Startup Acquisition Process: The Magic Behind the Merge — Interview with Jason Nazar, Founder of Docstoc

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In December of 2013, serial entrepreneur Jason Nazar woke up, rolled out of bed, grabbed his iPhone and with bleary eyes read the headline:

“Document-sharing platform Docstoc acquired by Intuit for $50 million.”

This wasn’t just any headline – it was his headline.  Today was the day Jason would announce to the world that he had just sold the company he had worked on for 8 long years for a reported $50 million to Fortune 500 powerhouse Intuit.

Do you think he was smiling?

The Black Box of Acquisitions

We wanted to know the answer, so we spent some time with Jason to dig into the process.

The problem with understanding startup acquisitions and how Founders manage them is that people rarely talk about the process – they just talk about the outcomes. The process itself is largely a black box that gets overlooked in favor of the romantic story of the big exit.

But we were more curious, as Founders, what the real story and process looks like from the Founders’ perspective.

1. How did Jason as a first-time entrepreneur get the acquisition process started?
2. How did he know it was even time to sell?
3. What does the process look like and what can Jason help us avoid?

… and most importantly, when he read that headline, what was his reaction?

The Man Behind the Sale

To get a look behind the curtain we sat down with Docstoc co-Founder Jason Nazar. Jason is not only a Founder but also one of the best known connectors in the LA tech community, having interviewed many top entrepreneurs and venture capitalists with his Startups Uncensored series. He’s also serving this year as the Entrepreneur in Residence for the City of LA, appointed by Mayor Garcetti.

Within a year of selling Docstoc, Jason was already getting to work starting his next company, Comparably, which helps people compare workplace compensation & company cultures.  This is a man who lives and breathes startups.

By now Jason has gone through the entire startup lifecycle, from pitching his idea to investors to scaling quickly to completing a sale.  Combined with the amount of time he spends with other top entrepreneurs he’s learned some invaluable startup lessons.

More importantly, Jason was eager to share those lessons with his fellow Founders so that they could get a look inside the acquisition process.

How to Know When To Sell

Jason first pointed out that long before you even begin the process of a sale, you have to begin the process of serious introspection.  We’re literally talking about taking everything you’ve worked so hard to build – the thousands of hours of work, anxiety, risk and perseverance – and hand that over to someone else.

Jason reflected on where he was at mentally and emotionally at the time:

“The team and I worked tirelessly to take Docstoc from an idea I had in law school in 2006 to a company that employed over 70 people, drew over 20 million small business visitors per month, and had over 50 million members worldwide.  We had raised venture capital and had a lot of folks counting on the success of the company.  I had forgone countless nights and weekends with my friends and family all in the interest of seeing Docstoc succeed.

I knew when I started that my eventual goal was to sell the company or take it public, but we had been heads down for so long focused on building the business, I had never really thought much about that outcome.  But after 8 years, and more and more inbound interest in the company, it forced me as the founder and the primary fiduciary for all the shareholders and stakeholders to make a call on how best to proceed.

I decided it was time to consider an acquisition.”

Getting to the point of even considering a sale is a milestone within itself – it means that you likely have built something of value worth purchasing.  But that alone doesn’t make selling your company any easier.  In fact, it makes it harder, because you have far more at stake if you get it wrong.

Everyone has their own circumstance but the most common questions a Founder or a team must ask themselves are:

Can I keep going?

Founder burnout is real, and as it happens the most turbulent times tend to occur in the early days, meaning that as the company grows, often past the 5-10 year mark, the constitution of the Founder and the early team is severely tested.  The hit points are nearly gone and the energy bar is blinking red.  

“I was really excited about where we were at with the business in year seven & eight, our revenue and reach was at an all time high.  Not surprisingly we started to get M&A interest from a number of companies.

In our case we had only raised $4 Million, a very small amount for a platform our size, so I was considering three options:

1. Continue to run the business profitably
2. Raise more capital
3. Or, pursue M&A options.

It’s always such a hard decision to sell your company, even when it’s venture-backed and you know the eventual intended outcome is a liquidity event.  I was feeling great about the business, but I had also been working non-stop building the company for eight years, I was moving into a different phase of my personal life, and wanted to make sure we had a great outcome for all the stakeholders of the business.  There’s some inevitable fatigue after founding a company and running it for almost a decade. All that was mixed together along with a personal desire to have more time to focus on my health.”

How will everyone be affected financially?

Will investors get their money back?  Will I take home enough to make it worth my while?  Will my team feel like they were rewarded for all the sacrifice I signed them up for?  If you’re selling LinkedIn for $26 billion then you can probably assume the answer is “Yes.”  But if you’re like most companies who aren’t dividing a multi-billion dollar pie, it’s not clear if everyone’s serving size will be enough.

Most of our early investors got a 10X on the deal and some even got 20X.  We also had a number of team members that had been with us for many years and I wanted to make sure they were going to make enough money to get out of debt and buy their first homes.

Personally, I hadn’t built any wealth as I was previously in grad school and actually took out loans to originally fund the business (that I was paying back until we sold).  So I was also conscious that the sale would really change things things for my co-founder and me, and set us up for financial freedom.”

Is it too soon?

By the time you’ve made it to the point that the company has the potential to sell, you’re often saddled with trying to figure out whether to sell at all.  No one wants to be the guy who sold his Apple stock before the Mac was released.  Yet at the same time holding on has a huge cost too.

“My first concern on the financial return was for my investors and employees, I wanted to make sure they were both going to have a great outcome.

According to Nazar “Almost everyone regrets it [the sale] afterwards, because they think they can keep growing.  The DNA of any successful entrepreneur is to believe that they can always achieve more.”

How to Start the Acquisition Process

Once you’ve gotten to the point where you feel comfortable exploring a sale, the next question becomes – how does the sale process even start?

Typically companies are bought, not sold, which means the acquirer tends to call you.  In the case of Docstoc, though, Jason wanted to be more proactive and control his own destiny.  Over the years he had collected a list of potential suitors that made good strategic sense for Docstoc.  One of those potential suitors was Intuit who has a strong focus on small businesses whom Docstoc targeted directly.

“We had a couple high profile companies in 2013 reaching out about M&A opportunities.  At first I didn’t really pay attention, but one suitor was quite serious.

It got me thinking who I wanted to partner with and where I would want our product to live on if we did get acquired that year.   We had built the largest content site to help folks start and grow small businesses.  Intuit was a company I had long admired, and had a similar mission to serve small businesses.  When we started discussing potential opportunities together, it just kinda clicked.”

Positioning the Deal

Presenting your company for a sale is similar to pitching to investors – you want to show that you have a fantastic opportunity for growth, but you don’t want to look like you’re showing up with your hat in hand.  It’s a fine balance between selling the future while justifying the present.

Jason knew he had a lot of potential upside for Intuit.  He researched Intuit closely so that he could see where they were focused and where they were lacking.  With that intel he carefully selected a handful of critical selling points he knew would be interesting to Intuit including:

Growth Rate

Everyone loves growth, especially big, established companies who have long since exhausted their market opportunities.  Jason knew that the rate that Docstoc was growing was beyond any of the lines of business that Intuit was currently running.  While their existing business lines were growing in the single digits each year, Docstoc had nearly doubled every year since inception.

Market Expansion

Intuit’s core customers are small businesses that use it’s products like Quickbooks and TurboTax.  While those products were the stalwart money makers for Intuit, the company needed to expand into critical new areas that SMBs cared about, and providing highly relevant business documents to SMBs was a very big market to enter.

Customer Acquisition Costs

Intuit spends tens of millions of dollars acquiring new SMB customers every year.  In one purchase they would get access to millions of new SMB-focused visitors every month on Docstoc’s platform which could be comparable to even their most ambitious customer acquisition efforts

Established Success

Everyone thinks big companies can simply build their own version of a startup’s service, but in reality that rarely works.  Docstoc could provide Intuit instant market traction in a space that would otherwise take them years to establish themselves, even if they were successful at all.

Just like a Judo master, Jason found the weak points of his acquirer’s businesses and countered them with the strengths of his own.  The more prepared he was at understanding the needs of his acquirer the more valuable his asset became in their eyes.

Negotiation

While pitching to suitors is similar to pitching to investors, the negotiation process in a sale is dramatically different.  A key difference is that in the early days of the company, when pitching investors, the terms used are fairly standard and both parties can envision an almost unlimited upside which offers lots of wiggle room in the negotiation.

In an acquisition, the deal that gets done is more or less the final deal.  Whatever price the seller agrees to at that moment in time is the end of the story.

This makes the deal points far more salient because you often have very specific financial hurdles to consider, like the amount of money investors put into the deal that they would like to get back.  You also have to consider what terms may impact the team, such as “lock ups” that require the team to stay on board for a fixed period of time.

As Nazar puts it, “The devil is always in the details. Just like raising money.”

The Key Terms in an Acquisition

When you’re engaged in the acquisition process, your Letter of Intent (LOI) will have lots of terms and it’s up to you to negotiate many of the key business points. A few key points that Nazar pointed out are:

What’s the term of due diligence?

Ideally you can set an initial term of the due diligence to give the acquiring company a fixed window with which to make a go/no-go decision on the deal.  A long due-diligence term can leave your company in limbo which can be very dangerous.

As Jason describes it “You don’t want to be in an exclusive lockup period where they get all the info and you can’t talk to anyone else.”

What’s the lockup period?

A typical lock-up period can require the Founders or other shareholders to have to stay on board with the company for a fixed period of time, or in some cases restrict their ability to sell their shares.

Are you on a single or double trigger acceleration clause?

This is mainly an issue for startups with special provisions that investors required when putting money into the company.  Simply put, single triggers tend to allow Founders and key executives to fully vest their stock upon the sale of a company.  Double triggers can be more complicated, requiring the team to meet special conditions before getting the full value of their vested stock.

What’s the new reporting structure?

You’re merging two companies into one, and inevitably those who had control of certain operations are going to lose that control to the acquiring company, including the CEO.  You need to be sure that this new “job” is what folks really want.

What’s the salary/responsibility/bonus structure for the Founders?

While the company itself is being acquired, the team that comes with it is essentially being re-issued their jobs.  As such, the question as to what the compensation and upside of the job is comes into question.  Ideally the new job should be a real opportunity, not just a period of indentured servitude to guarantee the value of the sale (although, that’s not uncommon).

Stock or cash purchase?

Many deals, particularly with large publicly traded acquiring partners are paid for in stock as it’s easier to “raise” than cash.  These deals often carry restrictions on when the stock can be sold as well as run the risk of being devalued by the time they are made liquid.  As always, cash is king.

How much is the holdback insurance?

There’s a widely held misconception that when a deal is done, all the cash is transferred and the Founders go on to build their own Scrooge McDuck money pool. The truth is many deals require “holdback insurance” which allows the acquiring company to hold back payments due on the acquisition.  Jason suggests you ask “What’s the period of time? What are triggers that could cause that to go into effect?”

When Jason looked at his situation he knew that he had a few major deal goals that had to be met:

“The most important thing in any deal process is the people.  You paper an agreement, but it’s the people and how they treat each other during and after the deal process (in a company acquisition) that create all the value.

The most important thing in any deal process is the people. You paper an agreement, but it’s the people and how they treat each other during and after the deal process that create all the value.

In our case I wanted to make sure we had a clean deal without any unnecessary complication.  Intuit was very straightforward to deal with, from the time we got the LOI to signing was 30 days.  I was primarily concerned with the investors and employees getting a great outcome.  We had a small escrow holdback with a short time period, and our entire team came with the deal and all got meaningful raises in the process.”

CLOSING THE DEAL (OR NOT)

The negotiation with Intuit took just a couple of months to move through the deal negotiation and onto final signing.  Jason was fortunate that he was able to continue to advance the deal through each phase.

Incidentally you don’t read about all the acquisitions that didn’t get done. As such, you rarely get to hear what can derail an acquisition, which actually happens more often than not.  The common assumption is “we couldn’t agree on price” but there are many more factors that go into derailing a deal.

Momentum

Acquisitions, particularly within large companies, rely on a certain amount of bureaucratic momentum.  That means the stakeholder who initially sponsored your deal needs to continue to convince the “powers that be” that the deal is still a good one.  During that time people get fired and re-assigned – political circles and agendas change quickly.  It’s easy to lose that momentum at any time during the deal process.

Diligence

The early part of an acquisition is like a first date – you start with all the things that you love about each other and find charming.  It’s not until later (the due diligence part) where you get into the nitty gritty of who the person really is and whether there is a real long term marriage to be had.  Diligence can easily de-rail even the most promising deal as the giddy biz dev salesmen hand the deal over to accountants, lawyers, and the tech team, all of whom are sans giddiness.

Murphy’s Law

Every additional day a deal takes to get done is an additional opportunity for things to blow up.  Maybe your company hits a bad quarter.  Maybe your stakeholder gets fired.  Maybe the world is invaded by Cree aliens.  Whatever can happen, will happen, and it will never result in you making more money and your deal getting signed more quickly.

None of these factors have anything to do with price or whether the buyer is interested in your deal, but all of them are the reasons that deals fail to get done.  Jason was keenly aware of these challenges which is what lead him to take an important stance on getting this deal done:

“Every deal needs momentum. So many things can go wrong from the LOI to closing, and I’ve seen countless deals fall through due to market conditions, cold feet, or just poor communication or taking to long.

In our case I wanted to make sure none of that was going to happen.  My executive team and I worked around the clock for 30 straight days working nights and weekends to get out all the diligence requests.  I think we turned those around in record time.

Speed and momentum are critical in any deal process.”

Announcement Day. AND THE DAY AFTER THAT.

At this point you can easily imagine the fairytale ending where the world hears about your glorious exit, the business press throws a virtual ticker tape parade for you, and your inbox swells with high fives aplenty.

Like the all-star quarterback winning the Super Bowl, at that moment, all the attention goes to the momentous accomplishment in the press at the expense of recognizing the sacrifice that it takes for that one fleeting moment to exist.

There’s that one moment when an entrepreneur has the ability, in the privacy of their own world, to reflect on everything it took to get to that milestone and genuinely appreciate the journey few ever make.

When looking back on that warm December morning in Los Angeles, thinking about the very moment when he read the words “Docstoc Acquired by Intuit”, Jason remembers exactly what expression was on his face.

Was he smiling?

“Yes! But more from relief at first than joy.

The joy came later…”