail to plan, you plan to fail.” In basketball, a team needs to have a good understanding of the system, what they want to achieve collectively, and how they’re going to execute on that game plan.
For companies, it’s important to set realistic expectations around the valuation and what would be considered as a positive outcome. We have often seen co-founders set a goal for when they will exit (i.e. I want to put $10m in my pocket after tax) and then change their mind as the business grows. If you perpetually keep pushing an exit off into the future it could never happen, especially if something in the landscape changes (which happens frequently in tech).
Compare this to the huge debate around Kawhi Leonard – who will become a free agent after this season ends. Depending on how this year’s playoffs go, Kawhi will have to make the decision of staying or leaving Toronto. If they win, however, it would be a much more difficult decision to make. As the Raps grow, their changing mindset could positively or negatively affect the future of the franchise at large.
Address weaknesses in your business
Listen, trading DeRozan and JV hurt, but it was an essential change the Raptors needed to make to elevate their game. Now with the transitions made, you see the difference on the court. If the Raptors didn’t make these pivots early in the season and adjust before playoff time, they wouldn’t have had the same run as we’re currently seeing.
It’s hard for many entrepreneurs to admit this but every business has weaknesses. It could be slower market growth, an outdated piece of software, high churn or high customer acquisition costs. It’s important to acknowledge these weaknesses and address them early as any of these factors and many more can have a material impact on the valuation you can command in a sale. For example, if your company has high churn, think about how a customer success team might be able to help identify customers that might leave early and convince them to stay.
Talk with potential buyers
It often seems crazy to talk to your competitors and others in the industry that could be your potential buyers, but its always good to get to know some of the likely buyers ahead of time to more easily facilitate conversations around a potential M&A deal. For example, a re-sale or distribution agreement can be a great way for a company to get to know your products and see why your business might be complimentary to theirs. Obviously, you don’t want to do this on an exclusive basis as it will limit your options, but these types of relationships can really help.
In addition, there’s a lot of opportunities to get to know competitors in an organic way without looking desperate. Trade shows are great for this and can allow you to start a conversation naturally and build on that dialogue over a multi-year period, so the potential buyers know about your company and what you are doing.
Have the right advisers
As much as the players are important, so are the coaching staff and management team. If you don’t believe me, take a look at what happened to the Lakers this year. Sure, they faced challenging injuries, but a lot of their tribulations were due to mismanagement and bad coaching. Plain and simple.
We see a lot of companies that get close to M&A and haven’t done the necessary tax planning to ensure they can maximize their capital gains exemptions. Usually this can be achieved through a holding company and family trust but they typically need to be set up two years ahead of an M&A event for them to be effective. We also come across companies that don’t have their legal documents in order which can really slow a deal down, so we recommend keeping this stuff up-to-date on an annual basis. As part of this legal work it’s also important to have a Shareholder’s Agreement that can prevent last minute obstructions to a transaction – for example drag along and tag along rights are essential.
Lastly, some companies think they can go it alone on the M&A and not hire an M&A advisor. We think this usually results in them leaving money on the table as they do not know the market value of the company and without the threat of competition that an adviser brings, there isn’t the competitive tension to ensure buyers pay up for the acquisition.
To conclude, it’s never too early to think about what you need in place to ensure a smooth exit and we recommend you having discussions early in the life cycle so you can maximize value and minimize deal complexity when a transaction is on your radar.