Should a Startup Raise Series A Funding To Grow Or try to Sell and Get Acquired by a Larger Company?

🌲 The days of easy-flowing vc investment funding likely led to the intense funding swell of the past few years leading up to 2022. Currently, the economic environment in 2023 is rocky, the Fed keeps raising interest rates, which makes borrowing capital more expensive, bank failures and practically everything you go purchase costs more now. In recent WSJ article titled “More Startups Throw in Towel Unable To Raise Money For There Ideas” points out that fresh capital from venture investors and bank loans is scarce and expensive. Going public is near impossible. Some business models that worked when cash was cheap are unsustainable now. That means venture-backed startups are running out of money and facing hard choices. The article also mentions that some venture investors see the impact already.  “It is hitting now,” said Elizabeth Yin, co-founder and general partner of pre-seed investment firm Hustle Fund.

Of her firm’s first fund, only about 60 of the original 101 portfolio companies are around. There were roughly 90 active startups a year ago. 

Most startups will face a moment where the decision has to be made whether to raise more capital in order to build it out further or just put it up for an M&A sale transaction. 

Is it is better for a startup to try and raise Series A, B, C funding or just try to get acquired and sell to a larger company such as how Mailchimp or Looker did.  The answer to this depends on a number of factors, including the startup’s stage of development, does it have product market fit, monthly revenue, stickiness, its growth goals, and its valuation. At what point should companies make the decision to either raise more capital or sell?

In a forbes article about this topic, Steve Gurney, a CFO of an investment bank Viant Group explains “In the case of a capital raise – the build option – I would say at the point when there is six months’ worth of cash burn in the tank or when a clear need for more funds presents itself. In the case of selling the company, a sale process can take from six to nine months to a year to close. Since buyers will give more value to a growing company, you want to consider selling while growing and ideally not wait until growth has slowed.”

Here are some of the pros and cons of each option: 

Series A funding 

• Pros:
  • Can provide the startup with the capital it needs to grow and scale
  • Can give the startup access to experienced investors who can provide guidance and support
  • Can help the startup build brand awareness and credibility
• Cons:
  • Can dilute the founders’ ownership stake in the company
  • Can come with a number of obligations, such as reporting to investors and meeting certain milestones
  • Can be difficult to raise, especially if the startup is not yet profitable or the market has changed where the cost of capital is not cheap anymore

Selling (M&A / getting Acquired) to a Larger Company 

• Pros:
  • Can provide the startup with a quick infusion of cash
  • Can give the startup access to the larger company’s resources, such as its customer base, distribution channels, more money to invest in growth, better technology, and more experienced managers. In theory, this should help the small company grow even larger.
  • Can allow the startup’s founders to exit the company and realize their investment If the deal goes through, the founders and early employees can cash out and make a lot of money. This can be a life-changing event for many people.
• Cons:
  • Can result in the loss of control over the startup
  • Can lead to layoffs or other changes that impact the startup’s employees
  • Can be difficult to negotiate a fair price for the startup 
  • The larger company may be more risk-averse and conservative, which can stifle innovation and creativity

Ultimately, the decision of whether to raise Series A funding or sell to a larger company is a complex one that should be made on a case-by-case basis. There is no right or wrong answer, and the best option for a particular startup will depend on its specific circumstances.

Here are some additional factors to consider when making this decision: 

• The startup’s stage of development: If the startup is still in the early stages of development, it may be better to raise Series A funding. This will give the startup the time and resources it needs to grow and mature before it is ready to be acquired.
• The startup’s growth goals: If the startup is looking to grow rapidly, it may be better to raise Series A funding. This will give the startup the capital it needs to invest in marketing, sales, and product development.
• The startup’s valuation: If the startup is already profitable and has a strong valuation, it may be better to sell to a larger company. This will allow the startup’s founders to exit the company and realize their investment.

If you are a startup founder, it is important to speak with an experienced financial advisor to discuss your options and make the best decision for your company.   

What is a typical build VS Partner inflection point for a company?

The Forbes article points out that often small startup companies will reach a point where they need to decide if they are going to build out a large sales and marketing team or if it makes sense to join a company with an in-place sales and marketing team. Maybe the founders have little sales experience and even less experience building out such a team. Maybe the founders don’t have a desire to build out a team. Sometimes the goal is to get a product or service out to the entire market as soon as possible to stay ahead of the competition. In these cases it may make sense to join an existing company with sales channels that are well-established and even global. 

Be Prepared for Due Diligence whether Selling or Fundraising    

During due diligence, you’ll have to show that the structural integrity of your company is clean. This means you’ll need to: 

• Show a clean cap table, with all the equity in the company’s past, present, and future accounted for
• Be prepared to open your books so they can audit your financials
• Sit your lawyers with their lawyers to sniff out liability and risk, and also make sure your intellectual property is properly protected.

Not all startups are built for a billion-dollar exit — or to grow as a stand-alone company at all     

Recently reported about an SF based tech startup, called Heroes Jobs, which provides a social app that helps GenZ job seekers build their professional footprint, get career advice, and engage with their future employers. The company had raised $9 million in total and was previously valued at $18 million. The Heroes Jobs startup had been raising a Series A with a signed term sheet but ended up instead selling and getting acquired for an undisclosed amount by a competitor named JobGet, an hourly job marketplace startup that has raised more than $50 million in venture funding.  

Heroes Jobs’ data and technology will become fully integrated into JobGet’s platform and its co-founders will help with the transition before leaving to pursue other opportunities.

Cyriac Lefort, a cofounder told Techcrunch that Heroes Jobs had actually started the process of raising a Series A round but found the terms unfavorable. One of their current investors also warned that the term sheets were low-balling them on a valuation. Investors were offering the same terms for a Series A that they had received a couple of years earlier with 10 times less revenue. So they pivoted on an exit strategy and started looking for a deal to sell.  

Lefort said. “I don’t think we could have done it differently,” Another cofounder Tristan Petit told Biz Journals “you have so many scenarios. Even for us, we didn’t know if people would be more interested in our tech, more interested in the data or more interested in getting the customers. So, that’s very difficult because you’re playing several different strategies and games at the same time.”

At one point, Heroes Jobs had around 40 employees but they began winding down the team for about 18 months once they decided to pursue an acquisition. Ultimately, Petit and his co-founders felt like selling to JobGet offered the best combination of terms and flexibility, allowing them to move on. Their acquisition comes during a time with exits of all sorts have slowed down. The WSJ article mentioned another example of a startup, that had to take a similar path, was Park Place Payments, which had raised $4 million in venture funding, had to act fast when the largest investor of a planned financing failed to send the check last September.  The founder Samantha Ettus slashed expenses, raised $440,000 in bridge funding from existing investors, and hired an investment bank to sell Park Place. “When I first started the company, we said we will build this [into a] billion-dollar company. I had never intended to sell so early,” Ettus said. Publicly traded Logiq acquired Park Place in April in an all-stock deal valued at more than $6 million, allowing Ettus to continue building her business with the resources of a larger company. 

While IPOs have been on ice since early 2022, many observers had predicted a flood of mergers and acquisitions this year — but that’s not how the market appears to be playing out.   

According to the Biz Journal article, globally, mergers and acquisitions were down by almost one-third in the first few months of the year, according to Crunchbase, and relatively flat compared to the last three months of 2022.

The number of M&A deals between venture-backed startups has also declined in the U.S., according to another recent Crunchbase report. Only 82 U.S.-based startups were acquired by other startups in the first quarter, compared to 137 during the same period in 2022.

Conclusion 

Startup failure rates may continue during downturns, if companies don’t have money then they cannot continue to operate. 

A large part of successful raising capital is “who you know.” Can your existing investors introduce you to other, larger potential investors? Is your Company in a currently “hot” sector? Timing is everything. Like currently startups building AI products and solutions is a hot sector for investment. 

If you are thinking about possibly selling a few things to think about. Have you been approached by any companies? Do your competitors or  larger companies know of you and your product/service? If not, you should reach out to them and let them know that you exist. Mr Gurney said in the Forbes article that he advises small companies to periodically reach out with updates to potential buyers from day one, so that when it does come time to sell, the buyers will be familiar with the potential target. If you are having trouble raising funding (since the current macroeconomic trends has made some business models not sustainable) and are going the sale route then contacting an investment banking firm or broker is wise choice. If you don’t have a solid offer, you should at least be investigating one or more implied offers. These hints and clues will come from partners, customers, competition, and even investors and advisors with connections to other investors and PE firms. If you have none of these, selling the company is going to be a lot more difficult, but not impossible. In this case, acquisition is a lot like fundraising. If you don’t have any offers or leads, you need to build connections and relationships.

A sale of a business is a highly complex matter from a legal and tax perspective. Don’t rush into it without getting expert advice beforehand. Working with a CPA professional can help you navigate some of the complex scenarios and find a strategy that can help to reduce the amount you owe in taxes. If you have any questions feel free to reach out for a free consultation.