Preserving Startups During Acquisitions

Reasons why large companies are focusing on acquiring startups

It's all about innovation. But most large companies are not innovating in a groundbreaking way. Instead, their innovations are what I call adjacencies. What they are producing in-house are incremental changes to existing products or services.

Google, Facebook, Apple, Tesla and Amazon are among the few who have successfully established in-house incubators to create groundbreaking technologies and allow those in-house startups to grow and leverage their current infrastructure.

Other companies have tried to establish incubators but have not been very successful or achieved very little. And by the way, what I mean is a completely different product that is not even related to your original product.

Take the case of Google, an example is Gmail. Gmail was released in 2004, it was a completely different product from search and ads. It was groundbreaking at the time of its release, and as of today, Gmail has been able to leverage Google's infrastructure and withstand on its own as an amazing product. There are several examples of those products at Google, like Google Maps, Google Pay, and that also happens at Apple. Those were products built in-house. They were not acquisitions. 

For most companies, replicating that ability, that magic to create completely different products from their core offerings has been very difficult. But startups are constantly innovating, and it makes sense because it's a game of numbers.

For every successful startup that makes it, thousands of startups died and didn't make it. Some of them are producing very similar products to the startups that made it. The startups died for the following reasons: 

• They didn't get enough funding
• Their leads gave up
• Or simply, the idea was not working.
  

You get startups constantly popping up, and if you think about the profile of a classic entrepreneur, most of them are passionate about building something new that is not yet in the market. So tremendous innovation continuously happens in the startup world.

Most large companies have realized that, and they are in a race against each other for acquiring startups that will allow them to enter new markets and users. If done well, they can grow that startup explosively, leveraging the large company's existing infrastructure. 

So the key question I always ask when we are looking at our target is if the target is better off if we acquired them. If the answer is yes, then it makes sense to move forward.

Statistically speaking, the future is entrepreneurship. Most young people I know in this new generation don't want to work at large companies, even a lot of very experienced Gen X people, as well. 

They realize that they can build their own company, there is now wider access to funding, and they are creating new things and they have the experience to leverage that.

To summarize, large companies are now focusing on acquiring startups because of groundbreaking innovations that they cannot produce in-house.

Why startups thrive in larger companies

To make a tangible example, we have an acquisition where they are producing amazing products, but their market is in the US. We already have a presence all over the world, and we are leveraging that technology to now produce it in EMEA, APAC, and commercialize and sell it.

We look at those startups and think, are they better off being acquired by us? I would say yes because we can help them penetrate markets to which they did not have access before. 

Penetrating new markets is one example. There are other examples. I was talking to a friend years ago, and her startup got acquired by Merck. I asked her how she liked it, and she said she liked that now, she got access to an R&D and scientist top-of-line that her startup did not have before. They had a small product they wanted to expand, and she could do that after the acquisition with Merck. 

Access to very specialized talent is also one of the benefits of a startup. Other big pros of being a part of a larger company include the brand. It depends on the acquirer if they have a positive, well-known brand recognition that allows the newest startup to have that kind of access.

To give you an example, in a few of the acquisitions we had with Google, which is a public company,  part of the allure that we did was leveraging the brand. We powered products by the amazing search engine that Google has, and that made the product way better. We leveraged the brand and existing technology at the large company for the startup.

Reasons why startups don't thrive in a larger company

I would say the two top reasons are speed and clash of cultures. In terms of speed, startups are used to moving very fast–that's part of their secret sauce. 

• They pilot
• Fail
• Learn from the failure
• Iterate
• Create a new pilot
• If it works, grow the pilot
• Fail again        
• Pivot
• Start another pilot

In most large companies, that concept of failure is not well seen. And getting approvals for those kinds of pilots takes time. Most of the time, by the time it gets approved, it's not even relevant because it goes through several layers of reviews and that frustrates the startup fox. And if the competitor is moving faster, the project will fail already.

That takes me to the next point; there is a clash of cultures. Working at a large company can feel for startups like going at a hundred miles per hour and suddenly hitting a brick wall. Likewise, for large companies, those startup team members might feel like people that don't want to follow processes, and they might feel entitled and they would just want to do their own thing.

There are a lot of archetypes on both sides of the table, and they don't help while trying to create an integration for a startup.

Factors to consider when acquiring a startup

The answer to this question always, it depends, on, on a variety of factors. So for a question like that, we would need to step back to the fundamental strategy of why we are acquiring them? 

• Is it to penetrate new markets?
• Is it an acquihire?
• Is it a new technology?
• Are we doing it for publicity? 
  

It depends on where we are in terms of our strategy as a company. For example, in a prior acquisition, when we looked at the portfolio of offerings, we determined that one of the products was weak. And we looked at targets that we could use to complement that specific area of our product's offering. 

Once you select the target, assuming everything goes well, you integrate it with the product, and we build a stronger product. That can be one. It also depends on the economic cycle now that the economy is starting to cool off, and we're potentially heading into a recession. 

I can foresee a lot of acquisitions being focused on companies acquiring startups that have access to a different set of customers that priorly the company didn't have access to.

Certainly, the technology would also take years to develop and our competitors already have as well. 

As for their characteristics, I look for how much of that company depends on the founder. 

• What is their secret sauce? 
• Is it the way they develop products? 
• Is it the way they go to market?
• Are we prepared to ensure that once we acquire them, they will not get lost inside the big machine?
• If we acquire them for their service or product, can we replicate that in-house in a moderate amount of time? Because if that's part of their secret sauce and they are moving very quickly and that's what makes them successful in developing that product or service, then we will not be able to replicate that. 
• Will that startup be better off by joining us?
  

Considering the founder dependency of startups

I would say 80% of the startup's secret sauce is dependent on the founder. We can also break that down to whether it can be replicated in-house.

Ultimately, when the founders or the startups come into a large company, they get some retention packages so that they could stay a couple of years, hopefully three years. 

Most entrepreneurs are chronic entrepreneurs. There is a reason why they went and started their own company. 

• They wanted to create their own rules.
• They want to have their own time for working.
  

We are aware in Corp Dev that they will not likely stay, but that heads back to: can we replicate what that founder has done in terms of the secret sauce? Is the founder pursuing new projects or closing new deals?

I've seen all kinds of founders, the ones who are talented, gifted salespeople and the ones who are highly technical. And they are engineers creating new products and being able to connect the dots.

It's also a matter of identifying what kind of gift the founders bring to the company so that we can replicate that. 

To this point, in most cases, the startups die inside of a big corporation if the founder leaves. But more and more companies are realizing that, and to that end, they're taking more and more steps to prevent that.

Factors that make startups unacquirable

It's hard to assess because everyone is on their best behavior, particularly when trying to sell. They wouldn't even take the calls if they didn't want to be acquired by a company. Other companies where I have been are not as flexible with the companies acquired. 

What I have seen in the clash of the culture heading back, not only with the founder but also with the rest of the team is that when they are used to certain things that the startup provides, and they are no longer going to have once they joined, such as the following:

• Free food 
• Flexible work environment 
• Two days per week culture
  

Not only is the founder not going to want to stay, but also nobody. That goes back to the question: can we replicate their product or their secret sauce? Most likely, the answer will be no, because, in the beginning, you need at least that transition period for that replication.

Team composure 

For example, for Brady and my prior companies, having a team in the EU was not a deterrent because we do have a presence there. But it's more about certain practices that at the startup are allowed. And in a publicly traded company that has to follow SEC regulations and all these ethics and compliance rules, it might be difficult to get them to adjust to that for sure.

For example, when I was at Siemens, we didn't provide food for our employees, and neither did coffee. So we were looking at a startup if that was actually their culture. And most of the team members had some entertainment practices that, for a large publicly traded company, we probably will not sponsor these kinds of outings.

It was not a deal breaker, but we had to send a message that they cannot expense those expenses and shouldn't promote it or invite everyone. It's not a company-sponsored activity, and whoever doesn't want to join you should not be penalized for sure.

Preserving startups in the larger company

I have seen during my years of experience that the leadership and the acquiring company fall in love with this startup's idea. There will be courting just like in dating. They go and promise the following:

• Preserve the culture
• Ensure they are not merged immediately
• Continue to iterate independently

Sometimes, that's the plan and what the leadership and executives have in mind. Then, suddenly, the acquisition is done, now it's time for integration. 

I have been in cases where we had to delay the integration in 1-3 years, but sooner or later, they must become part of the company. We are not acquiring a startup to be a hanging arm not joined to the body. 

So, it is important to be transparent that integration will happen. There might be a period for allowing them to continue independently, but there will be an integration.

In every team where I have been, we have debated: is it better to rip off the bandaid for this startup immediately on integration day two, or do we delay it? We had great arguments for both sides of the table. It's a tough balance.

The second point is, some startups have non-negotiables. Find out what those non-negotiables are and be open to adapting to those. Because if you find out the non-negotiable after the acquisition is done and everything is signed, and the acquirer is not willing to concede, it will turn out to be a very bitter marriage where negativity starts settling in.

Some negotiables include the incentives and the factors that are part of their culture.

• Free food
• Not working on certain days
  

That affects talent retention, so find out what those non-negotiables are. 

Joint planning approach

This heads back to the Corp Dev person leading the transaction. Earlier in my career, I was shy of pushing my executive team, pushing back on my president. But now, I'm more vocal, especially about red flags in the integration process.

What are the scenarios where you truly think we will not integrate in the first year? Because that's possible. If the startup is doing so well and having an excellent year, it might make sense to leave them alone. If you see them struggling, it doesn't make sense to integrate quickly.

I have found that by being braver and asking these questions, they appreciated it more, especially the feedbacks, because at the end of the day, the person in Corp Dev, ideally, should have had all these life experiences with deals that went sour to be able to say they've done this for years and seen all those scenarios playing.

Sometimes the executives don't have that kind of experience, mainly if the company has not been highly acquisitive in the past.

Keys to a strong relationship

Keep an eye on both ends. If you are sitting in Corp Dev, you are at the best place to keep an eye on the pulse of both the acquirer and the startup. Startups are not like a merge of equals. It's not an acquisition of two publicly traded companies that have similar processes and understand the compliance aspect and the procurement process.  

Startups are highly dependent on their culture. So if you're in Corp Dev, keep an eye on that startup, communicate early and keep the line of communication open. Ideally, you should have weekly or monthly reviews to understand what is going well and what isn't, besides the normal integration meetings. Don't leave them alone.

Another thing I've seen being successfully implemented is creating a system of onboarding buddies or Two in the Box, where you can pair the person from the startup with an experienced person in the company so that they can ask questions safely.

There are simple questions and more important questions such as around approvals, decision-making, and the process. This two-in-the-box is more of a peer-to-peer pairing. That has been very successful.

Avoid burnout, integration is a marathon. At the end of the day, the startups also have to accomplish their synergies promised during the acquisition. If the idea is to grow 20% or 10% quarter over quarter, usually those targets are high, and the benchmark is very high. That can be stressful once they are part of the larger company. So have empathy and patience. 

How large companies can protect the acquired small company

It always helps when the senior leadership does not abandon them. During the due diligence and the pre-deal closing, you always get the attention of the company's president, the president of the vision. And once the acquisition is done, they move on because they are busy executives. They move on to their day jobs and to the next acquisition.

I've seen many times that the founders and even level two executives in the startup felt abandoned. So it helps to have, if not a monthly, at the very least, quarterly touch points, one-on-ones, the way it used to be before the acquisition.

This is tough because everybody is so busy after the acquisition is done. Most likely the executives have moved on to the next target. But this goes a long way because I have seen how disappointing it is to the startups that they got all this executive attention, and suddenly it's gone.

Integration

I'm also an angel investor. So one of the questions I ask when investing in a startup is: what are your plans for exit?  

I'm always curious to hear everything from the founders about their big plans. Others are very vocal about wanting to be acquired. If the founders are honest about why they are doing this, that's helpful.

• Why did you start this company?
• What was your vision when you were starting it?
• Did you want to be independent all the time?
• What's your objective from the beginning to be acquired?
  

Compensation

I have seen multiple times how the compensations are vastly different for each department. Suddenly you acquire a startup where a person in marketing is earning way more than their manager in the acquiring company. That happens not that often, but certainly, it happens a lot in sales. The bonus structures, every time I assume, are going to be completely different.

That's a tough one because when you are going through the due diligence and start planning for day two, you have to agree with both the sales team on the acquiring company and the startup. So how are we going to handle this changing compensation and the bonus structure?

Here's why it's important. Most salespeople go into sales because they like money. So if you change the compensation, assuming someone who is a star salesperson, you will lose that star because he or she will go to another company that pays him or her as much as the startup used to.

And at the same time, if you don't change that compensation sooner or later, the sales team in the acquirer company will find it unfair that some people are earning more than them. Compensation alignment for the sales department is very important to do early on.

How startups can protect themselves

If one of your listeners is an entrepreneur being courted for an acquisition, ask questions early on as to what you will integrate first or what your plans are for integration. 

Keep in mind the talents. I have seen that most founders and CEOs have already identified who is the key talent, as part of their secret sauce–people who have been with the company since the beginning.

A lot of those founders are good at letting us know when we go do the due diligence. They go through the engineering team, the marketing team, and identify the key people. And that's great because that allows the acquirer to assign the two-in-a-box to ensure those guys or girls are not going to leave or feel lost in the big machine.

Again, most founders should know what their non-negotiables are and think through preserving those benefits or losing them. Losing those benefits after the acquisition angers some people, so ensure what you're getting into.

I have this firm philosophy that everything is negotiable in this life. So if there are things that you can negotiate early on or during the courting period, go for it. Ensure what those non-negotiables are for the startup.

When to walk away

What I have seen in my career is that, believe it or not, your gut tells you a lot and most of the time we don't listen to it. The best decisions I have made in my career,  both in business and on the personal side was when I listened to my gut.

So if you are getting the buy that the acquirer is telling you everything you need to hear or you want to hear, but you get the sense that they are not going to follow up with their promises, say no before signing. It's not the end of the world. Go back to the question: Is my startup better off being acquired by this big company? You know better than anyone in what financial situation the company is.

Building relationships

As an acquirer, sitting in Corp Dev, I have to keep an active pipeline of both opportunities that bankers, accounting firms, even our own sales people bring me and tell me about a target ready for sale. 

On my own end, I constantly sit with the presidents of my divisions to discuss their strategy. We map where we are playing very well and probably do not need an acquisition and where we could play better. Once we identify the areas where we can play better, are we going to dedicate the R&D and the sales teams to go in this area? Or does it make sense to acquire? 

So once you decide, let's go find targets, then my team and I find specific targets that might not be for sale and then I make an approach. Heading back to the example of courting, I get a lot of nos in my job.

I reach out to many potential targets, introducing myself, and 95% of the time they are not interested in selling or talking. It's a matter of heading back and continuing and building the relationship, because these things take years.

It's definitely usually very convenient to have your senior leadership engaged, helping you on making the intro from CEO to CEO and get them to talk. That's usually one of the most effective ways, if not changing their minds, at least for the targets to know that there can be a potential here someday.

How to mitigate the risk of destroying a small company

Know and understand the startup very well early on.

• What is their secret sauce?
• What makes them tick?
• How dependent are they on the founder?
• What could get them to break?
  

As a strategy person, when you look at a company and you've been doing this for years, you will quickly realize what makes this company special. And if it were to be taken away, the rest would fall apart or the company will go into obsolescence. 

For example, there was this startup where, on paper, they had interesting technology that we don't have. So we visited them and I realized the technology could be bought. 

They were relabeling, but their secret sauce was not the technology but their installation team, and their go-to-market practices. They have a very proactive vice president of business development who can close deals and keep the relationship going with their customers.

So I thought, if that guy comes with the deal, this company is going to work out in our company. Identifying what's the secret sauce takes time, and you have to spend a lot of time with the company to figure it out.