After receiving an unsolicited acquisition offer for a portfolio company, a partner at Nexus Venture Partners (Nexus) sat down for a long, meaningful discussion with the founder of the portfolio company. The conversation ran something like this:
Founder: “Let us accept the offer, it is very good.”
Nexus Partner and Board Member: “But the company is on fire. What is the hurry? We can take it public in a couple of years.”
Founder: “You don’t understand. I am working 24/7. I have a baby and I don’t get to see him very often and my wife is mad at me for not helping out.”
“Red Hat acquired the company (Gluster) to create a computer storage division – something they might have been able to do, but an acquisition was a faster and lower risk approach.”
NBM: “You have a team; you don’t need to be working 24/7.”
Founder: “I have to make (the company) the biggest success it can be.”
NBM: “This is not a sprint, it is a marathon. You have to pace yourself. We will do well.”
Founder: “Plus, the sale is good for everyone, financially.”
NBM: “Okay, if that is the issue, we will find a buyer for a portion of your stock and you can roll the dice on the rest. You will still keep most of the upside.”
Founder: “What about my team?”
NBM: “They can take some money off the table also.”
Founder: “I polled my team and everyone wants to sell, except one VP who made money in his previous venture.”
NBM: “But why? Are they worried the company might go up in smoke?”
Founder: “No, they are all very confident, but why take a chance?”
NBM: “We owe it to all of our employees to do the best for them – we cannot sell too cheap or too early.”
Founder: “It is a fair price. They (potential acquirer) say that this is the best they can do.”
NBM: “I think that the company is worth a lot more than they are putting on the table.”
Founder: “I hear you, but I need your support to make this happen.”
Post many more talks and a substantially higher offer, the company eventually sold out.
The conversation relayed here has several interesting elements being discussed. The investor and the entrepreneur are worried about valuations, employees, and the future growth prospects for the company. The founder’s personal situation is also taken into account. Exiting a business is a big deal, financially and personally, for every stakeholder and the final decision can have its effect on a large number of people.
“Red Hat acquired the company (Gluster) to create a computer storage division – something they might have been able to do, but an acquisition was a faster and lower risk approach.”
We decided to rope in three partners from Nexus to discuss the dynamics of building and selling a business. Nexus, of course, has exited five technology businesses over the last 18 months. Recently, it sold its stake in Netmagic Solutions to Japan-based NTT Communication Corporation. Prior to this, the venture exited its stake in Dimdim, Cloud.com, OLX and Gluster (all technology firms) to various global corporations. The common point in each of these acquisitions is that these companies were all built keeping an IPO in mind, but eventually exited through a strategic acquisition.
The notion of exit-ready
Suvir Sujan, co-founder, Nexus, says, “At the fundamental level, one needs to understand that companies are never sold. They are bought. If you go about building a business keeping an exit in mind, I’d say that is pretty dangerous.” Sujan’s belief is that as a growth company, the important aspect is to build value and what the founder can do as a standalone player. Sandeep Singhal, also a co-founder at Nexus, agrees, “It is just that simple. You should scale your business as rapidly as possible with an eventual path to profitability. It’s the core of the business that is crucial; it’s not about having an exit strategy at all.”
In the case of Netmagic Solutions – a company Singhal closely worked with – the focus was on building a solid data centre business with top-notch managed and value-added services for its clients. The business model gradually evolved and Nexus played a vital role in shaping up the company’s strategy. From helping them to expand their target customer base to advising the company on entering higher-margin service areas, the value addition from the investors came in the form of strategic advice.
Naren Gupta, another co-founder at Nexus, gives us an example of another portfolio company, Gluster, and how it got acquired. “Red Hat acquired the company to create a computer storage division – something they might have been able to do, but an acquisition was a faster and lower risk approach.” Red Hat also looked at the value, in terms of differentiated services, that Gluster could bring into its portfolio of offerings and had the team to grow the business significantly post-acquisition.
Sowing the seeds early
As venture capitalists repeatedly say, it’s the entrepreneur, the entrepreneur and the entrepreneur who makes a business work. Sajan gives us an example from inMobi and how Nexus didn’t invest in the company. He confesses that he missed the boat on that one because Naveen Tiwari’s (the founder of inMobi) initial business plan didn’t impress him. “But what we didn’t realise was that the entrepreneur was top-class. He was nimble and quickly changed business models,” says Sajan.
He listed out the crucial characteristics of a good entrepreneur. “The entrepreneur must not be muddled in his thinking. That is crucial.” Additionally, it is important for entrepreneurs to listen to the market and make changes as the market demands. Staying quick-footed is important. Nexus is also convinced that the entrepreneur has to be someone who has the passion and the ability to articulate his grand vision to all stakeholders – employees, customers and partners. “At the end of the day, he has to be a sales person,” adds Singhal.
A company’s evolution
In almost every company, irrespective of whether there is a huge change in business model or not, the company does make continuous changes be it to revenue model or target market or even its people strategy.
In the case of Dimdim, a company that was started with the vision of democratising web-conferencing, the broad level vision hardly changed. However, its target segment did widen over time. After the early adopter phase, the company made inroads by targeting pro-sumers (professional consumers), which consisted of several categories of people including small business owners and online tutors. There was a freemium model (free model for some features, but more sophisticated features can be accessed after payment) that came into play and Dimdim was well on the way to building a company that can remain independent, grow fast and stay profitable. However, somewhere in-between, the web-based product was applied in sales trainings. It captured the attention of Marc Benioff of Salesforce.com who felt tremendous synergy could be built if he bought Dimdim out. The deal was made. As often repeated, Singhal and Sajan are convinced that most exits happen like this. The company is evolving, and somehow another company sees value in acquiring it.
Singhal says, “In the case of the NTT-Netmagic transaction, the big draw was that Netmagic could now expand globally and the role a strategic investor could play in the acquired company is what prompted a sale.”
On the negotiation table
Once a deal is on the negotiation table, there are several questions entrepreneurs and investors need to analyse. Singhal says, “The primary question we always ask is ‘what does the entrepreneur want to do?” Investors and entrepreneurs pool together and analyse future growth prospects, what is good for employees and even what the founder is thinking at a personal level.
The issue of valuation is always tricky. Sajan says, “The thumb rule here is an entrepreneur should always know his walk away price.” Also, analysis using the earnings multiple (for unlisted companies) is complex, as every company is different and ever buyer can bring in a variety of synergies into the equation.
At the end of the day, an exit is about what works for the entrepreneur, the investor and the buyer, and who has the ability to convince each other to agree upon something that works for everyone. The world of venture capital relies on exits and it is one of the most crucial aspects of a vibrant startup ecosystem. Getting your exits right – for your entrepreneurs and your limited partners – is the single most important aspect of a successful VC firm. The journey of Nexus through five exits in a short period of time is certainly an interesting case study to analyse further.
Executive Summary
At the fundamental level, one needs to understand that companies are never sold. They are bought. If you go about building a business keeping an exit in mind, that could be pretty dangerous.
As entrepreneurs build companies, it is crucial to stay nimble footed and evolve in terms of business and revenue model. As the Nexus partners mention the top four qualities they look for in an entrepreneur are someone who thinks clearly, someone who listens to the market, acts on it quickly and most importantly, someone who can sell that big, grand vision to various stakeholders of the firm including the guy who comes knocking to buy the business.
Once on the negotiation table, always have a walk away price. If you don’t have a walk away price in mind, you’ll, almost certainly, be low-balled.
