Draper drives M&A debate

A panel discussion in Hollywood last week underscored the confusion for entrepreneurs and investors over when is a good time to sell a startup. The debate became so fired up that one panelist responded to another by saying, “That’s bullshit!”

The good news is that no one “charged the mound.” Everyone laughed off the comment instead.

The panel discussion took place at a conference sponsored by the media property AlwaysOn. About 100 people attended and saw the panel’s participants – venture capitalist Tim Draper; banker Mike Montgomery; attorney Mark Stevens, a partner at the Silicon Valley office of Fenwick & West; and entrepreneurs Jason Calacanis and Josh Resnick -agree on a number of issues, such as that it’s better for an entrepreneur to stay on board after an acquisition rather than hightailing it when the check clears.

Draper said, for example, that entrepreneurs who stay with a company after a merger or acquisition often continue pursuing their vision are “generally happier” than those who cash out immediately or soon after the transaction is done.

Giving up on a startup can be crushing, Draper said. “It’s like a divorce or losing a child,” he said. “Entrepreneurs don’t always realize the range of emotions that follow an acquisition.”

Another important consideration for entrepreneurs when weighing an offer is their personal financial situation, though there was little agreement on the panel about whether financial security is worth more than the satisfaction of continuing to steward a successful startup.

Calacanis, CEO of the blog network Weblogs, which sold to America Online for $25 million last year, suggested that if you don’t have money in the bank, it’s often smart to take what’s on the table for the sake of loved ones.

“Family is a very motivating factor,” he said. “When you come from a middle-class or a blue-collar family, as I have, and your mom is 60 years old and has worked her whole life,” it’s not worth second-guessing what kind of multiple an entrepreneur might get in the future.

Another option, highlighted by Resnick, is to partially sell one’s company. Resnick co-founded video game developer Pandemic Studios and sold a sizable portion of it to Elevation Partners last year. The partial buyout allied Pandemic with Canada-based BioWare. (The combined investment was slightly more than $300 million, according to Elevation.)

The partial liquidity event helped to mitigate risk, Resnick said. “We also wanted to get some capital into the business so we could take advantage of some growing opportunities,” he added.

Montgomery, president and head of media banking at Montgomery & Co., noted that more and more investors are becoming aware of this conflict and are allowing and even encouraging more partial liquidity events. “If you have an entrepreneur with a little more money in his pocket, his risk-profile changes dramatically.”

The panelists, however, had difficulty finding common ground over how acquirers value exits. Not one of them offered any usable formulas. In fact, none seemed to think cash flow was all that important when evaluating potential M&A deals. “When Microsoft bought Hotmail [a DFJ-backed startup that sold for $425 million], it wasn’t for cash flow,” said Draper. “It was a great marketing company.”

Stevens said that an entrepreneur should never focus on selling a company. “Build a great business and make decisions that are not driven by a possible transaction,” he said. “In fact, make decisions that might not even make sense to a transaction. Hire people. Get that additional office. If buyers see you making decisions based on them, they’ll jam you on it every time.”

The panel was titled, “Buy, Sell or Hold,” but it went off on a tangent at one point with Calacanis arguing that entrepreneurs should only raise money from individual investors, not VCs. He said that invidual investors won’t turn ugly on you if the market turns, unlike VCs. Draper countered that VCs do care and in a down market, individual investors are less likely than VCs to give a company more money. VCs care about their investments and they have the resources to nurture them, he said.

It was then that Calacanis said, “That’s bullshit!” and went on to talk about VCs cramming down rounds. The audience laughed and the debate continued.