RETURN

Should I stay or should I go now

In this guide we explore different directions you may shift your startup towards depending on where you land. Whether you are raising capital and growing your business into a billion dollar unicorn, or struggling to capitalize, monetize, and reach product market fit, it is important to understand all the different options and exit paths you can take your startup rocket ship. In this guide we explore the options for when to shut down, pivot, and or sell your startup.

The point of no return

Startups typically come at the cost of stability relative to a cushy salary with benefits corporate job. Thus, the question for most founders is how long can I keep going into the unknown on this bumpy ride? This is a personal decision that is different for everyone. Most startups become a founder’s baby. It is a special bond that you nurtured given all the time and investment sunk. Walking away from a startup may be one of the most difficult decisions a founder has to make. However, the reality is that most startups fail. While failure may seem like a hard pill to swallow, it doesn’t have to be.

Startups are a science. You put on your lab coat as an entrepreneur and you run experiments. Not all your experiments will yield results that confirm a hypothesis. With failure comes learning. You will be able to look back and now know what you did not know. While this learning may have been expensive in terms of time and money, it comes with invaluable knowledge that can set you up for future success.

If you are going to fail, fail fast. The worst thing you can do is realize that your startup ship is sinking and do nothing. When considering whether to shut down your startup, the question you need to ask yourself is, “have I learned enough from this venture?”. If you believe you have learned all that you can learn, it is time to shut down shop and move on. If there is more to learn, and you have the energy and resources to do such, persevere, learn and pivot.

Do not go gentle into that good night

Perhaps failure is not yet an option for you and you have more to learn/prove. Do you and your team still feel passionate about solving the problem you set out to solve and have more gas in the tank? Great! Along the lines of running experiments and failing fast, the more you can run with the resources you have, the better. Sometimes the original path we set out to solve a problem, leads to a bigger problem or opportunity to solve. If you were to look at most successful companies, the basis for their beginning was likely a completely different idea all together. Well known pivots include Twitter, Instagram, and PayPal. All three of these companies initially started as completely different ideas. Sometimes a pivot can be just a simplification of features, focusing on one. Such is the case of Instagram. Originally a gaming company with the likes of Mafia, Instagram ultimately removed all features except from the photo sharing and the rest was history. Alternatively, some pivots include an all out change in course entirely. This is the case for PayPal and Twitter. PayPal was using Palm Pilots to send payments before figuring out how to become the de-facto online payment platform for Ebay and the internet. Twitter was a podcast subscription platform akin to iTunes before it became the pulse of news on the internet. These storied companies and many others did as Dylan Thomas’ poem states, they did not going gentle into that good night. Rather, as failure closed in, they burned and raved to pivot into a new light.

Exit options

Whether you have established PMF, have recently pivoted, or are considering shutting down, you always have an option to exit via merger or acquisition. Selling your company is a full time job in itself. It will require sales and marketing efforts. You will need to play investment banker to find a strategic buyer. As we have discussed in the Boostrapping guide, more established companies you have partnered with may be the best potential exit. Courting a potential acquisition is a dance. Assuming you find a strategic buyer, there are a few different ways you can sell your startup.

Acquisition

In order to exchange ownership of your company, the buyer will either need to do a stock purchase or an asset purchase. A stock purchase means selling your company’s common stock to the buying company in exchange for their stock or cash. In a stock purchase the acquirer will ultimately own the common stock of your company entirely. Contrary, in an asset purchase, the acquirer purchases assets which carry intrinsic value. Asset purchases are purchased in exchange for cash or an equivalent value of their stock. There are tax implications anytime there are proceeds or gains in any transaction (regardless of stock or asset purchase). For an example, there could be a double tax event when an LLC acquires a corporation via an asset purchase. Gains may be taxed both at the company level and when reporting your individual tax gains. Thus, it is important to seek tax advise from a CPA experienced in transactions and ensure that you have filed an 83(b) election for any initial stock grants (typically common stock purchase agreements or exercises options that lead to common stock purchase).

In an acquisition, your cap table will determine the number of shares that change hands. This is why it is imperative to manage the ownership of your company’s stock in your cap table. Typically, if you are in discussions for a stock or asset sale, you most likely have a capitalization structure and investors. A liquidity event where stock is priced and exchanged such as a merger or acquisition will trigger a priced conversion of equity for your investors (assuming they hold convertible equity notes or SAFEs). Investors will get their cups filled up first and then the waterfall of stock proceeds will fill up the common stock holders cups based on the ownership structure set in your cap table. Carta has become the de-facto system of record for cap table management.

Acquihire

An acquihire is typically referred to an acquisition where the price for purchasing your startup is lower and more focused around hiring the startup founders and team. Some strategic companies may value your skills and experience more than your product or market. They have been impressed with what you and your team have been able to do in the confines of a startup. Thus, they may want to hire your team to build relevant products for their business. An acquihire is typically not as lucrative in terms of a return for your investors, but it may lead to good opportunities for you and your team. This is especially the case if you can negotiate equity in their business, which in return motivates you and your team to drive value for the company that hires you. It is very difficult for companies to hire entrepreneurs, and sometimes it is way more efficient to acquire a team that has already established good values and a proven track record to work well together.

Asset Rich, Cash Poor

Whether it is an acquisition or an acquihire, you may still find yourself having to wait before cash is in your bank. Transactions typically require expensive lawyers who represent both sides. They also take time. Additionally, when you make money there will always be taxes. While you may be asset rich, you will likely be cash poor until all the major milestones in a transaction run its course. Here are some of the steps you will likely need to navigate when exploring a transaction to sell your company.

Letter of Intent

An acquisition starts with a Letter of Intent (LOI), which formally lays out any informal or verbal terms discussed during negotiation of the deal. This often includes the purchase price, the details of stock vs cash, the dependencies of the deal, break up terms should the deal not work, et al. By agreeing to the LOI, both parties are acting in good faith to move towards finalizing the transaction. Once an LOI has been executed, the due diligence begins.

Due Diligence

In order for the acquirer to feel comfortable paying a premium for your stock, assets and or team, you will likely have a lengthy due diligence. During such, you will need to organize, clean up and hand over all the company documents and code. Thus, it is important to make sure your formation and capitalization documents are organized and clean when preparing a data room for due diligence. At any time during this due diligence, the acquirer could call the whole thing off. Thus, strategically, you should negotiate a break up fee in your LOI. This will compensate for lost time, as exploring acquisitions can be a giant distraction and opportunity cost for making progress towards your core business.

Escrow and Warranties

Upon acceptance of any due diligence, the cash proceeds of the deal will be funded through escrow. All but a specified amount held for warranties will be released upon finalizing the deal. This protects the acquirer should anything that was hidden, not disclosed or not discovered all of the sudden surface. After a year in escrow, this amount will then be released from escrow and the cash proceeds will be funded to shareholders assuming nothing was warranted.

Stock Purchase Agreement

The stock proceeds for the transaction are finalized through the Stock Purchase Agreement (SPA), which establishes your vested interest in the new company. This will be an entirely different SPA than what represented the stock issuance and purchase of your company. Thus, it is important to ensure you work with a lawyer who can represent and bless your shareholders best interest. The SPA will dictate the type of stock (common stock vs options to purchase common stock), vesting for stock, the last valuation of the stock, and the amount of stock in terms of units you are being granted, etc. Stock that is being issued from the new company could be a combination of vested common stock and unvested stock options that will need to be exercised. Thus, you will want to explore all the possible tax events with a certified tax professional. For an example, you will likely need to file an 83(b) election for any unvested stock to benefit from longer term capital gains.

Employment Agreement

Should you agree to becoming an employee for the acquiring company, you can negotiate terms in your employment agreement. This could be a great opportunity to negotiate accelerated vesting terms for any unvested stock that you or your team are receiving, should you be terminated without cause. This will prevent or deter your new employer from letting you go after the acquisition. Additionally, you may be able to negotiate a cash bonus as part of your employment offer to bridge any cashflow that will be held up in escrow. However, it is important to know that any cash bonus or salary will be taxed at your ordinary tax rate.

The Heroes Journey

Starting a company is a daunting journey. If there can be one motivator to help you launch your idea, it is that you will come back from this journey changed for the better. You may not figure out how to find PMF and turn your startup into a growth venture with a billion dollar valuation. You may not yield an acquisition that yields a life changing return for you, your team and investors. However, you will return having learned invaluable lessons. You will be able to tell your story to others. The job market can be very competitive. When it comes to standing out, your story can be what makes you stand out as the best candidate for the job. Many employers are impressed with entrepreneurs and could offer a job opportunity that you otherwise would not be considered or qualify for. Your entrepreneurial experience is akin to an MBA. You will be that much more prepared as to what to do and what not to do next time you decide to venture into the unknown of startups.

Return to Earth Checklist

In this guide we discussed the different paths you may take based on how things are going for your startup. In the next guide, we explore how to decompress when you return to earth from a startup. Before returning to earth, below is a checklist to evaluate based on what opportunities have been unlocked during your journey:

1. Did you reach PMF? If so, continue raising capital and growing your business. Otherwise:

2. Did you learn all that you can learn about the problem you are solving? If not:

3. Do you still have the energy, effort and resources to continue? Perhaps it’s time to pivot. If not:

4. Can you find strategic partners or companies that would be interested in acquiring your company, assets or team? If not:

5. Can you now tell a unique story that makes you stand out as an entrepreneurial candidate for a new job opportunity?