a16z Podcast - M&A, Before and After: What Founders Need to Know

Episode Date: January 26, 2022

Welcome to the a16z podcast. Today we’re talking about the mindsets and frameworks founders should know about when navigating the mergers and acquisitions or M&A process, both before and after – including how to think about the pricing dynamics, factors that go into the decision-making process, and what to expect from the integration once the deal is done.A16z editorial partner Zoran Basich recently talked to two a16z experts here to give us their big-picture view of the most important things to know – for founders seeking to acquire companies and how they might think about it, or those considering selling a company, or just those deciding to merge with an acquirer.Blake Kim is a partner on our Enterprise Network team and a former investment banker who works with companies on strategic partnerships; he also recently co-wrote a post on Future outlining all the different exit options and considerations for companies. And general partner Martin Casado discusses common M&A issues and shares his experiences both as observer and participant – including the challenges of integration, which he saw from the inside with Nicira, which he cofounded and was acquired by VMware for $1.26 billion in 2012, and where he remained for years to lead its networking and security business unit.As a reminder, none of the following should be taken as investment advice. Please see a16z.com/disclosures for more important information.They start the discussion by outlining the frameworks for understanding M&A dynamics, including the “kingmaking dynamic” and the difference between “selling your company” and “getting acquired.”

Welcome to the A16Z podcast, I'm Zoren. Today we're talking about the mindsets and frameworks founders should know about when navigating the mergers and acquisitions, or M&A process, both before and after, including how to think about the pricing dynamics, factors that go into the decision-making process, and what to expect from the integration once the deal is done. We recently talked to two A16Z experts here to give us their big picture view of the most important things to know,

both for founders seeking to acquire companies and how they might think about it, or those considering selling a company, or just those deciding to merge with an acquirer. Blake Kim is a partner on our enterprise network team and a former investment banker who works with companies on strategic partnerships. He also recently co-wrote a post on Future, outlining all the different exit options and considerations for companies. And general partner Martine Casado discusses common M&A issues and shares his experiences both as an observer and a participant, including the challenges of integration, which he saw

from the inside with Nicira, which he co-founded and was acquired by VMware for $1.26 billion in 2012 and where he remained for years to lead its networking and security business unit. As a reminder, none of the following should be taken as investment advice. Please see A16Z.com slash disclosures for more important information. We start our discussion by outlining the frameworks for understanding M&A dynamics, including the king-making dynamic and the difference between, quote, selling your company and, quote, getting acquired. Blake begins by outlining the big-picture reasons for M&A.

I would say that there are three primary reasons. One is a company gets funded and they're looking for product market fit and they realize that product market fit just isn't there. And it is pretty clear to the management team and investors that the company just can't get the next round of financing. And at that point, if the company is not going to be able to finance itself, then the company only has one choice, which is to sell the company. The second case is the company could have enjoyed limited product market fit.

Maybe the company scales to $30, $40, $50 million in revenue. But the company is starting to see its growth getting stalled. And it becomes evident that the company may not be in a position couple of years on the road to be a public trade identity. So the company has some limitations on how fast and how big it can get to. So that could be a good reason for the company to potentially sell themselves because an IPO path is not an option for them. The third option is a company getting acquired when a buyer approaches the target, when the seller isn't thinking about selling the company and the buyer offers to acquire the company generally at a pretty good premium to what the company is worth. And the company has a fiduciary duty to its shareholders. and if the offer is compelling enough, the company has to take it seriously and the company may

may not decide to take that offer. And the reason why you want to be acquired in tech versus getting sold is if you're being acquired by another company, generally the price and terms are going to be much more favorable if you're trying to sell yourself. Generally, something isn't working out and oftentimes it could be somewhat of a distress sale. So what can a company do to get acquired rather than sold? Putting yourself in a position where you could be acquired actually takes a lot of work. So a lot of times people think that you can just hire a banker and then you can just sell the company, but that's often not the case.

What you have to do is build a pre-existing commercial relationship with a strategic buyer many years ahead of and actually having any M&A discussions. And for buyer to feel comfortable about making the acquisition, feel comfortable about paying a really good price for the target, they have to feel like they know the company really well. They have to feel like the integration of the target with the buyer's existing customer base is going to be pretty seamless. And so without having this level of comfort, it is going to be very difficult for any buyer to pay a meaningful price for the target. And by the way, when companies have this conversation, commercial conversation with large strategics, they shouldn't think about

whether they can sell themselves to this particular company down the road. What they should really think about is how can this commercial relationship help me scale my revenue faster than I could on my own? And if this relationship down the road turns into something more strategic, then that particular company could have that emanate conversation down the road. But it should really be focused on commercial strategic relationship. And if it turns into something that's more strategic in nature, we could all have that conversation down the road.

Okay, let's get deeper into this. Having this pre-existing commercial relationship is clearly, important in the two parties getting to know each other. But what are some of the actual valuation implications and dynamics at work here? So one of the reasons why you want to have this commercial relationship for a couple of years is as a seller, what you want is you want the buyer to take a pricing risk. What I mean by that is you want the buyer to pay a price that the buyer feels uncomfortable with. And that's when you know that you're maximizing your sale price. And in order for any buyer to do that, they have to have internal

champion. The internal champion could be an EVP or general manager of a business unit that is sponsoring the acquisition. And unless that person has the conviction based on historical commercial relationships, it is going to be very difficult for that person to pound the table and take on the pricing risk that the seller wants. And so this is exactly the reason why you want to have that pre-existent commercial relationship. Okay, so that gives us the landscape of the different types of M&A scenarios and how they affect price. Let's move on to the next step and think about actually making the decision on whether to be acquired or not. So let's take an example of a company that's doing well, has some strategic value to a potential acquireer and is being, quote,

acquired rather than quote sold. Which frameworks should those founders be using to make this decision? This is like one of the more significant questions of founder faces at any point in time. The goal from a founder standpoint, and in fact, the board standpoint, is to maximize shareholder value, right? But that's this kind of fairly simplistic sentence for a very, very complex landscape. And I'll give you some examples of why that is. So say, for example, like you're doing well and you think you're going to do well, but there's another company, a public company that's also doing very well. And you can sell to that public company in exchange for the equity of the company. It may be the case that the actual shareholder value would go

even greater because you're now selling to a larger company who's also doing very well. It also may be the case that there is a company that has an incumbent that has a very strategic position and whoever they acquire, they can king make. And so even though if you stayed independent, you would acquire more value. If they bought somebody else, then that would diminish your value. right? And so, you know, it's better to be in that position than somebody else. Or it could be that somebody offers a very good risk-adjusted value, meaning, yes, maybe if you did it for 10 years, you could hit that value, but there's a lot of risk to it. And so there's always a very complicated calculus every founder needs to go through on this question. And in my experience, having faced it

myself many times, there's no simple answer. So how did this play out for you? You co-founded Nysera and were acquired by VMware. And you had also co-founded an earlier company that was a acquired. How did you and your co-founders and investors think through these issues? So, Nasira, we had acquisition offers almost every year of the company. And when we decided to, and the number just kept increasing, and even when we decided to sell it, which was, you know, it was a huge price. I mean, we were still a very young startup. It was a $1.3 billion price at $1.26 billion price tag. And even then, the majority of the board didn't want to sell because we knew it was a huge market and we were the leader. So then the question is, why did we see?

sell. You have to understand that an M&A can change the landscape itself, right? Well, it turns out, in this case, that VMware was basically a kingmaker. So whoever VMware acquired would own the majority of the market. And so that would make it much, much more difficult for us to execute. Now, would they have bought somebody else? We weren't exactly sure, but they may have. So let's say that we decided about for southern. And let's say they bought somebody else, like the number two or number three player. So we were easily the market leader at the time, right? Like we had the brand, we had the team, we basically created the technology. And so why would we have sold? It was a huge market. We were effectively uncontested. So why would we have sold? Well, the reason is,

is it turns out that in order for us to insert, we needed a cooperation of a company like VMware. They owned the majority of the market at the time, right? But if they wanted the wallet that we were going after, which it increasingly looked like they would, then it was quite likely they would acquire somebody else. And then it would be very hard for us, right? You know, we probably had months of discussion every time an acquisition offer came in. And then the decision to sell, it was not a simple one.

And even then, I mean, this is pretty serious stuff. It's a super complicated, big stake, serious stuff. What are some of the other reasons that come into play in these decisions? Like, what else do people not know about what goes into it? So the one thing that we don't focus on, which I think is incredibly important, is founder psychology and their motivation. So oftentimes founders, when they make decisions sell the company, it's very personal.

So one of the personal reasons why they might want to do that is based on their financial and economic background. So as an example, if you're a first-time founder, you have an opportunity to sell the company and make a lot of money, you might make a decision to sell the company because that might be a meaningful amount of money to you versus a founder that may have sold a company in the past and has enough cash in the bank, and that founder may want to take the additional risk of not selling it, potentially hold out to build a business, to potentially sell at a higher price on the road. The other thing is age. What I found is the younger founders, especially if

this is the first startup, they are willing to take on greater risk, run the business, and maybe they are bigger dreamers, and because of that, they may not want to sell the company because they may want to run it for a much longer period, just simply because they're younger. Whereas if you're a founder that's found a couple of other companies, for you, if the price is right, you may want to sell it because you may want to retire or you may want to do something else, such as being advised to a bunch of other startups. So you may just have different motivations. Okay, so these issues are super complicated.

What are the actual financial frameworks that founders might think about to sort through it all and make the best possible decision. So Blake is totally correct that a lot of it is the motivations of the founder, but it's not just the motivations. It's also like what's the risk tolerance and the practicality of money, right? So expected outcome is the size of something times the probability that it happens, right? If there's a 1% chance that you sell for $100 million, then the expected outcome is $1 million. So it turns out the highest expected outcome is almost certainly not selling, right? Because, you know, you could potentially be a Facebook or whatever. You could be a $100 billion company potentially, even if the probability is low, but there is a chance,

right? So it's almost always that the expected outcome is hold, hold, hold. The problem is, is a 1% chance of something happening just isn't practically useful for a founder. Like, if you had a choice, If you're like, okay, I'll give you a 50% chance of making $20 million or I'll give you a 1% chance of making $200 million. Like, what would you do? You probably take the $50 million, right? Now let's get back to fiduciary duty. But your duty to the shareholder is the highest shareholder dollar. The expected outcome is actually higher if you don't do it.

It's just the chances are lower. So so much of the complexity of these discussions comes down to. the chance that something is going to happen versus the actual outcome. So it's the risk-adjusted outcome, and it's not maximizing the expectation. It's maximizing something else, right? It's saying, like, listen, shareholders probably don't want this to go to zero in 99% of the cases. They probably want it, right? And so there's a lot of great area for these discussions to have.

If we really cared about expected outcomes, we'd all start energy companies because that's a trillion-dollar market, right? Except for it just turns out like they're really hard and the chance of them being successful. are very low. Okay, we've talked about the different M&A scenarios based on the stage or performance of the company, the motivations of the founders, and even where they are in their careers and age-wise. So what about the other side? How should founders think about the different kinds of potential buyers and the motivations that are driving them and how that affects a potential deal? Generally, there are three types of buyers. So one is large strategics, and the strategic tend to pay the most for the target. There could be some revenue synergies. There could be

on cost savings. So you can really increase the revenue base of the target by having the target become a part of the larger company. The second type of buyers, which tend to be less relevant for venture-backed companies, are PE firms. And the reason why I say that is PE firms typically buy very mature companies or they take public companies private. And a lot of the VC-backed companies tend to be too small to be a standalone target for PE firms. However, the PE buyers does make sense when they have an existing portfolio company that could be a strategic buyer for a VC back company. So basically, you're doing a token of a VC back company into one of their portfolio companies. What I've typically found with PE firms is that they don't pay as much as large

strategics, and they tend to be much more disciplined type of buyers. So if I were selling a company, my preference would always be to sell to a large strategic where there is a large strategic value that you can monetize as a seller. The third type of buyer could be another private company, so you could have a private-to-private type of merger. Typically, private companies will buy small teams. We call that acqui-hires, or sometimes a private company, might buy a meaningfully sized private company to just get to a larger scale. For the venture world for startups, the most interesting buyers are strategic buyers because they're buying into the same reason you started to the company, which is a dream

or a vision. They often have this interesting conversation with founders where they're like, listen, we're making no money at all. They won't pay very much for us. But the reality is that that's not how they think about it. And in fact, I've actually got two anecdotes on this. The first one is I remember, you know, when we were selling this year, I remember Ben Horowitz, and it was a great deal. And it turned out actually to be, you know, a great acquisition

for VMware as well. But I remember him telling me saying, hey, listen, you're going after networking, which is a $40 billion market. They're doing a future option on all of networking. So, you know, a billion dollar option under $40 billion market. Like, that totally makes sense, right? So it wasn't like they're looking at the finances. They were actually looking at the market you're going after. There's a second one is companies also view a change to their stock price which is their market cap, which is a very large number, right? And so if you provide some strategic value, it augments that, it can very easily compensate for whatever the acquisition price is, right? So in the case of App Dynamics, which Cisco bought for $3 billion, I believe it was, like the

lift of the stock price was far above that. So again, it's not a straightforward discussion between, oh, you make $5 million an error or $20 million, therefore you're worth this. It's like, what can you do for the large company. And because these companies have such high market caps, the lifts can be enormous. And so again, you know, if you're a founder and you're in the position for a strategic acquisition, you should feel comfortable knowing that you're worth a lot more than you probably think that you are to the company that's acquiring you. By the way, a good example of that Markine that we saw recently was salesports buying SLAC, like Slack would probably make a company with public market cap. But, you know, there were a lot of analysts and in the media, a lot of people were saying that the salesp

course, what we're paying for SLAM. But I got to believe the value of Slack then was a lot more than what they publicly pay for the company, including the large premium. So that's a real good example of what Martin was saying. In Enterprise, there may be three important networks. There's LinkedIn, GitHub, and Slack. As far as, you know, I can tell, as far as I kind of real big networks, and all of them have demanded massive premiums on acquisition for exactly this. reason. You're not just buying into, to Blake's point, which is correct, to cash flow. You're buying into a strategic asset. You know, it's a network of people, right? So it's got one of the top brands and the top communities and the top networks in the industry. GitHub, the same thing. It's

the entire developer network. And LinkedIn is the professional network. So yeah, absolutely. Let's go to the post M&A part now. Let's say the deal is done. It's all signed, ready to go. What does life after an M&A really like? And what do founders need to be ready for? The hardest thing about an M&A in my experience on the other side, once you do it, is actually the team integration. You could have two totally different cultures. Like in the case of Nassira, like Nassira was kind of like a commun, right? Like when we started the company as a bunch of academics, we were all fairly senior. You know, many of us had PhDs.

We were all core researchers. And we had this very senior, very flat team. We made decisions through consensus. I mean, it had just a certain culture, which worked well for us, right? And when we got acquired, we got put into a 350 person. and org that was like a military. So it was like very top down. And both of these cultures totally work, right?

But there's absolutely no value judgment I've like. The military is a great efficient culture. You know, like having a commune can be a very creative culture. But mixing them together is tough, tough, tough. And so I actually think that a lot of the complexity in M&As is okay. So you've got it done. Now how do you do these integrations? So help us understand what was so tough about it.

What was the overriding challenge in those first weeks about figuring out how to meld these two cultures and where everybody fits. I mean, you've got, you know, managers that are used to managing one way and subordinates that are used to being managed a different way. And, you know, these don't always melt, which causes a lot of infighting and a lot of clashing, like breakdown in communication, you've got to align processes, all of that stuff that happens, you know, and that stuff. You also often have these other dynamics where, like, if, let's say, a large acquisition

happens, the company that gets brought in just made a whole bunch of money. So you have a bunch of individuals that made a bunch of money. money that got brought into the new company and there can be like some dynamics as result of that too, right? And this is just kind of, you know, especially the team that's acquiring is also working on the same things. And so, I mean, I think it's a very significant people management and culture management issue to make these things successful. And that's not even talking about like the business alignment or the product alignment or the architectural alignment. And all of those are things as well. But I think first and foremost, it really is a people problem. Take us behind the scenes a little bit.

What do people not know about how this integration of cultures actually works in real life? This hugely is dependent on like the org and the situation. There are some acquisitions where the company that's being acquired doesn't get touched, right? Like salespeople stay in place, P&L stays in place, they're separate. So for example, VMware bought a company called AirWatch and they basically didn't touch it. There are other acquisitions that are basically mergers, right? They're like, okay, here's an existing org and we're going to go ahead and squish you in that org. We were a merger.

There was an existing networking team that we got squished into. That was actually larger than those. Those just tend to be a lot more difficult. And then, yeah, I mean, there's massive trust issues. You know, there's arguably inequity issues, right? Like, let's say two teams, both were working for four years on the same thing. One, you know, sold a company for a whole bunch. And the other one has to go ahead then adopt their technology or work with them or partner with them.

I mean, that's kind of a tough thing to manage. And so having gone through it, actually not twice, if an M&A happened, And the first order of business is to really, really make sure that, like, communication, culture, operating, like, all of that stuff is in place to manage the people aspect of the merger. So what are some strategies that founders should think about to make it work after the acquisition? What don't people know if they haven't actually lived through it? So in order you're selling this era, we actually had multiple companies that we were kind of thinking between, and then we decided to have VMware is the best strategic fit.

We decided to go to VMware. So I called Diane Green. So Diane Green, of course, was the founder of VMware, was the CEO of VMware. And I said, Diane, you know, listen, we're being acquired by VMware. Do you have any advice or anything I should know? And she said something to me at the time. I didn't understand how kind of, you know, spot on and prophetic was. She says, Martine, no matter what, don't give up your sales team.

You must keep your sales team. I'm like, why is that? So not really knowing why, when we were actually finalizing the details of the deal, I basically said, you know, with the CEO of Steve Mullaney, We're like basically, like, in order to do this, we keep our sales team for at least a year. Steve may have known why we were saying that I had no idea why we were saying that. But it turns out that I think the difference between acquisition being successful and not was the fact that we kept our sales team. And the reason is because in large companies, sales teams often carry many products and they are already used to a certain type of a buyer.

And if you sell to a different buyer and or your product is more difficult to sale and the customers like at a different. adoption curve. It's very, very hard to get an existing sales team to sell it. The fact that we're able to control our own sales team, we had a bit of a different buyer, which is kind of network and security, which wasn't the core VMware buyer. Like 100% of the quota was our product allowed us to really build out sales. And so, again, these things are situational. If you're in B2B and you do have a direct sales motion to sales team, I think keeping your sales is one of the absolute keys to being successful post acquisition. It's almost that trust issue. I don't want to sell their stuff. I'm going to sell the stuff we've always been selling.

So the simplest way to think about it is if you have a sales team that's used to selling to compute folks, and now you're like, go sell the networking folks. They're just not the right team. It may be a little more complicated. If you have a team that's used to selling to a mature market, you know, like this is a mature market with a mature product where you're basically just order takers and like most of the discussion are around financials, right? Just because it's like it's about discounting because everybody knows the product. And now you tell them to sell a challenger product. oh, this is an evangelical sale, it's not a discussion about numbers, this is a discussion about value or whatever it is. That's not going to be the right team to sell it. Even more complicated,

let's say you've got a team that has 50 things to sell, right? Now you're giving them something that's new and hard, then they're not going to sell that. They're going to sell the other ones to sell. I mean, you have so little control. So if there's anything different about your cell than the core company sell, then your chances of success are lower. From the company's perspective, however, is having multiple sales team is very expensive, right? Like, why would I have multiple sales team, but I have one sales team? And so they will want to roll your product into their sales team as quickly as possible. And so that's the tension and that's what you have to fight. And so, you know, I love Carl Eschenbach to death. He's at Sequo. He's a phenomenal GP.

So he was the counterpart at VMware when I got acquired. And he and I would argue every year you would want, you'd want our sales force to be rolled into his org so he could reduce the number of sellers we have and I wanted to keep it. And it's a very real tension. And I'm going to say to founders, if you're selling in your B2B, keep your sales team as long as you can. How many years did you keep your sales team there? Did you win those fights every year? Yeah, so we actually kept our sales team until I left. So four years. We did give it up once to Europe and then that failed. And so we got it back. So that was good. The trick is, is you can't operate alone. You have to cooperate with the core sales team because they make it the intros to the accounts and they help the sales.

And so we were pretty much added alone the first couple of years. And then we started cooperating with the core sales team. And that's when things really took off. And so was successful, but it required a lot of cooperation from the core sales team. And when it doesn't work, what does that look like? Like, what's the fatal mistake? The sad reality is the majority of acquisitions fail. My suspicion is it has to do with actual just a team level integration, right?

Is, you know, the white blood cells in the organization are going to come out. There's going to be, you know, clashes on strategic. alignment. I mean, you're cramming two totally different organizations together, and that's a hard thing. You know, I share a board seat with John Chambers. Cisco is our number one competition. I think he's probably the best executive ever in our industry for M&As. This is the best, the best, the best. They've bought so many companies that made them successful at Cisco. And we were chatting about it after a board meeting one day. And he said, you know, Martine out of a, I think it was 127 acquisitions we did, I'll tell you what makes the

acquisition successful. And it's like the strongest indication of it's going to be successful, is that the founders stick around. That's the leader stick around. And if you stick around, then it's likely to be successful. I suspect one of the reasons is, is the founders and the leaders are there, they can manage their team to get through the actual integration, which is a tough thing to do. And so I do think, you know, selling a company, if you want the integration to be successful, leaders should be there. And they should really, really focus on the personnel and the integration problem. Martin, Blake, thank you so much for being with us today. Great. Thank you. Thank you.