June 9, 2023

End of the line exit: What strategic buyers really care about, Jonathan Rothenberg, Cyderes

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Unicorn Bakery - The Startup Founder Podcast

In this episode, Jonathan Rothenberg, Chief Strategy Officer at Cyderes, shares their experiences and tips on M&A. He emphasizes the importance of a solid company foundation and M&A from a buyer's perspective. Why is due diligence critical here? And why should you focus on acquisitions? You'll also learn why and how market changes affect M&A deals. In addition, there's a look at the seller perspective: how do earn-outs and retention affect decisions?





What you'll learn:


When am I attractive as a company to potential buyers?

Reasons for M&A beyond growth

Evaluating potential acquisition targets and programmatic approach


(0:01:34) Defining success and failures in M&A.

(0:04:23) Reasons for M&A beyond declining growth

(0:05:31) The right time for M&A as buyer & seller

(0:08:18) Validating and prioritizing acquisition targets

(0:19:36) Why there are no perfect acquisitions

(0:23:47) Market environment for corporate divestitures

(0:27:00) Deal structure and operational alignment

(0:34:11) Earn-out arrangements and non-compete agreements

(0:45:13) Structured process for M&A negotiations and due diligence

(0:48:24) Integration plan and difficulties in the M&A process


Jonathan Rothenberg

LinkedIn: https://www.linkedin.com/in/jonathanrothenberg/

Cyderes: https://www.cyderes.com/



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(0:00:00) Welcome to a new episode of the Unicorn Bakery. Today we'll have a look at (0:00:05) Jonathan Rothenberg's recipe for success when we talk about corporate (0:00:10) development and M&A because I think it's a huge topic that felt a bit too easy (0:00:17) throughout the last two or three years in the hype cycle that we had on the (0:00:21) startup ecosystem and there is a lot of stuff to talk about and to revisit on (0:00:26) how companies on an M&A side look about, think about opportunities and look at (0:00:33) opportunities. Jonathan is the chief strategy officer at Sideris and (0:00:38) Sideris provides the people, process and technology modern enterprises rely on to (0:00:46) manage risk, maintain compliance and respond to security threats with (0:00:51) greater speed, scale and cost efficiency than traditional in-house solutions. (0:00:57) I think you might know, some of you might know one of the founders of (0:01:02) Sideris, it's Robert who is also part of Shark Tank. Me as a German I'm not (0:01:08) watching Shark Tank too often but when I was in the US I watched it quite often (0:01:13) and I enjoyed it so therefore back to Jonathan. Jonathan is focused on M&A for (0:01:20) more than 20 plus years so a lot to learn from and I'm super happy to open (0:01:25) up the black box on corporate development and M&A together with you. (0:01:28) Jonathan, welcome to the Unicorn Bakery. Hi Fabian, thanks for having me. (0:01:34) Let's quickly start with the first, like more on the definition side before we (0:01:40) come back to your story a bit but what's your definition of being successful in (0:01:46) corporate development, M&A, the whole topic of mergers and acquisitions which (0:01:51) is like something that everybody talks about but I think a lot of people don't (0:01:55) really know what it actually means to do it well. Well one definition of success (0:02:02) is getting deals done but that's just a near-term proximate kind of viewpoint. (0:02:07) Ultimately what you want to do is create long-lasting sustained value for your (0:02:14) company, the acquiring company, by bringing in additional capabilities, (0:02:18) talent, whatever it is through acquisitions where you can look back and (0:02:23) hopefully tangibly and quantifiably be able to point to value creation and (0:02:28) accretion or equity. Without pointing to specific deals and name them but what (0:02:36) what deals didn't work out that you do throughout your career? Well fortunately (0:02:42) I would say I don't I can't really think of deals that blew up that were (0:02:48) total catastrophes but I think from time to time you run into acquisitions (0:02:56) where it just didn't click in terms of creating the synergies that you're (0:03:01) looking for and in my past and through my career I've always been working for (0:03:07) technology companies or technology enabled companies and typically in this (0:03:13) industry we do acquisitions for growth for growth synergies meaning revenue. (0:03:19) There are other instances or other contexts where companies are doing (0:03:24) roll-ups or other types of strategies and they're certainly looking for growth (0:03:29) but they're also very heavily reliant on cost synergies and cutting out (0:03:35) duplicative G&A for example. So in in my experience the ones that didn't work out (0:03:44) are the ones that just didn't create those revenue synergies at least as much (0:03:49) as we would have hoped. A friend recently told me if you as a startup and the (0:03:55) growth scale up let's put it that way and look at M&A you're officially or (0:04:03) you're slightly admitting to your shareholders that your current business (0:04:07) model is not growing at a fast enough rate anymore and you need to find (0:04:11) different revenue streams to keep the growth coming. Would you agree on that or (0:04:18) would you say that's not a hundred percent true? I would say that's not a (0:04:23) hundred percent true. There are there are plenty of reasons to engage in M&A as a (0:04:29) buyer and and plenty of them that are not about replacing or covering up for (0:04:36) declining organic growth. You obviously could be looking at new market (0:04:43) opportunities where your company doesn't currently play and that has nothing to (0:04:48) do with your existing business for example. What kind of company and like (0:04:54) what kind of company do I have to be to think about M&A but also what should I (0:05:00) have solved for myself to start thinking about M&A because I think for a lot of (0:05:05) companies that I saw throughout the last years mostly earlier stage startups (0:05:10) starting to be into the growth phase they just took on companies and were (0:05:15) like yeah we're now we're now acquiring companies and you're like are you even (0:05:20) focused on your core products or when is the right time to start thinking about (0:05:24) M&A first? As a seller there there are obviously there's so many different (0:05:31) types of companies and therefore there's no one answer to that question it really (0:05:36) depends. In the technology world a lot of companies are formed that really end up (0:05:43) being features or at best products as opposed to companies and so those kinds (0:05:50) of startups or early stage tech oriented companies that again that are (0:05:56) features really or products but not companies would think about it (0:06:01) differently than a different kind of business that maybe truly is a (0:06:06) standalone business that for whatever reason whether it's the founders or (0:06:14) investors time horizons on when to gain liquidity or feeling that they've tapped (0:06:20) out their ability to grow with current capacity current financials current (0:06:27) talent whatever it is and want a partner to help with the next stage of growth. (0:06:31) You have companies where the sale is truly the the exit and they're out and (0:06:37) they monetize everything others that want to stay involved in the business (0:06:41) and continue to grow so there's so many different scenarios and permutations (0:06:46) that ultimately for each entrepreneur each business owner you really have to (0:06:54) start back to first principles of why you started the company not only what (0:06:59) you sought to achieve what market opportunities sought to exploit but also (0:07:04) from a personal or if you're a VC or more of a professional investor what the (0:07:11) goal was for that investment. (0:07:13) And from a buyer's perspective when am I grown up enough to start acquiring companies? (0:07:20) When you're grown up as a buyer enough to be a buyer yourself? (0:07:27) Yeah exactly. (0:07:28) It's a good question I would say when you feel that you've got a good handle on your own (0:07:38) business number one I think it's really a dicey proposition to start acquiring (0:07:44) when you don't have your own house and water. (0:07:46) Now maybe there are some businesses that are set up sort of as a shell to go out (0:07:53) and roll up an industry so maybe that's a unique kind of case but you should have (0:07:59) a strong enough handle on your business on your market so that you can conduct (0:08:06) due diligence and make an assessment of the strategic fit and the degree to which (0:08:13) your target companies are actually achieving for themselves but then  (0:08:18) ultimately for you if you buy them what the goals are. (0:08:24) I think it's a good timing to also ask okay let's say you're currently in the buying position (0:08:33) how do I assess my target? (0:08:35) How do I understand if the company is actually something I should buy? (0:08:40) And let's start from here before I try to find all the small ways out of the deal again (0:08:48) but I think what are the main things I need to understand to validate a deal or opportunity? (0:08:56) So I actually prefer to take it a few steps backward from there. (0:09:02) In my view if you're starting from the position of looking at a particular target (0:09:08) and then figuring out where it makes sense that's actually later than where I would like (0:09:13) to make that assessment. (0:09:15) The ideal situation for me is first you start off with looking at your own business as the (0:09:21) buyer and determining what are the gaps we want to fill? (0:09:25) What are the opportunities we want to exploit? (0:09:28) What are the types of companies in abstract that we want to acquire and make a prioritization? (0:09:36) And just a handful if you have too many priorities obviously you don't have any at all. (0:09:40) So just a handful of actual priorities of archetypes really of the kind of target you (0:09:48) want to acquire. (0:09:50) Then you've got that template and then you can go out and do a market search, do a bunch (0:09:55) of desktop research, talk to industry participants and so on. (0:09:59) Build your target list and then you have an objective standard that template against which (0:10:06) you can compare all of the potential targets. (0:10:09) And that way keeps you honest to your strategic rationale and it also makes it more difficult (0:10:17) to do what I see all too often which is to come upon a target that it's actionable and (0:10:23) it's available and then you end up reverse engineering your strategic rationale to acquire (0:10:29) it. (0:10:30) I have the feeling the smaller and the younger a company is the more opportunistic they think (0:10:36) about this process. (0:10:41) You're probably right about that. (0:10:43) I think for example if a company has some professional besters, they have some VCs who've (0:10:48) been around the block a few times, maybe they can bring some of that perspective and (0:10:53) that experience to it to be more programmatic as opposed to more opportunistic. (0:10:59) And what I described before is really about having a thematic or programmatic approach (0:11:05) to M&A as opposed to a more reactive or opportunistic approach. (0:11:12) On the one hand it's definitely on the team side because you don't have the budget to (0:11:16) also have a corporate development team that's that senior already. (0:11:20) Maybe you don't even have a person that's just like, hey we should think about X and (0:11:23) then you look at opportunities like who might be on the market. (0:11:27) And at the same time it's also that maybe you're just too young to acquire companies (0:11:34) and you're just like, oh this could be an idea and like it's all of this like little (0:11:40) sparks instead of as you said the really assessing like the self-assessment that you (0:11:46) then use to identify possible growth and growth opportunities and also maybe even product (0:11:55) innovations and because I think what a lot of and you mentioned it, it's often to drive (0:12:00) revenue but it can, what do you think about it being developing or like improving the (0:12:08) product through acquisition that then drives the revenue like the implication of we improve (0:12:14) the product and then therefore we will see more customer satisfaction or a new customer (0:12:19) segment and that's how we will make more revenue in the long run and not like in the short (0:12:26) term. (0:12:27) Absolutely, 100% you're right about that. (0:12:30) So it's not simply taking the target P&L and adding it to your P&L and simple arithmetic (0:12:37) and you have new revenue. (0:12:39) It's really about what value creation can take place by putting two sets of assets of (0:12:45) capabilities together and so you're right about either acquiring technology or whatever (0:12:54) the attribute is that enhances your own offering as the buyer whether it's products or services (0:13:01) to be able to then translate into more revenue. (0:13:05) If you do it with I think the proper kind of rigor and discipline what you do is translate (0:13:11) that into a business case, a business case with numbers and then you're able to look (0:13:18) back retrospectively and really compare performance of the acquisition against your business case (0:13:27) and see if you've achieved those goals. (0:13:29) So the qualitative elements of the fit ultimately should be able in some amount at least to (0:13:37) be quantifiable and then be able to go back and measure that. (0:13:42) So might be a bit of a trivial question but how much of your time is then spent internally (0:13:47) to talk to head of leaders whoever and then make decisions on the fields that you want (0:13:54) to improve the company at and then also at the same time talking to external people to (0:14:00) figure out okay what opportunities you want to chase further? (0:14:04) Yeah, it's a good question. (0:14:07) I haven't really kept track of that but it feels sort of like 50-50 actually. (0:14:15) There's a lot of not only internal deliberation about prioritization and of course priorities (0:14:22) change over time especially in a fast-moving industry like cybersecurity where I currently (0:14:27) am or prior industries like analytics or software engineering. (0:14:34) So that's a constant I would say a continuous process but then so much of the work also (0:14:41) is maintaining relationships with bankers, investors, doing just my own research, finding (0:14:48) companies based on our criteria that we set out for acquisitions that we want to make. (0:14:55) Interesting question that I have in my mind right now that came up and might sound a bit (0:15:00) funny but how much do you have to align your interest in buying companies with also making (0:15:08) the right strategic decision as a company to say okay we want to think about expanding (0:15:14) our business growth-wise, product-wise, etc. (0:15:17) So we could buy all of these businesses and then you have to niche down to let's say one (0:15:22) or two acquisitions a year. (0:15:24) I'm just making up the number. (0:15:26) It has nothing to do with your current job and the current companies you're buying and (0:15:32) you then have to say okay we have an opportunity list that we could buy because of all the (0:15:36) areas we want to do or could develop and then we have to niche it down to focus areas. (0:15:43) What would you say how aligned are the values here because you might think hey I would love (0:15:51) to buy all these companies and at the same time you can only buy a certain amount of (0:15:56) companies to even grow strategically and also responsibly. (0:16:02) Sure. (0:16:03) So are you talking about specifically alignment between my own personal preferences and what (0:16:10) the company's priorities are or just as a company altogether being able to do as much  (0:16:19) as we can do as opposed to everything we want to do? (0:16:23) More the inner conflict of being in the role of okay I have to think about all the possibilities (0:16:29) and then even when I want to do all of them I have to shrink them down to prioritize one (0:16:35) or two. (0:16:38) So MA is similar to many other disciplines in a number of ways. (0:16:45) One of which is knowing when and how to say no. (0:16:50) Whether it comes to organic growth when companies are growing one of the challenges that we (0:16:56) see and this may be a lesson for founders actually who were thinking about being acquired. (0:17:02) One of the lessons that we see and I've seen in my own companies that I've worked for is (0:17:08) it's hard to say no but you really do have to say no sometimes. (0:17:12) And meaning no to business and especially when you're young it's hard to say no to new (0:17:17) business and new clients and new revenue streams. (0:17:20) But it's important to know what you're good at, what you're not good at, what drives your (0:17:26) business model. (0:17:27) So if you've got a good delivery model, a good business model, it operates efficiently (0:17:35) and generates good margins but you sort of pollute it by taking on these opportunistic (0:17:42) inbound situations that deviate from your core. (0:17:47) That can cause problems over time and those problems can snowball over time. (0:17:52) So similar in M&A there's an opportunity cost to doing anything. (0:18:00) I don't really view it as a conflict. (0:18:02) I think it's just an inherent requirement of this role is understand that there are (0:18:09) trade-offs. (0:18:10) And I think actually not just in M&A, not just in business, I think throughout society (0:18:17) actually you can see that there's a lack of understanding of what that concept of trade-offs (0:18:23) means that for every decision that's made there are positives and negatives. (0:18:28) And every decision that's not made or every situation or every opportunity that is foregone, (0:18:38) you've foregone that opportunity but also you've gained things maybe that are hard to (0:18:43) measure or quantify. (0:18:45) So being able to prioritize, being able to say no and being able to keep the blinders (0:18:50) on and stick with the program is an absolute necessity. (0:18:57) I think that's so interesting because everybody... (0:19:00) I would think, okay, hey, I'm very opportunistic and like shiny objects in terms of from time (0:19:06) to time. (0:19:07) So I'm like, oh, we could do something here and there. (0:19:09) And like prioritizing is so hard for me sometimes and I can imagine for a lot of other people. (0:19:17) So what are the indicators when you're like, okay, I know this could be a good fit but (0:19:23) it's not good enough. (0:19:25) Where is the fine line between it's good enough and not good enough? (0:19:28) Because it's definitely a grayscale that's like super thin and not very like black and (0:19:34) white. (0:19:35) Right. (0:19:36) So one of the other lessons for me from M&A is there's no such thing as the perfect acquisition (0:19:43) target. (0:19:45) Every target, every deal has hair, as we call it, has hair in some way. (0:19:52) There is something that's maybe a little extraneous from the business that doesn't (0:19:57) exactly fit in yours. (0:20:00) The valuation may be out of whack. (0:20:02) Maybe something about the financial profile isn't 100% as you like it. (0:20:09) There's no such thing as the rainbow colored unicorn that is perfect and has no imperfections. (0:20:19) So that's why going back to what I talked about, that programmatic approach and having (0:20:25) that template or that archetype in advance of going out to look at targets, that gives (0:20:32) you that load star to come back to that you have that constant comparison point that you (0:20:42) can compare back to every target you look at. (0:20:48) And then the more that you look at and the more that you evaluate, the more then you (0:20:53) start to understand, okay, what are the trade-offs that I have to make? (0:20:58) Am I willing to make trade-offs in financial performance because this has the best technology (0:21:04) or this really has the best management team that I like and maybe they don't have the (0:21:09) best clients, but I really want that management team. (0:21:15) And so as long as you're intentional and you're deliberate about looking at not just (0:21:21) the benefits, not the positives, but also the negatives or the weak elements of your (0:21:29) potential target list, then you can start to make those comparisons and trade-offs. (0:21:35) It's interesting. (0:21:37) I just thought about, okay, how would I assess it? (0:21:40) Would I look for enough reasons to say yes or enough reasons to say no? (0:21:45) And as I have maybe too many opportunities, let's put it in quotation marks, that I could (0:21:49) buy potentially because there is always enough space for development and growth, I think (0:21:55) I would rather look for enough boxes to check to say no, to prioritize quicker. (0:22:00) I'm not sure if that's the right thing and definitely, but it would be the easy mind (0:22:05) game that I would play at first to get myself into the space. (0:22:10) Yeah. (0:22:11) Well, a colleague of mine once said due diligence is a negative exercise. (0:22:18) And I like that phrase and I've used it myself. (0:22:22) What that means is whenever you're going in to look at a company, after you've penetrated, (0:22:30) after you've looked at the website, you've heard all the great things about it, once (0:22:33) you get into due diligence, that's where you really uncover that hair that I talked about (0:22:38) earlier. (0:22:39) And due diligence being a negative exercise means you've probably already heard everything (0:22:45) good, all the sell job and the spin and the positioning, and now you're uncovering all (0:22:51) the weak points or where the skeletons are buried. (0:22:55) So that's a totally normal part of the process. (0:23:00) And if your mindset is predisposed to look for reasons not to do the deal, you probably (0:23:06) always find a reason not to do a deal. (0:23:09) So it's not on an absolute scale, it's really on a relative scale. (0:23:16) Fair enough. (0:23:17) I think one question that I have, because I'm more from the startup side earlier stage, (0:23:22) and I saw a lot of valuations skyrocket through the hype cycle in 2020, 2021. (0:23:28) And you mentioned that valuations are sometimes like too high or whatever. (0:23:34) How do you look at the current market? (0:23:36) I'm a buyer, valuations are always good. (0:23:39) What are the current market developments? (0:23:44) What do you see in general about the acquisition market?  (0:23:47) Are there more or less acquisitions compared to, let's say, 2020, 2021 now? (0:23:54) Because it's super hard to say from a founder perspective, if you're too deep into the woods (0:24:02) in the earlier stage right now. (0:24:04) How does it change? (0:24:05) What is the current market environment for, let's say, selling my company? (0:24:10) Yeah. (0:24:11) So obviously, as interest rates have gone up, and equity markets have gone down or sideways (0:24:18) or whatever, but certainly it's different than it was in 2020, the latter part of 2020 (0:24:23) and 2021. (0:24:25) That always has an impact on the market. (0:24:29) Usually what I've seen in past cycles is when there's a re-rating of valuation from higher (0:24:36) to lower, it takes a while for sellers to internalize that new reality and just come (0:24:45) to grips with what their company is worth in the new environment. (0:24:51) This time around, it seems like that has happened more rapidly. (0:24:55) Everything in life is happening more rapidly now than before. (0:25:00) But it seems like that realization has now set in. (0:25:04) So I would say a few quarters ago, things were pretty slow. (0:25:12) In the past quarter, past few months, I think the activity started ramped back up at new, (0:25:21) more, from my perspective, reasonable valuation levels that sellers have come to terms with. (0:25:29) Besides valuations, what are the biggest changes in the deals? (0:25:34) Oh, sorry. (0:25:36) Yeah, sorry. (0:25:37) One element to add to that is the debt factor. (0:25:41) So obviously, debt is more expensive than it was, and I think probably less available (0:25:48) than it was also. (0:25:50) That plays an important role into the valuations also in terms of, especially sponsor-backed (0:25:57) companies being able to fund acquisitions. (0:26:01) So besides the valuations that are obviously changing, coming down, what are the implications (0:26:09) for the actual deal? (0:26:11) How do the terms change? (0:26:14) What am I getting myself into now when I'm selling a company? (0:26:21) Because a lot of deals that we saw with a lot of the super high valuations was a lot (0:26:26) of asset deals. (0:26:28) You get a lot of shares for the valuation. (0:26:31) So if you're selling a company for a billion dollars, then a lot of that was also issued (0:26:37) in shares and not too much in cash often. (0:26:39) Of course, there were exceptions. (0:26:41) But are buyers now still interested in buying in options? (0:26:47) Are they interested in buying with cash because they know we are now at more reasonable priced (0:26:53) valuation levels? (0:26:55) How do deals get together now? (0:27:00) What changes? (0:27:02) Yeah. (0:27:03) If you have the cash, I think certainly you want to use the cash. (0:27:08) Equity is more expensive than cash usually. (0:27:11) When you're talking about using equity consideration as part of a deal, then you're getting into (0:27:17) a relative valuation discussion, meaning what's the valuation of the target relative to you, (0:27:24) the buyer? (0:27:25) The more of a disparity there is with you hopefully being higher and the target being (0:27:30) lower, then the more accretive you can make that to be. (0:27:36) The more important element though of purchase consideration, I think, is the deal structure (0:27:42) and how that plays into the kind of operation that you want going forward. (0:27:50) So if it's really important for you to have the management team incentivized to have skin (0:27:56) in the game and to be committed, maybe you actually do want to have some equity in there, (0:28:03) but if you're able to fund the whole thing in cash because that business imperative is (0:28:08) ultimately more important maybe than the near term spreadsheet answer that you get. (0:28:16) So I think it makes sense to also quickly talk about the most common terms that we have (0:28:22) in such a deal structure. (0:28:24) So I think we talked about valuation, we talked about cash and equity options, but what is (0:28:31) in there besides that that can be in different variations obviously because every deal is (0:28:37) different, but what terms are in a signed deal agreement? (0:28:44) So usually there would be a combination of upfront consideration, meaning at the time (0:28:50) the deal is closed, here's your purchase consideration, whether it's cash or whether it's stock. (0:28:57) And there also would often be some kind of earn out component and what earn out is a (0:29:03) portion of the purchase consideration that's held back for future achievement of objectives. (0:29:12) Usually earn outs are used to bridge a valuation gap where obviously the buyer maybe doesn't (0:29:21) have confidence as much in the financial projections as the seller does and so they use an earn (0:29:26) out to bridge that gap and say that payment is contingent on future performance. (0:29:33) That brings with it complexities after the deal in terms of not necessarily having all (0:29:40) incentives aligned across the organization, maybe difficulty in giving credit for cross-sold (0:29:50) revenue or just the accounting for expenses, things like that. (0:29:54) So it's not as clean, but it's certainly done very frequently. (0:30:01) So that earn out is another important element for people to think about. (0:30:07) There's also another element of hold back that's not really a part of valuation. (0:30:12) So I don't know if this is the right area to talk about it in, but there's often an (0:30:17) escrow that is held back by the buyer to back what's called reps and warranties. (0:30:26) So when a seller is selling a company, there's a portion of the purchase agreement that lists (0:30:31) all the representations that they make about their business, that they're compliant with (0:30:36) laws, that they recognize revenue in a certain way, that they don't know of any problems (0:30:44) with client relationships or that they don't have any employee issues, things like that. (0:30:48) And these are pages and pages of legal terminology in purchase agreements. (0:30:54) And the escrow is held for a certain period of time just in case that there's been a breach (0:30:59) of one of those representations and warranties. (0:31:02) So if everything's okay, the buyers get it all back, no problem. (0:31:07) But just something to, sorry, the sellers get it all back. (0:31:10) I'm sorry, the sellers get it all back, no problem. (0:31:14) But just something for sellers to know that usually at the closing of a deal, there will (0:31:19) be that part of escrow that's also kept behind that they'll have to wait for. (0:31:26) It's interesting. (0:31:27) I'm just, I have to put it in here right now. (0:31:30) It's more on the funny side, right? (0:31:32) For us too, maybe, but not for the company. (0:31:36) Wasn't there the case that JP Morgan bought a company for a very high valuation and that  (0:31:43) was like completely built on like bots and more like anything but real value. (0:31:53) And they paid out most of the exit immediately. (0:32:00) And the founder, she was a female, but doesn't really matter. (0:32:05) It's more that she then, and that's why I needed to state that she then also ran away (0:32:12) with all the money and bought everything she wanted already so that when they wanted (0:32:15) to charge her and get the money back, it was not there anymore. (0:32:20) And now they have to sue her for sure. (0:32:23) And she will definitely go to jail. (0:32:25) But it's interesting like how sometimes also, and I think this is also due to the hype cycle, (0:32:32) due diligences are not made that clearly maybe, or people were very good in hiding. (0:32:39) But it's crazy that there is not much more safety measure or safety guards that were (0:32:46) placed so that she could spend all the money. (0:32:50) Everything was already a done deal and nobody uncovered that it was a very, very, very bad (0:32:55) deal that imploded. (0:32:56) Yeah, that's a perfect example of why due diligence is so important. (0:33:02) And real due diligence, not just check the box, go through the motions, due diligence. (0:33:08) For me, one of the most salient examples of that, at least in recent times that I can (0:33:14) remember is FTX. (0:33:15) It wasn't acquisition, it was investment. (0:33:18) But you had some really big brand name global investors who put money in and it seems like (0:33:24) the due diligence was certainly less than what I would have expected. (0:33:30) And maybe you can be a little influenced by reputation or something like that, but you (0:33:36) really have to do your due diligence. (0:33:38) I always use outside accounting advisors, outside legal advisors, and you really have (0:33:46) to make sure you do the work. (0:33:47) There's no replacement for doing the work and then matching up your due diligence findings (0:33:53) with the provisions of the purchase agreement, like the reps and warranties and the escrow (0:33:58) that I mentioned. (0:34:00) If those are all in sync, then you've done your work. (0:34:04) It was just so crazy when I read the headlines. (0:34:07) One thing I wanted to mention, I know a lot of founders who sold their companies already (0:34:11) and about the earn out, a good proportion of them left the companies they sold to before (0:34:21) the earn out, not taking or even when they, that meant they had to give up millions, if (0:34:29) not tens of millions of dollars. (0:34:32) I'm just curious what you think might be the reasons for that. (0:34:38) And then afterwards I can share what I think, but it's just interesting to see. (0:34:43) I know so many founders who left millions on the table. (0:34:47) Well, first of all, let me preface my answer by saying that I really would love to be in (0:34:54) a situation where I can leave tens of millions of dollars on the table, number one. (0:34:59) But in a situation like that, it sounds like they knew either very early on or it just (0:35:11) evolved over time that they recognize that there's no way they're going to hit that earn (0:35:15) out and they have enough money that it's just not worth it to them. (0:35:20) The marginal utility for somebody with a lot of money of more money might be less than (0:35:27) the marginal utility of time. (0:35:30) And for everybody, that's a different equation, but I think it probably comes down to that (0:35:35) in the situation that you described. (0:35:38) There's another, I won't call it a flavor of earn out, but there's another element of (0:35:42) purchase consideration actually that's retention. (0:35:46) So earn out is future contingent payments based on performance. (0:35:53) Retention is just future contingent consideration paid on being there. (0:35:59) And so that's another sort of flavor or version of holding people and keeping them incentivized (0:36:08) that it would have been the same outcome in the situation you just described. (0:36:11) If they left, they wouldn't get either of those. (0:36:15) But back to your question about why somebody would do that, like I said, they must have (0:36:20) realized that it's just never going to happen and why should they spend the time there knowing (0:36:26) that if they've got the money they want to have. (0:36:31) I think performance is definitely one of the things, especially if you sold on the hype (0:36:36) cycle and then it was just not possible to keep up with the performance. (0:36:41) At the same time, as you mentioned, that's also what I thought. (0:36:44) If you, and let's be honest, like 0.1% of founders ever get into the situation of selling (0:36:51) a company and making like 10 to 30 million from it. (0:36:55) Let's put it down, like just a number on it to make it easier for my example. (0:36:59) If I have 20 million on my bank account now after an exit, it might not make the huge (0:37:06) difference to have three to 5 million more. (0:37:10) And they thought, okay, it would be cool to have the number for the exit. (0:37:15) And then they realized it's also cool enough to have X percent of money less on the bank (0:37:20) account. (0:37:21) And now they're like, okay, I can spend two more years here. (0:37:24) If you're talking about the dependency on like how long am I staying with the company (0:37:29) or I could use these two years to travel or to work on something new and because otherwise (0:37:35) the IP belongs to the company I'm with right now. (0:37:38) There are so many things that I would say at the moment that you have a substantial (0:37:44) amount of money on your bank account, it's also that if the earn out is not too crazy (0:37:49) incentivized that you're like, okay, why should I spend my time here? (0:37:54) I can also do something else with my time, think about new stuff, even if it's taking (0:37:59) time off, which a lot of founders not do during their, during bringing like the time of bringing (0:38:06) a startup from zero to one. (0:38:09) So a lot of potential reasons. (0:38:11) And it's just interesting that because I saw it so often and it's super hard to ask them (0:38:17) directly, like, why did you leave? (0:38:19) And nobody will tell you, hey, it's because the performance was not there. (0:38:22) It's always another reason. (0:38:23) And that's totally fair. (0:38:24) And I don't judge that. (0:38:25) It's more like an observation. (0:38:28) Yeah. (0:38:29) It's worth pointing out here also that what you will typically find as a seller in selling (0:38:36) your company, in addition to all the other provisions is there should be, I always insist (0:38:42) on it, a non-compete provision.  (0:38:46) So as a seller, I want to make sure that the person or the people who are selling their (0:38:50) company to me aren't going to turn around the next day and just build a new competitor. (0:38:56) So I always get at least a couple of years, usually it's more than a couple of years, (0:39:01) several years of non-compete. (0:39:04) In the United States, there are certain states where there's effectively no such thing as (0:39:10) a non-compete as an employee. (0:39:13) So in California, for example, employees are free to leave a company and go to a competing (0:39:20) company anytime they want. (0:39:22) And non-competes are not enforceable. (0:39:25) There's a difference though, being a selling shareholder. (0:39:28) If you're a selling shareholder, then those non-competes are much stronger and much more (0:39:33) enforceable. (0:39:34) And as a seller, you should expect to be bound by a non-compete. (0:39:39) Fair enough. (0:39:40) Often they think about, OK, can we do something completely new, which would then be fine. (0:39:44) But yeah, that's also a valid point. (0:39:49) I had something in mind that I wanted to ask, but I think I lost it for a second. (0:39:57) I'm just meaning to talk to him. (0:39:59) No, no, it's more my I'm getting old. (0:40:02) It's my brain. (0:40:03) No, I'm joking. (0:40:04) But it's more on the let me think a second. (0:40:09) What was it? (0:40:13) We were talking about burnout. (0:40:16) Or people leaving companies. (0:40:18) Ah, yeah, perfect. (0:40:20) Especially because of the people and the founders that I know who left companies before (0:40:26) getting their earn out. (0:40:28) I always have the feeling of, OK, buying the management team, which is an incentive that (0:40:33) a buyer might have to have the management team on board to lead a product division or (0:40:37) to integrate into another leadership team, depending on the exact case. (0:40:43) How well does it function to keep these people in the company? (0:40:46) Because as I only see the examples of founders, then sometimes or often, in my opinion, (0:40:53) rapidly leaving the company. (0:40:55) How well does it work for management teams? (0:40:57) Do they stay? (0:40:58) Is it something that is actually working well because they are not the people getting (0:41:04) maybe a substantial amount of cash up front because they're not the founders? (0:41:08) Like, how well does it work? (0:41:09) And for me, it feels like, OK, maybe it doesn't really work because I only know the (0:41:14) founders leaving afterwards. (0:41:17) So you're talking about management employees who aren't selling shareholders and how (0:41:23) successful they tend to be when being acquired? (0:41:26) Is that exactly what? (0:41:27) Yeah. So I found that actually to be quite successful in a number of situations, (0:41:34) especially where the new management team that has come in via acquisition is part of a (0:41:42) new initiative or is leading a new kind of area that the acquiring company doesn't (0:41:51) already have or where they just don't have the critical mass that they want. (0:41:56) And again, being at growth companies. (0:42:01) Talent is always one of the constraining factors or one of the challenges is hiring (0:42:07) enough talent, enough of the right talent. (0:42:10) So usually there's enough space for bringing new people in. (0:42:15) And also, usually if you're going from a small company that's been acquired to the (0:42:22) bigger acquirer, that will mean broader opportunities, whether it means operating on a (0:42:30) more global basis. (0:42:31) Maybe your company was only regional or national and then you get to be on a more (0:42:37) worldwide platform. (0:42:38) Maybe it means instead of working with small and medium sized businesses, you're (0:42:43) working with more enterprise businesses and that's more exciting. (0:42:47) But there's often, I think, attractive career paths for acquired management teams. (0:42:55) And I've seen that work out very well. (0:42:57) Okay, interesting. (0:42:58) As I said, I'm just too much into the founder perspective here and therefore it also felt (0:43:05) like, okay, maybe that's something to question. (0:43:08) So that means the post merger integration with the team side. (0:43:15) Are you then also, when you make an offer, are you calculating with the high risk that (0:43:22) founders are leaving and you're just taking the team without the founders? (0:43:28) I wouldn't say that I count on that or that I am expecting that. (0:43:35) But the more that you can have succession planning in place or just mitigating plans in (0:43:41) place, in case that happens, obviously the better off you'll be. (0:43:48) I think the incentive for people to stay being financial is just one part of the (0:43:57) equation. I think it's really important both for the sellers and for the buyer to be very (0:44:03) candid and open up front in the negotiations or just the discussions as they're getting to (0:44:10) know each other to really talk through what is the investment thesis? (0:44:17) What is the integration plan? (0:44:18) And not necessarily a detailed integration plan, but generally speaking at a high level, (0:44:24) how do they view the businesses coming together? (0:44:27) What is the ambition? (0:44:28) What is the growth plan? (0:44:30) The more open and the more transparent that the buyer can be with the seller, I think (0:44:37) then the more confident you can be that anything they say about being committed to it (0:44:43) post-deal, that you can rely on that a little bit more. (0:44:48) I really do believe very strongly that that openness and that candor about the future (0:44:55) state ultimately will help alleviate more problems and that the more secretive it is, (0:45:03) the more problems you'll create. (0:45:05) So to bring it back to the founder perspective, if I'm asking for a structured process of (0:45:13) going into the process of M&A, I should have made my thoughts what I am willing to offer, (0:45:19) like also about the founding team and what we want. (0:45:24) We should have pretty realistic market, like think realistically about what the market (0:45:34) offers right now and not go in with our last VC valuation, maybe if we got that in 2020 (0:45:40) and 2021. (0:45:42) And we then also have to think about are there actually amazing synergies, because otherwise (0:45:48) on the one hand, my team might not be happy. (0:45:50) I'm going to the new partner. (0:45:52) The new partner might cancel the process anyway. (0:45:55) And at the same time, to find a new hub and a new home for my company, it just makes sense  (0:46:03) to think about the synergies more than, let's say, just the price. (0:46:07) Yeah, I think founders are often much more focused on what does the future look like (0:46:16) for me or for my employees than a financial investor who's not really part of the business (0:46:23) and certainly not going to be part of it post-closing. (0:46:26) So especially for smaller companies where the founder may really know every single employee, (0:46:34) they may have met everybody before they were hired. (0:46:37) Smaller startups and founder led companies often are more sort of like a family than (0:46:45) bigger companies, certainly. (0:46:46) And so they often place a greater emphasis on making sure that wherever the company lands (0:46:53) with a buyer, it's a good home for people. (0:46:56) It's a company that has good employee relations, that has a good culture, that culture fit (0:47:02) is not to be underestimated at all. (0:47:05) And so they'll be much more attuned to those kinds of questions. (0:47:11) They're obviously going to be very attuned to the financial aspects and the valuations, (0:47:17) but they'll also be very interested in what that future looks like for their people. (0:47:23) Do you have the feeling that founders take the due diligence of the buyer, like doing (0:47:29) their due diligence on the buyer? (0:47:31) Do they take it serious enough or should they emphasize a bit more on that? (0:47:36) That's a good question. (0:47:37) They probably should do a little bit more than they do. (0:47:43) Really more so on that aspect of the culture, the fit, what the future business plan looks (0:47:52) like, particularly for their business, whatever they'll be part of after the deal. (0:47:59) Fair. I can imagine that there will be founders who are like, OK, we're more on looking for (0:48:04) a new home or we're more looking on the financial side. (0:48:06) And either way, they will then be on the scale of we're doing due diligence to maybe not (0:48:12) that much because we are just looking for the financial outcome or a lot of due diligence (0:48:16) because we're looking for the perfect way to also grow further and integrate the business (0:48:22) successfully. (0:48:24) Yeah. And just be also be mindful, though, that not every element of the integration (0:48:31) plan is going to be ironed out. (0:48:33) It's rare, in fact, to have a full integration plan done before a deal is closed. (0:48:39) I think that's the extreme. (0:48:41) That would be the extreme exception. (0:48:43) You should as a seller or founder seller, you should really have your expectations set (0:48:50) to having a higher level, not necessarily vague, but higher level sense of how the company (0:48:58) will be brought in, what the reporting lines will be, what the again, the MO will be in (0:49:06) terms of selling, in terms of delivering, in terms of how if you're a technology company, (0:49:12) how R&D might be integrated, things like that. (0:49:14) So if not specific plans and tasks of an integration plan, at least concepts and guiding (0:49:24) principles. What would you say are the biggest misconceptions that founders or let's say (0:49:31) sellers in this case, because that makes it easier, have about M&A? (0:49:39) The biggest misconceptions that sellers have about M&A, I think, is probably how (0:49:47) straightforward the process might be, or how, I won't say easy, I don't think anybody thinks it's (0:49:54) easy, but maybe underestimating how much of the heavy lift it is. (0:49:58) And it really is a heavy lift. (0:50:00) Usually, smaller companies don't have robust accounting systems. (0:50:05) And so the financial and tax due diligence is going to require a lot of legwork. (0:50:12) And that's not to be underestimated. (0:50:13) I think just the, for a buyer who's doing the work, as I described earlier, doing the proper work (0:50:18) of due diligence, it will be very intrusive, very time consuming. (0:50:24) And you really need to be prepared for that physically and mentally. (0:50:31) Let's say you want to buy my company. (0:50:34) What kind of preparation from my side and thought work will set me apart from the rest of the (0:50:42) deals that you might look at? (0:50:45) So having all of your information for due diligence in good order and good shape, that alone (0:50:55) would set you apart from everyone else. (0:50:57) So whether it's having all of your contracts together, ideally you would already have a VDR (0:51:08) virtual data room set up and you would have a folder with all your contracts and with all of your (0:51:13) corporate documents and your board minutes or shareholder agreements or anything like that. (0:51:20) You would have all of your trial balances and income statements, P&Ls, bank statements, tax (0:51:27) documents, information about your employees, an employee census, and then you would have a (0:51:35) history of attrition and recruitment. (0:51:40) If you can just go through the list of everything you can think of, and this is where a good (0:51:46) investment banker can be helpful. (0:51:49) Now I'm sort of arguing against my own interest because I prefer just one-off transactions that (0:51:56) are not part of a process. (0:51:58) But if you have somebody, at least you can trust who's been through the process of doing the (0:52:03) process before and can help you think through and prepare, it's very useful. (0:52:09) Also, quite a few companies, and this actually started more in Europe than the United States. (0:52:15) Quite a few companies go through a process called VDD, vendor due diligence, where they (0:52:21) themselves hire somebody like a big four, for example, or maybe a smaller accounting firm or (0:52:30) a smaller financial advisory firm, but sort of hire someone to do their own due diligence. (0:52:39) So then they have that VDD report and they've gone through sort of a mini due diligence (0:52:46) process that helps them prepare. (0:52:48) That can also be very useful. (0:52:51) I think these are all the questions that I have for today. (0:52:56) I think a lot of more topics to cover on M&A because it's definitely something that doesn't (0:53:00) see it in one small podcast episode like we did it. (0:53:04) But for a general understanding on how a process looks like from the buyer and the seller's (0:53:09) side and getting a sense for what to look at if I'm thinking about selling my company, I hope (0:53:15) we did a good job. (0:53:16) Maybe you have some thoughts on if we are quite complete or if we left out a topic that we (0:53:21) should have covered for sure. (0:53:24) I think that's it from my side for now. (0:53:26) Yeah, no, thank you, Fabian. (0:53:28) I would say that the most important thing is to be honest with yourself about what you're (0:53:36) trying to achieve and why you're trying to achieve it, whether it's personally or for the (0:53:40) business or for both.  (0:53:42) And then once you start from that step one, I think you can then make the right decisions as (0:53:51) long as you keep that in mind. (0:53:52) And just have all of your future decision points you have now referenced go back to of (0:54:00) why am I doing this and why am I taking this next big step? (0:54:05) Jonathan, thank you so much. (0:54:07) I'll put your LinkedIn in the show notes so that everybody can look at what you're doing. (0:54:11) And also maybe you'll get the one or the other question. (0:54:15) Let's see. (0:54:16) Thank you so much for taking the time. (0:54:18) It's been an absolute pleasure. (0:54:19) I can imagine that we'll have some questions and do another session at some point to go (0:54:26) deeper and in some sub topics. (0:54:29) Thank you so much. (0:54:30) It's been an absolute honor. (0:54:31) Yeah, doc. (0:54:32) Me too. (0:54:33) Thank you, Fabian.