In today’s frothy technology company acquisition market, it would seem that company founders have it made.
They can start a business – inexpensively relative to the past. Many angel investors are lining up to give them money on more attractive terms than have been offered for many years.
On top of all that, many of the large technology companies aggressively are buying smaller companies at higher and higher valuations even if the companies don’t have any revenue or even a viable business plan just to get quality people.
What many people are overlooking in all this is that most of these frothy acquisitions, especially of the smaller companies, are being done with restricted or just illiquid stock rather than cash or easily liquidated stock.
Many of the deals have three or four year earn outs and require founders and key employees to work at the acquiring companies for years to get their full payout.
If you watch the history of these types of deals over many cycles, what’s really happening is that founders and key employees often are being duped into signing up for what is really nothing more than a long-term employment agreement with an incentive component under the guise of having their company “purchased” at an exciting headline valuation.
I’m not saying these deals are necessarily bad for the founders or key employees at these firms. In many cases, the alternative would have been to liquidate their company at a loss, raise capital on very difficult and expensive terms, or just go find a job anyway.
These deals are also probably a win for the investors in these small companies because in most cases they would have lost all their money as the companies would go out of business.
Instead, the larger companies often pay the investors a small profit and even if there is a loss to the investors it is a much smaller loss than they otherwise would have faced without the acquisition.
However, these deals are not always the best option. It’s important for the founders, investors, boards of directors, and other stakeholders to evaluate carefully what is really being offered by the acquiring company versus just getting excited at the headline valuation that is being presented to them.
High valuations may create an ego boost and bragging rights, but you can’t spend a valuation. You need cash or other liquid assets for a real exit strategy. Everything else is just conversation.
Despite what some people would have you believe in the heat of this bull market, cash is still king. Without cash, or something you can quickly turn into cash, your net worth is just a number on a piece of paper or a computer screen.