How do you plan for M&A?

Happy St. Patrick's Day. Please find below my guest post on start-up company M&A from Ask the VC.

Question: How do you plan for M&A? Trying to build our company, thus far we went the regular path – market research, sales projection models, expenditure / P&L models, potential products/product lines and the like (text book?), but many people we met told us ("shouted") that we should plan for a strategic partnership/ M&A, how do you do that? Should there be a special business plan?How does a P&L look in that case? How do you plan the selling of your IP to a large company? Selling after you have a finished product? Selling the company after initial sales? Letting the company grow a bit more? Is it good practice / healthy to plan your business on somebody buying you? Will it be acceptable to prospective investors/ VCs?

Plan for Independence. There is a famous VC saying, "companies are bought and not sold." Accordingly, the best "plan" is to plan for success as an independent company.

The company’s operating plan, technology road map, and executive team should not focus on unnatural acts, in the hopes of attracting a buyer, but rather on building a company with the potential for independence. Companies built to "flip" often flop. They often flop due to the fact the team is not truly committed but, instead, looking for a quick buck. Bad motives drive bad behavior.

A fundamental concept that helps focus management on building to independence is optionality, or BATNA – which is MBA-speak for "best alternative to a negotiated agreement." BATNA is a fundamental tool for understanding negotiating leverage and strategy. If you work to ensure you have a BATNA – for example continued independence or a higher offer – the company is able to negotiate from a position of strength. If no BATNA exists (i.e. the choice is between a fire sale or running out of cash), the company is at the mercy of the buyer and the negotiation becomes an exercise in Russian roulette. Always have a BATNA.

Be Prepared for Acquisition: Sourcefire ("FIRE") went public this week. Since the last security company went public – NetScreen – there have been over 250 security M&A transactions.

So what?

While the security software market is an extreme example, it is far more probable that a successful tech company will be bought rather than go public. Accordingly, while no special plan for sale should be developed, it is highly logical to expect M&A to emerge as the path to liquidity.

While VCs believe "companies are bought and not sold," acquirers tend to believe that "successful partners make the best acquisition targets." Successful partnerships are characterized by

• a history of successful joint customer engagements,
• successful technical integrations and co-deployments,
• a joint roadmap,
• co-marketing and sales traction, and
• management teams and team members with a track record of collaborating to reach shared objectives.

A great example of the partner-to-buy model is SAP and Virsa, although there are many such examples.

Keep Good Records: Finally, M&A is a diligence driven exercise. The final cliché is that "good record keeping makes for good diligence and good diligence makes for expedited outcomes." Good records include:

• Articles of Incorporation/company charter
• all Board minutes, contracts, signed employee assignment of IP forms
• capitalization table
• option plan records
• prior financing documents
• audited financials
• patent filings
• documentation relating to litigation, assessments, or claims

Any material gap in records will either 1) delay the sale process and/or 2) will lead to a higher escrow to offset potential liabilities that may "appear" post-close.

In summary, all clichés are common sense and the M&A related clichés noted in this post are no different:

• build companies for independence (always have multiple BATNAs),
• partner well,
• keep good records