In the first entrepreneurship lecture of Fall Semester 2006, Honolulu attorney Larry Gilbert provided BYU-Hawaii School of Business students with "some real world lessons" on the "big payday most entrepreneurs dream of" — the exit, or selling off a start-up company.
"I will tell you what they never taught me about [exits] in school or law practice," said Gilbert, of counsel with Alston Hunt Floyd & Ing Lawyers and an expert in providing legal and management assistance to technology growth companies who has been personally involved in three exits.
Speaking in the McKay Auditorium on September 12, Gilbert said exits typically fall into three categories: IPOs — initial public offerings of stock, acquisitions or mergers, and organic or cost-effective growth from within.
While some entrepreneurs think of the financial rewards, Gilbert warned that exits also have serious implications for owners, investors, employees, suppliers and customers as well as a "drastic effect on the success of the venture going forward. A business can even die based on the way exits are done."
"The exit needs to be viewed from everybody's perspective. That's the entrepreneur's responsibility," said Gilbert. For example, the staff — especially those who own stock — might make a lot of money but perhaps not as much as they could, and "with new people coming in, sometimes their jobs might become redundant."
Looking more closely at the three types of exits, Gilbert characterized the IPO as "the big dream of most entrepreneurs" where a company is "attractive enough that investors might want to buy stock." But, he added, investment or i-bankers who take the company to market "usually have an agenda that is not necessarily yours."
"They need to please their investors," he said, providing them with one good deal after another. "They'll usually tell you the initial price will be really great, but the actual ‘pricing call' may not be nearly as good. Just be aware that this happens. They're going to want you to come out at as low a price as you can tolerate."
For example, Gilbert said a lot can happen between the time the IPO process starts, and the stock actually goes on sale. "Getting your house in order before the IPO can be a very distracting process" which can put "a damper on your customers and the market place. You're likely to lose sales, and then maybe you're not such a sweet-looking thing to the investment bankers," he continued. "You can, in fact, kill your own IPO."
Also, once you're post-IPO, "everybody is frequently checking the stock price. People are very distracted. Plus, you're a public company and you have to police the staff, management and CEO," he said, pointing out it's then illegal to respond to relatives and friends who might ask whether they should buy or sell. "After an IPO you can't give hints, because you're disclosing insider information."
"Externally, you now answer to the street, as in Wall Street," which he described as a "very unforgiving animal: It doesn't take excuses, even if they're very good excuses. Events external to you now control your company," and "every quarter the ‘street' wants to see an improvement in earnings."
Gilbert described acquisitions as "the lure of the perfect marriage [where] the valuation of your company may frequently be higher than in an IPO. There will also be a lot of talk about synergies and leveraging… These are the siren song of the acquisition."
He also warned about "value leakage," which may occur as the acquisition process starts, because working staff may not see the vision of the two CEOs. "The vision starts to fade, yet you're committed to the deal. It never seems to work out the way it's seen. The only thing I can tell you is, plan for [the leakage], and minimize it."
Mergers, he said, require a lot of due diligence: "What will the company really be like after the merger? Who is it that you're really going to be dealing with? Get to know the people you're actually going to be living with. Go there. Meet the people. Meet the staff…because once you're acquired, you lose control of your company, of your destiny."
Gilbert also advised the would-be entrepreneurs to find out about the "survival rate and happiness factor" of other acquirees and whether you can still execute your plans. "How much autonomy will you have? Get it on paper. It's not that they're lying to you, but their priorities will change."
He described "earnouts" as another type of acquisition "where you don't get full price, but a lesser price up front and more later based on performance. Remember the principle of value leakage. Things take longer and they go slower in a big company. It's very hard once you've been acquired to tell the division head you now report to that you guys are going to be sued if you don't get out of the way."
Some people look at mergers, Gilbert said, as "an acquisition without the money." Other important merger issues include "who's going to run the show. What is the compelling reason that these two companies, put together, are going to be more than the sum of their parts? If it's not there, then maybe it's not such a great deal."
Finally, Gilbert said some "investors don't usually think about organic growth" as a viable method of acquiring a new company...but it works with some investors and even employees."
"I would suggest as you grow a company," Gilbert said to the business students, "think about the alternatives for exiting."