Founders have been told that the ground is now shifting beneath their feet. The question is what to do about it. Teams are already making plans to cut spending to conserve capital. They cause painful staff cuts towards the same goal – or impose a staff freeze.
But they should also think a lot harder about building relationships with bankers and the larger companies that might be interested in taking over their startup, say two attorneys who work on both the buy and sell sides of transactions with both large companies and venture-backed outfits, and both of which have over 20 years of experience.
To better understand some of the options founders may have, we spoke with Denny Kwon and Scott Anthony, who both represent the law firm of Covington & Burling (where former US Attorney General Eric Holder also practices). They answered a series of questions we thought startups might be wondering about now. Our chat has been slightly edited for length.
TC: How much has the world changed in the past few weeks?
DK: There is a sense of more pressure on sellers to close deals as quickly as possible, given that there is a lot of market volatility right now, and they don’t know how buyers can react to a significant drop in their stock price. Smaller companies are also facing the prospect of a slightly more challenging fundraising market, so their alternatives are narrowing.
TC: Given that public stocks are so volatile right now, are acquirers more or less inclined to offer stock as part of a deal?
DK: It’s much more challenging to price deals with a significant share of this market. With some volatility, you won’t get a clear picture of a stock’s inherent value, so all-cash deals are much more beneficial for targets.
TC: Are targets in a position to make demands now? How much influence does a startup with diminishing options have?
DK: Whenever we see volatile markets where valuations were incredibly high [and are] resets, it always takes a while for sellers’ expectations to reset, so while they can be temporary [lull in activity] if there is a ‘normalization’ on the way, we are likely to see mergers and acquisitions because of the market, especially when valuation expectations on both the buyer and seller side are lowered.
My feeling [right now] is that buyers view the market correction as potentially opportunistic. Still, sellers may not have the same expectations as they hope for a recovery shortly. Once seller expectations come down and they keep hearing from VCs that financing may not be as available as they were 6 to 12 months ago, they will be pressured even harder to turn down any acquisition offers.
TC: Do you see deals being pulled back as buyers want to reprice previous contracts in their favor?
DK: The pending deals I’m working on are moving fast.
TC: We’ve all heard and read about steep valuation declines. Do you know how much value your customers have lost in recent weeks or whether certain sectors are being hit harder than others?
SA: There is valuation pressure, but it is difficult to measure [the degree]† Sure, we have companies racing to close the valuations [before Russia invaded Ukraine], and [that period since] has changed everyone’s expectations. I think there is concern on the company side that investors are not seeing it anymore and that valuations are going down.
Companies with revenues and good prospects will weather any downturn better – they always have. As for the sector, it will depend, but the whole stablecoin [debacle] didn’t help the crypto stuff.
TC: What are the concerns of antitrust regulators for your larger customers?
DK: It’s top of mind for all practitioners, but there’s a dichotomy in that some transactions are reportable and others are not. For those who are reportable — the threshold is about $100 million — we spend an incredible amount of time analyzing the potential for regulatory problems.
TC: How long does an M&A process take, and when do both parties agree on a price?
DK: From that initial approach to an acquirer, the timeframe can range from a few weeks if there is immediate reconciliation to several months if the target company wants to see if there is another interest. Much depends on how appealing that initial offer may seem. Once you get a handshake for an appraisal usually takes six to eight weeks to get a signed final agreement.
SA: If the [startup] is the one who decides to find a buyer, then the process – maybe they hire bankers, perhaps they use board members’ connections to reach strategic individuals – the process and timing can be very different depending on how quickly they get the money and how quickly they can interest potential buyers. † † and company size, but buyers are still going to do their due diligence process.
TC: Let’s assume mergers and acquisitions will be a more important factor given the cooling financing environment. What points would you make if you were to advise a startup on the pros and cons of going ahead?
DK: Many companies that are at a turning point and need to raise money to fund their growth or expansion will have to make a difficult decision, which is to either file another round where the valuation may not meet their expectations or [where they see a lot of dilution]or an M&A exit, where they now see returns but lose on [potential] upside down.
TC: Should startups open to sales need to contact everyone, or should they wait and see who approaches them? Some may worry that their startup’s value will drop once they declare a willingness to sell.
DK: I would advise startups to talk to bankers and build relationships with people at the bigger companies they know, simply because we may be facing a longer-term correction where funding will become even more challenging than it has been in the past few months.
SA: It makes sense to have relationships with the bankers, so if you need to control the market, you already have those relationships. Also, interacting with customers and larger strategic partners who would be natural buyers for the business would help any sales process that can interrupt later.
