Notes from Earth #2: Two Conferences on Acquisition, Out-licensing and Fresh Capital
This article is intended for those of you running a revenue-generating business and expecting a liquidity event or capital raise in the next five years, including out-licensing a product or IP. As usual with Intelliversity, it offers a healthy dose of contrarian and controversial ideas, all worth considering or chuckling at. For those of you who are still developing a product, this blog is a permitted peek over the horizon.
On point, I’ve attended two interesting conferences in the last 45 days: the JP Morgan circus in San Francisco for biotech and health-science companies, and the more sedate but equally interesting Alliance for Mergers & Acquisition Advisors conference in Las Vegas. Both allowed for a deep dive into the world of exits and out-licensing, a likely intended result of your entrepreneurial adventure. Let me tell you what I observed.
First, here at the opening of 2017, the business world is awash in liquidity. Private equity firms, lenders and corporate treasuries are often overflowing. The private equity industry alone needs to deploy a record $1.47 trillion of committed capital, according to Bain & Co.’s 2017 global private equity report. And regardless of political leanings, there’s additional optimism driven by hope of looser regulation, faster approvals, reduced corporate taxes, economic stimulus and repatriation of corporate funds. If you’re not taking advantage of this cyclical liquidity environment in some way, you’re missing the boat in my opinion. Your liquidity options are: 1) raising capital (whether debt, equity or royalties) to enable rapid growth; 2) out-licensing IP or products to larger businesses prepared to take over the marketing; 3) seeking acquisition by a private equity firm or strategic buyer. Are you considering one or more of these?
I don’t know how long this flush arc of the economic cycle will last (and there’s no way to know with much certainty). However, at the AM&AA conference, we were privileged to a conversation with Jeff Mortimer, Director of Investment Strategy for BNY Mellon Wealth Management (among the U.S. top 10 wealth managers), known for his unique methodology for predicting economic cycles. His system breaks the economic cycle into 12 segments, like hours on a clock, where each hour is accompanied by specific indicators of the speed at which the clock is ticking. This allows for an estimate of the beginning of the next part of the cycle. Based on his system, there is a reasonably strong probability that the current high level of liquidity and optimism may last about 18 months. After that, capital becomes less available. This gives you little time to plan and act.
In general, how far in advance should you prepare for a liquidity action, including the raising of additional capital, licensing event or acquisition? Let’s break this down by category of action:
For an expected acquisition, you should be actively preparing at least three years in advance, according to a consensus of leaders of the Alliance of M&A Advisors (AM&AA). This is all about maximizing valuation. In other words, develop a detailed valuation-maximization strategy at least three years in advance of acquisition. During this period, take action such as 1) cleaning up the cap table (such as buying out troublesome investors or partners), 2) cleaning up the balance sheet (such as consolidating debt to reduce interest expense and selling off low-performing assets), 3) settling lawsuits and potential liabilities, 4) settling tax obligations, 5) strengthening IP protection (patents and trademarks in all important geographies), 6) getting rid of other issues that will come up in due diligence, 7) filling gaps in the executive team, and 8) accelerating revenue growth. You can probably think of other ways to maximize valuation for your company specifically.
AM&AA leadership recommends that an outside acquisition strategy advisor is retained at the beginning of this three-year acquisition preparation period. This “quarterback” then leads the team of experts who will tackle specific valuation issues such as those listed above. This advisor should NOT be the kind of business broker who is mainly interested in closing the deal. The acquisition quarterback takes a longer-term strategic point of view. AM&AA can help you find the right acquisition quarterback from its extensive membership of advisors.
Intelliversity has long championed the idea of creating a PDC – “Product Development Company” for innovators not willing to build a billion-dollar unicorn, but also not interested or able to engineer a fast exit. In such a company, you maximize the value of your underlying technology, platform or process by creating multiple products that are each licensed out to larger companies who have the marketing prowess to fully monetize each one of them. Such a strategy can be highly lucrative and satisfying, allowing founders to do what they do best – innovate. This strategy may provide a basis for a sustainable company, one that you can lead and develop for many years without seeking an acquisition.
Instead of placing each product (or product line) into a separate entity to attract capital interested in that particular product, you can invite investors to invest in a product or product line through the use of royalties. This simplifies the legal and corporate governance issues by an order of magnitude. Intelliversity would be happy to discuss with you how to design a royalty contract that will satisfy you and investors whether you continue to grow sales internally or sell a product off.
Once again, we recommend preparing for out-licensing three years in advance. During this period, you are discussing licensing with prospective licensors, determining exactly what features and benefits would have the greatest strategic value for licensors, making sure your IP protection is defensible worldwide. The actual negotiation of a licensing deal takes place in the last year of the 3-year preparation period. Here again, it’s a good idea to retain a licensing advisor with a long-term strategic perspective to act as the quarterback of the licensing strategy.
Raising fresh capital
If you’re having trouble raising capital right now, and you have an operating business, it’s not for lack of capital available. I can think of several good reasons: 1) you just don’t have access to the right kind of investors, 2) you don’t have a wide community of customers that may invest or pay in advance for services as a collective source of cash, 3) you’ve overvalued the company by not fully considering the risks that investors perceive, 4) you’re trying to sell equity when revenue sharing (royalties) or even debt would be more appropriate and attractive, 5) you’re trying to raise capital in one chunk rather than break it up into several rounds (tranches) each with its own risk-reducing milestone, 6) you don’t have an operating executive (COO or president) and you’re trying to be both the innovation-master (vision-master) and execution-master at the same time.
The process of raising fresh capital should be continuous, often for the life of a growing company. Preparation for each round should begin at least a year in advance, but following the contrarian pattern sketched in this article, preparation begun three years in advance will be fruitful in acquiring the necessary advisors, access and expertise; knowing all your options; building a complete team, making sure risks are reduced in every conceivable way, producing the necessary presentations and documentation and preparing for due diligence.
Begin to prepare for any kind of liquidity action three years in advance. A simplified template for this three-year process is:
Year 1 – Acquire your liquidity quarterback (an advisor with a long-term perspective and your best interests at heart) and fill out your board and key professional advisors.
Year 2 – Solve problems and reduce risk: Attend to your cap table, balance sheet, IP, revenue growth, gaps in your team, and so on.
Year 3 – Actively pursue sources – seek acquirers, investors or partners, as the case may be.
Actual lengths of time may vary. Year 1 may actually be the first six months, Year 2 may actually be two years long and Year 3 may be the last six months. The important point is you give yourself enough to do each of these three stages competently. Your future depends on it.