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the netpreneur's perspective on the
anatomy of an acquisition

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the audience: q&a

Ms. Lajoux:  Now is the time to ask your burning question of any of our panelists.  As you are thinking about them, I'll start with one that came in by email, "Did you actively seek an acquirer by making all the contacts and cold calls, or were they looking for you?"

Mr. Khera:  Well, we had a bit of an unusual deal.  It was fast.  We met with them in October, and they decided they wanted to do the deal.  If they were going to do it, it was going to happen in three weeks.  Before that, however, we had been approached by a couple of companies.  Those didn't work out because the valuations were just way out of line.  We actually had a lot of government contractors come to us.  If anybody knows the way government contractors value, it is strictly based on your revenue and that was not going to work for us.  One company valued us at something like $800,000 and I said, "You have to be kidding!"

          We had a colleague who knew somebody in a high position in VerticalNet and he introduced us.  We went there, met with them and everything happened very fast.  Within a month we had the deal laid out.  In another couple of weeks we got the letter of intent; then, within a month to a month and a half, we went through the due diligence process.  Frank is right.  It is a bear, so you had better have all your ducks in a row.  You had better get your accounting act together now and your legal act.  Do it now because you are going to have to have it ready then.

Mr. Strauss:  For us it was interesting.  In the second quarter of 1999, we made a decision that we were either going to raise a venture level round of money sometime in the next six months or we were going to seek out a partner for strategic partnership or acquisition.  At the same time we made that decision, these guys fell on our laps through the story I told earlier.  Once that happened, we sought a couple of other partners to try to get some bidding going and to see if anyone else was interested.  That was useful in helping push the process along.

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Mr. Wood:  We had pretty much the same deal as Oron in this respect.  We were looking at raising money, but, as I mentioned, the tradeoff leaned in the direction of acquisition.  Once we realized that AOL was willing to play, we went out to seek other potential suitors and were successful in doing so.

Mr. Spiro:  My name is Cyril Spider.  I know you can't get into the details, but could you tell us what percentage you got in cash and what you got in equity?

Mr. Khera:  100% equity.

Mr. Strauss:  We got about 90% equity, 10% cash.  We struck kind of a special deal for our investors.  We had raised a little less than half million dollars as part of our seed and angel money, and our deal allowed for some debt pay-off.  All of our investors got the cash back that they put in, in cash.  They ended up with all upside in terms of the stock, so they are all extremely happy.

Mr. Wood:  For all intents and purposes, 100% equity.

Mr. Hawley:  Good morning.  I'm John Holly from Netwhistle.com.  I'm going to assume that everybody made at least one mistake early in putting their businesses together.  What was the biggest mistake you made during your growth that affected the acquisition?

Mr. Wood:  I'm pretty happy with the way things turned out.  It seems that there are many ways to run a business.  For some styles of valuation, it makes sense to be as large as possible.  I don't understand this economic environment that says having 35 people is more valuable than three people.  I guess it is an easy way to hire folks.  The more people you have, the quicker you grow and the higher valuation you might end up with.

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Mr. Strauss:  I think that the biggest mistake which complicated our deal was a dispute with one employee.  It started a couple of years ago, and trying to do the right thing made it a personal issue.  We basically said we would trust each other, so we didn't bring attorneys into the process and do it the right way.  That turned out costing me a lot more later in terms of legal fees and consequences within the deal itself.  As much as you hate it, and as much you think you have to do the right thing, sometimes you need to bring the attorneys into the process.

Mr. Khera:  One thing you need to realize is the tax implications of what's going to happen after the deal.  If you do something that is 100% equity, somebody is going to have to pay some kind of capital gains tax along the line.  When does that happen?  I didn't know what all those issues were.  The types of deals we discussed involved pooling, stock for stock, stock for asset, cash—a whole mix of things.  I didn't fully understand what the implication of all these deals were.  You think that X millions of dollars sounds good, but it doesn't work that way.  It could be X millions and take off 40% for taxes.  That changes things.  My biggest mistake, I think, was not getting educated on all the ramifications fast enough.

Ms. Lajoux:  That is how the magazine Mergers & Acquisitions got started.  When I was a teenager, my dad sold his company for $1 million in stock.  The stock flopped and he was poor.  Publishing is the best business to get into if you're poor.  I have a written question, and I'd almost say it's cruel.  Don't tell us the price you got, but how much lower would you have gone as a percentage?

Mr. Khera:  No comment.

Mr. Strauss:  I probably would have gone 20% lower.  One of the lessons I learned in the negotiation from Brad Feld is that at the end of a good negotiation each side feels a little pain—especially if you will be working going forward after the deal.  If you are just cashing out and walking away, then you want to screw these guys as best you can; however, if you are working forward, that is not necessarily the way you want to negotiate.  That was definitely our case.  We left some money on the table.  We could have gotten a better deal, and we would have been willing to take a worse deal.  You get to a point where, if you've bought in, your job is to get the deal done.  That's what we did.

Mr. Wood:  I plan on doing this again at some point in the future and giving away that information could adversely affect my ability.

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Mr. Leiber:  Marc Lever from CybeReg.com.  Can you comment more about the dynamic of the negotiations among your acquirer, your investors and your employees, such as the kinds of issues they brought up and how you would go about resolving them?

Mr. Strauss:  We ended up with three different constituencies—the acquirer, our management team representing our employees and our investors.  The investors, of course, had different goals and they didn't know the people at Netivation.  While they trusted us, they said, "Hey, we put our money in you and not in them.  Who are these guys and what is the deal?"  That was a critical issue.  The way we solved it was by getting the two sides together.  We had several negotiating sessions with Netivation's CEO, myself and one or two of our board members trying to work things out.  That ended up being the key factor there.

          The other thing we did was to bring our employees into the mix.  When Netivation came to town, we had a happy hour where we brought them out to meet the rest of our team.  Communications solves it, hopefully, but there are difficult points.  One of our board members had very serious issues with the deal.  At the end I brought in one of the other board members to try to mediate.  I was very open with Netivation and the three different parties there.  They actually helped with the process and accommodated it.

Mr. Khera:  One of our issues was that I didn't go to work at VerticalNet with the deal.  That was a big thing. Here's the founder of the company who knows that baby inside and out, and he's not going with the deal.  Earlier, we had brought on Dave Coakley as President of GovCon.  Previously, he had started a company himself and sold it.  We got around that issue since Dave was going with the deal.

          I wanted to work on MoreBusiness.com.  We've found a little niche where there's a hole in the marketplace, and we are going at it full force right now.  I wanted to build that out. My brother, who is also our partner, wanted to build it out, too.

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          We were not venture or angel funded.  The founders put in the money, so we didn't have those types of issues to deal with.  Some of the founders were pretty experienced people, so they had a lot of opinions about how certain things should be done.  They have their motivations.  I have motivations in building MoreBusiness.  Trying to put all that together is definitely difficult.  You have to figure out, "Okay, I'm going to give a little; they are going to give a little."  You try to create something that works well for both of you.  The advice that we got from our advisors was very valuable for how we structured the deal.  In fact, at MoreBusiness we have wonderful advisors, Bill Howe and Ed Brenniman, who are helping us a lot by giving us guidance.  Always have somebody to do a reality check with you.

Ms. Lajoux:  Frank, you mentioned the slingshot and being able to operate it as an entrepreneur and a scientist where AOL can't.  What about the culture fit?  When a small company is acquired by a large one, there can be a dramatic difference in culture.  What's it like operating a slingshot at AOL?

Mr. Wood:  I sit in cubicle 4BHO8 . . . and I'm really happy.

Participant:  How important were intellectual rights and patents to your discussions with potential acquirers?

Mr. Wood:  Absolutely essential.  I would say 95% of the value of our company was based on the intellectual property that we brought to the table.  This goes back to having all your paperwork taken care of and sorted out to the best of your ability.  I can't speak about exactly where we are in the patent process, but it is public information.  I have to make you dig for it if you really want it.  In a technology deal, being able to operate the slingshot is important, but the slingshot itself is very, very important.  It is important to be able to demonstrate the value; to have the process well underway and well managed; and it is important to be able to communicate it with some degree of confidence to potential acquirers.

Mr. Khera: Our intellectual property was our trademark, several domain names and things like that.  We didn't have any patented technology, but the databases we created were quite valuable.

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Mr. Strauss:  We had software and content, but that was not the real value of the deal.  We were running a very tight ship and had no investment in trademark, patents and anything like that.  We started from a clean slate and it didn't impact the deal.

Mr. Ross  My name is Larry Ross and I'm a recovering lawyer.  I wanted to offer some advice about lockup agreements and greed.  In a deal I put together when I was practicing as an attorney, I received stock of about 83˘ a share.  A lot of stock.  We put the deal together, worked with it for years and years and finally got it to go public.  It went public at $6 and shot up to $13 while I was in a lockup agreement.  Then, it started sliding.  It dropped to $12, and now I'm unlocked.  Should I wait for it to go back to $13 or $15?  Well, I waited.  It dropped to $10.  "It will probably go back to $13 again," I thought.  It dropped back to $9.  At that point I sold about 10% of my shares and recovered all of my investment in the company and my taxes.  It made me whole and the remaining 90% was supposed to make me rich.  Well, the stock is now back down to 83˘.  Let that be a lesson to you about lockup agreements.

Mr. Howe:  Good morning.  My name is Bill Howe with Strategic Marketing Group.  This is a little bit selfish since I'm a business advisor to Raj, but it's an issue we faced and lots of other people will as well.  I would like to have the panel speak to "going with the deal."  Often, there are performance aspects  called an earn-out.  Earn-outs are typically win/win because the entrepreneur stays with the company and builds it financially, and the acquiring company gets their talent.  However, two problems typically emerge.  One is that earn-outs are notoriously fraught with legal issues and litigation because of questions about performance.  The second issue is the one of culture, which Frank was so understated about.  You go in as an entrepreneur and are now subject to new culture and new bosses, even multiple bosses.  What lessons are there to be learned for thriving in that environment?

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Mr. Strauss:  We had an interesting situation where we originally negotiated an earn-out tied straight to revenues that we were producing.  A few months into the deal, after we had agreed on it but prior to closing, we thought it through a little bit more.  We figured that it didn't make sense because our new role was not just to run what was formerly Net.Capitol, but the entire division made up of five other companies we have acquired.  There's a conflict if I receive financial incentive to hit my revenue targets, but my job is to run four or five other companies as well. What do I do?  It's a balancing act , and those are decisions I didn't want to be in a position to have to make.  We renegotiated it out of the deal.

          The culture question is interesting as well.  While the company that acquired us was not that big, it was different.  For one thing, they are headquartered in Post Falls, Idaho, which, as beautiful as it is, is very different.  They are also a little older and have more experience, so there is a culture gap.  We had a retreat this weekend and culture is one of the main issues I brought up.  The way you deal with it is by communicating.  We had a very strong culture at what used to be Net.Capitol here at the DC office.  It is very important to me that we have fun, that we be irreverent, that we have a dog in the office and have the office look a little crazy.  When the Netivation folks walk into the office in DC, on the one hand they are like, "Wow, this is pretty cool.  We have these hip, cool guys.  That's part of the Internet image, and we want to be a part of it."  On the other hand they are like, "What's going on here?  Is this a real business?"  You just have to explain to them how important it is to you.  If it is important to you, you fight for it.  You have to pick your battles.  That's the bottom line because you are now part of a bigger company.

Ms. Lajoux:  Now we would like to introduce Mario Morino.  He is very much a businessman and a great success story.  His company, Morino Associates, merged to form Legent Corporation in 1989, which grew to become one of the 10 largest software firms in the world.  In addition to being Chairman of the Morino Institute, he also serves as an advisor and limited partner to General Atlantic Partners, a premier private investment firm in information technology.  He sits on a number of boards including the Internet Policy Institute, the Counsel On Competitiveness, and the National Commission On Entrepreneurship. He has been on both sides of the table in transactions like the ones you have heard about today, so he has a unique perspective.

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