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Why I Walked Away From a $12M Acquisition Offer 18 Months After Our Launch (groovehq.com)
236 points by nilmonibasak on Nov 13, 2014 | hide | past | web | favorite | 61 comments

The upside potential is exactly why they offered 14x revenue - they had to sweeten the pot and make sure that they incentivize you to move now as opposed to later. They are willing to pay a little more now in exchange for insuring that they don't miss out, or miss a huge inflection point.

However, bear in mind that as time goes on, and there's more data about monthly run rate, that multiple will likely go down.

First, as time goes on, it will become increasingly less likely that you will "pop", or have a huge hockey stick of growth. Part of the multiple is designed to get you out of the game before you hit that inflection point.

Second, many companies fall down once they try to scale their business. It requires a different set of skills, often different employees, and makes it a lot more likely that you'll miss on execution. Once you have a few quarters in a row of ~2% growth instead of 5%, your valuation will drop dramatically.

Third, the market moves around you. Even if you're continuing to grow, what your competitors do can influence your valuation, to your betterment or detriment.

I'm not saying that the author made the wrong decision, only that it's always easier to say, "Well, if we keep growing, and wait another year, we can get acquired for 2X more!". Heck, a year from now, that acquirer themselves might not exist anymore.

I think that if you expect you'll want to exit the business at some point in the next few years, if you are fortunate enough to get a more than fair offer where all of your employees and investors would see it as a win financially, you need a really compelling argument not to take it.

TL;DR: A bird in the hand is better than two in the bush.

Agreed, the more data you have the harder and harder it is to command a 14x multiple. I have now made that mistake 2 times in my previous startups.

That, and you have to actually go into the bush to get them. If you can successfully start businesses, a year of founder work is itself worth a significant amount of money.

However, bear in mind that as time goes on, and there's more data about monthly run rate, that multiple will likely go down.

Are there any astrophysicists around? This reminds me of the bit about how an asteroid might be at 5% chance of hitting Earth, then tomorrow as it gets closer it's now at 4% chance, then a week from now it's only 1% chance... It's not what you expect, but it makes sense when you understand that the uncertainty of the asteroid's trajectory shrinks with time, dramatically changing the prediction.

(Similarly, it could be 5% today, 20% tomorrow, and 99% a week from now)

Yeah, the picture comes into focus. I think this is one of the reasons why a big chunk of the companies that pivot post-series A do so. You raise some money, and you don't see that revenue growth arc improve (or it flattens). Now, as time goes on, it becomes harder and harder to argue that if you only have a little more:

- Time - Money - Talent

That you can adjust the curve - the curve is reality. So the only way to justify greater upside/multiple/investment is to change the discussion. Change sales strategy, change product focus, etc. etc.

That's because yesterday, it wasn't really 5%, it was 5±4%.

In this context, putting error bars on a probability doesn't really make sense. Your uncertainty about the probability is already encapsulated in the probability itself.

In other words, 'more uncertain than 5%' wouldn't be 5±x% , it's be, say, 6%. If you have no information at all -- you're as uncertain as you could possibly be -- the probability would just be your prior for this event, and the more data you get pointing to the event either happening or not, the more the probability will move away from your prior towards either 0% or 100%.

Swinging for the fences is great, but so is getting on base.

Twelve months ago I accepted 7-figure acquisition offer for my company. Members of our team thought the offer was too low. It was a struggle for me to get everyone on board for the deal.

In the past twelve months, the market conditions and competitive landscape have changed dramatically. Had we not accepted the acquisition offer, we'd be out of business, and we would have lost all of our investors' money. This would have had little to do with our execution, and much to do with exogenous factors out of our control.

Just one data point though.

>Members of our team thought the offer was too low. It was a struggle for me to get everyone on board for the deal.

Do those same members (who hopefully cashed out) agree with the blessing of 20-20 hindsight, or do they still believe the acquisition offer was too low?

They have each told me that they now think we absolutely did the right thing. Being the one that pushed the deal through, this makes me feel much better. I'm so glad I wasn't wrong!

I respect this post, but the most important thing in my mind is not mentioned:

"past performance is not indicative of future performance"

You need to give credence to the fact that you could have competitors offer your exact product for much less than you do. That a newer, better product could offer more for less. Or also that your product just becomes less good over time and your customers leave. Ecosystems change as does business.

You need to account for the fact that you could be left with nothing also. This isnt to say not taking the money was the right/wrong thing. Thats your call alone to make.

That is totally true. I suspect many companies sell when they know grow will start to slow, but that trend isn't obvious yet.

The real answer is a third of the way through the post: "First-time founders care most about their exit. Every time after that, you focus on legacy."

The author already had a successful exit, so they have their money. Now they want to make a difference.

I saw that he had an exit, but he also said his $6 million payout if he had sold Groove would have been "life-changing". That suggests his other exit netted him a bit less.

As far as making a difference, I think calculating that is pretty complicated. Elon Musk had two big exits before he did more fulfilling work with SpaceX and Tesla. Some people want to make that level of massive impact. If that's the case, it probably makes sense to sell, take the money and tick off another exit on your resume, and start your next journey. But if someone is happy with making a smaller difference (I know I certainly would be!), then this might be your big chance to, so selling would not be personally fulfilling at all, even if it is financially fulfilling. There's no guarantee you're ever going to make $6 million from your company, but there is also no guarantee you're ever going to start a company that allows you to have the kind of impact you're having.

The fact that the author already had an exit really stood out to me. Many early startup founders struggle just to pay rent.

While I hate the idea of selling early, there is the practical matter that a small exit allows for a lifetime of future startups. If Alex didn't already have money, I think the best answer would have been to sell. You only get one life.

I think a key difference here is Groove is actually a real company with real revenues which are growing. This is not true for many similar sized acquisitions you see. Good on Groove!

Reminds me of a story I heard about Photobucket. The founder there apparently had a $1M cash offer early on to sell out. At that point his credit cards were maxed and was really struggling to keep the thing afloat.

He chose to pass and went on to sell the company for $300M to Newscorp. Of which he owned a significant portion.

I remember that Tony Hsieh had a similar experience with Linkexchange.

>Of which he owned a significant portion.

He sold Photobucket to a company that he partly owned? That sounds more like a merger..?

Significant portion of his start-up, Photobucket. He didn't own Newscorp...

Can't wait for the follow up, a year from now about how things went after this acquisition attempt and post. I'm not insinuating that they'll fail, just that the follow up is more important than this declaration.

> We had a handful of meetings between with their business development team and executive teams, and their engineering team did a thorough technology review of Groove.

I'm curious, why would you let them do a thorough technology review of your startup in the first place? (Edit: Because it can be dangerous)

This stuck out to me, too. This is exactly the scenario where you want to bring in a third-party consulting team.

My team has been hired for this role several times: we receive full access to the technology stack and the target's engineering team. We then prepare a thorough report that the potential acquirer can ask us questions about, discuss any concerns, and request potential solutions to any issues and associated costs.

This has at least three benefits:

1. Isolating the target from revealing their IP to the acquirer,

2. We're experts in the target's stack (say Rails), whereas the potential acquirer may be more of a Java or Django shop, and be unaware of stack-specific issues to look for,

3. Allowing us to offer an unbiased opinion: we don't have any vested or emotional interest in the sale going through or not, so we can be pretty blunt about anything that might be an ongoing issue.

I won't say how much we charge for a service like this, but it's absolute flea spit compared to the $14 million on the table.

Interesting. What would you the keyword be to search for such services?

I'm not sure, we received our gigs through referrals. I've long thought I should set up a landing page for this kind of service—this seems pretty well-received on HN so maybe I'll finally get around to it now.

@AznHisoka: I'm interested in knowing what term the type of services the parent's company offers generally go by. Something like "outsourced technical due diligence" perhaps?

not all businesses rely on SEO.

First time I've heard about such a service. Sounds useful.

Just curious, no offense intended, but how would I go about trusting a third party company which likely has much lesser reputation than the potential acquirer.

I've long suspected that this would be a valuable service.

I'm curious about this as well. It would be good to know how groove sorted out whether the company was just kicking tires, or looking at potential competition, thinking about a partnereship, or considering an acquisition. At some key point, it must have dawned on groove (or maybe not) that they were going to receive an offer. I think the context of that happening would be educational.

Here's the reply from the founder, to the comments on his blog :

Q: Alex - I'm curious why the company was doing such deep due diligence on you in the first place? Was this for a potential partnership opportunity (you said it wasn't a natural fit?) Or were you simply receptive to an acquisition offer at that time, even if you weren't sure you actually had a genuine interest in selling? ...

A: Thanks for the comment, Michael. The conversation steered toward a potential acquisition very quickly. I'm not opposed to exploring opportunities, so the meetings went on. It wasn't until after the offer was made that I decided to turn it down.

Depends on what their definition of "thorough" is - it's very standard to have architectural and design discussions pre-term sheet. However, you defer any deep dive into code or structure or "secret sauce" until a term sheet is signed and you're in the due diligence process (and typically you'll have a neutral third party due any direct code reviews).

I suspect it was allowed to foster a potential partnership.

The blog says:

It’s not a company that would be a natural product partner for us.

Because they wanted an exit? Or because the other party asked nicely!!!

I appreciate you sharing your experience, this is something we founders are not enough prepared to go through.

Two comments IMHO:

- Would you have said yes and looked into the details of their offer, you would have realized that the $12M are not upfront. Through retention packages and revesting, most of the price is typically paid over 3 or 4 years. So the offer was probably less attractive than it initially looks.

- $12M is never a good outcome for investors (at least big angels and VCs). They make their returns only on big exits.

>They make their returns only on big exits.

Don't they make returns anytime their money invested is less than the money gained from the sale?

In a narrow sense, yes, but virtually all investor returns typically come from a few big winners. For example, although many Y Combinator startups have achieved great success, most of YC's returns come from just three companies: Airbnb, Stripe, and Dropbox. If all an investor's winning startups exited at the ~$10m level, their returns would be anemic at best, and would quite possibly be negative after factoring in losses from failed companies. I think that's what the grandparent comment was getting at.

And let's be honest, AirBnB will go the way of Uber, regulated out of existance. I honestly don't know why it didn't happened yet, for both.

They're both multibillion dollar backed companies, so more likely the opposite will be true: any regulation against them will be lobbied out of existence.


Not exactly. There will be couple of other companies in their portfolio which would shut down and the VCs would lose all their money. So they really need a big exit which would make up for all the other losses.

> Through retention packages and revesting, most of the price is typically paid over 3 or 4 years.

I'd be very careful with "Typically". It's not at all uncommon for acquirers to write a check, and then tack on retention packages for key employees. They very easily could have intended a $12m cash buyout, with another $2m for retention, spread over the team.

With respect to the 5 questions at the end, it seems arguably that the author's own evidence demonstrates the incorrectness of the decision for everyone except current customers. Interesting path to take, and nice to read the thought process. How did the rest of the Groove team react?

"Our monthly revenue was around $70K at the time, making $11.8M a 14x multiple on our annual revenue. Even in SaaS, that’s on the very high end of the norm, and a multiple generally reserved for highly profitable companies (or ones with massive user bases)."

Congratulations to the company for the growth after only a handful of months. Very impressive.

Using multiples always seems a bit odd for me in super high growth early stage companies. If a product really takes off the early small numbers can really skew things in comparison to later big ones. It's like seeing a 10,000 percent growth rate in the first month on a tiny base.

Multiples are a convenient way of benchmarking deal performance, and it tends to work out very well for typical deals. Successful series B startup with a consistent growth rate? ~10x trailing 12 months revenue. High-growth series A startup? ~15x. Mature post-series C startup with large customer and revenue base? ~8x.

Obviously, the excitement in the market, the competitive landscape, bidding wars, etc. can all screw with those points, but time and time again you see those general ranges for acquisitions.

Good points. Keep in mind the OP is talking about a 14x multiple of annual run rate, rather than trailing 12. He's calculating annual run rate as 12x his most recent month. Considering it's a quickly growing company, if he were calculating his multiple as a multiple of trailing 12, it would be higher than 14.

I don't understand why so many here are questioning this move. You can shoot down his logic about the future upside but clearly it wasn't about the money anyway. Call me crazy but I find it encouraging that this guys is measuring the success of his business not just by how much it makes but also by whether it produces a good product that people actually want to use.

I couldn't agree more, DubiousPusher.

It takes a lot of guts to do this. Only time will tell if this was a genius move or... I am rooting for genius. Good on you for swinging for the fences.

Also, smart to talk about this publicly. Of course, it's good reading. But also many people like buying from those who care about the product they build than from a faceless bigcorp. You can't buy that sort of credibility.

Congratulations to you! I think it's good to iterate that you said you love what you're doing. That's what matters most. When I was a kid and someone offered to by my paper made ninja stars, for $5 (it was a lot of money as a kid and still is) I couldn't sell it because I loved it! even though the materials probably added up to couple of cents.

Haha ninja stars!

Curious what your team thought was a good exit and what your definition of win handsomely is. For me, I'm at a startup where I gave up 75k-100k in salary for the first 2 years. Owning 1.5% of the company, <20M exits only make sense the first 6-8 months. At 2 years, I would have done much better elsewhere.

I wonder how many first-time founders would have made the same decision. My guess is very few.

"Products that founders swore they built to be “simple” got bloated, overdeveloped and lost sight of their vision."

I wonder why.

I'm guessing Salesforce. Anyone know the bidder?

doubt it, since he says its not very related to his industry. I'm guessing someone like SAP.

Congratulations for the good job GrooveHQ.

Did the headline change from a normal one to a clickbait?

I thought Groove was Ray Ozzie's old company that he formed before Microsoft acquired it. I had no idea there was a new startup re-using the name.

EDIT: The original title said "Why Groove walked away...".

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