Key “M&A takeaways” from the sale of Clustree to Cornerstone OnDemand

Most startup literature is about STARTING a business or GROWING it. Not about EXITING it.

There are countless books, press articles and online content about the lean startup model, minimum viable products, finding product/market fit, scaling sales & marketing, maintaining your culture while you grow, conducting fundraising successfully, etc.

But it is hard to find real insights about startup M&A (which represents approximately 90% of VC-backed exits, as IPOs remain exceptional) and the challenges of navigating such a rare and specific process, which was, for us, the most intense, stressful, intellectually diverse, physically challenging and emotionally draining time of our careers.

We find this strange for at least 3 reasons.

First of all, everyone agrees that exits actually do matter.

• Selling your startup could be the best way (sometimes the only way) to keep developing your business, to continue addressing the problem with which you fell in love in the first place and to do it on a wider scale, with more resources (financial means and skills).
• Exits are also, of course, when the founders of a startup, their team and their investors get paid for all the hard work they put on and the risks they took, during many years.
• We also know that exits create "role models" and business angels in the startup community, that they build track records for VCs (and trust among their limited partners) and that they consequently result into more experience, dreams, hope, money, and mentors nurturing a startup ecosystem.

Secondly, selling your startup is both a very rare event and also a process handled by a very limited number of people at a startup (CEO and/or co-founders). This makes knowledge and experience of that topic extremely concentrated.

Some entrepreneurs can start several startups in their life, they can be part of several management teams and be involved in multiple fundraisings. Growing/scaling a startup is also a "continuous" job, with different phases. It is a process shared by several executives at a startup, all of which bring a broad set of experiences to the table. It is thus easier to learn from experience when it comes to starting or growing a business. On the other hand, a founder might be selling a company only once in his/her career. We would argue that this makes relevant advice on that matter really critical.

Last but not least, M&A is a chance for extreme value creation (or destruction) in a very short period of time.

“You can create more value for your shareholders and yourself in a 1 hour, well-prepared M&A negotiation meeting than you did in the first 3 years of your startup’s life”.

In the final stretch of an M&A process, over a few weeks, it is not crazy to imagine that you could end up selling your business for, let's say, $200m instead of (for instance) $170m because you prepared well for a critical negotiation, found the relevant champion at a prospective buyer or conducted a well-organized competitive process. If you think about it, it probably takes an average of 3 years of heavy lifting, 35% dilution and a successful Series B round for a founder to materialize a similar $30m pre-money valuation in the early days of his/her company.

Since the announcement of the sale of Clustree to Cornerstone OnDemand, Bénédicte and I have been regularly approached by founders asking us to share some pieces of advice, as they were embarking for an M&A journey themselves.

All those phone calls were extremely rich and fun, and they were also emotional experiences as we were recalling so many anecdotes. They made us want to share our insights in writing, more broadly and in a structured way, so that it could hopefully benefit other founders.

Our takeaways are obviously personal and relate to the specific context of our M&A process.

• Clustree is a French, 35 people VC-backed, AI startup with a subscription model, which is active in the HR field.
• We sold our company for an amount just shy of $20m to Cornerstone OnDemand, a US listed SaaS company, which is the global leader in the corporate learning space and whose market capitalization was around $4 billion when it announced the acquisition of Clustree.

If you want to find out more about the rationale behind that acquisition, you can read the press release from Cornerstone (CSOD) here; have a look at the analysis from Josh Bersin, the most renowned analyst in the HR space here; or go through that blog post from Thomas Otter, one of our advisors.

Some of our insights could obviously benefit from further details but we signed NDAs with most prospective buyers and are not at liberty to share everything. We hope it is still useful.

But without further due, here are the key takeaways from this cathartic journey.

CEO access is the n°1 success factor in an M&A process

At almost every company, whatever the strategic rationale for an acquisition and the size of the M&A deal, external growth is a CEO decision. Period. You need to get in touch with the CEOs of your prospective buyers. Target them upfront or make sure you have them in the loop as soon as possible.

During our M&A process, several companies got interested in Clustree (i.e. participated in follow-up calls after the first meeting and performed preliminary due diligence). More than 5. And we received several “letters of intent” (LOIs). More than 3.

“All companies that submitted an offer to acquire Clustree were those with which we had been in touch with the CEO from meeting one or two. No exception.”

With Cornerstone, Bénédicte had a corporate presentation and a product demo with Adam Miller, the CEO of CSOD, a few days after the initial 45 minutes pitch to his VP of Corporate Development. Moreover, Adam personally led all negotiations until term sheet signature.

Of course, not having direct access to the CEO early in the process does not necessarily mean that a deal cannot happen.

A potential acquisition can be presented to a CEO (or to a Board of Directors) after several weeks of discussions and negotiations and that deal can obviously still get approved. However, accepting such process undoubtedly increases the risk of failure. It makes you dependent upon your internal champion (it could be a regional leader or someone from Product or Corporate Development) who might not be ready to present the opportunity to his/her CEO (thus putting his career at risk if something goes wrong or the opportunity is rejected) after identifying even the slightest, most trivial risk associated to the transaction. That champion might also simply not be aware of the CEO’s strategic agenda or simply not have enough power to get internal resources on board (to analyze a deal) or to navigate the organization appropriately in order to convince all relevant stakeholders.

In any case, leaving CEOs out of the picture until the (hypothetical) end will at least slow down your M&A process. A CEO has no time to waste and will generally give you instant, brutal feedback, while it is simply the regular job of any Corporate Development professional to speak with potential targets, analyze them and put them in touch with colleagues from Product or Marketing to gather their opinions.

Hire a network, not an investment bank

Those are our 3 guidelines when selecting an investment banker:

1. Check that your bankers have access to potential buyers (real, proven access at the relevant level).
2. Make sure to hire a banker whose brand, personality and attitude will reflect positively on your company when they get in touch with potential buyers.
3. Your banker should be a sparing partner with a capacity to advise you and challenge you on the negotiation strategy you will put in place.

“Find advisors who can get you in front of the relevant people at your most probable buyers. That is the most important, by far”.

For us, all the rest (industry experience, business model understanding, ability to present your business, availability of junior resources to prepare transaction materials, corporate finance skills, track record, motivation, experience managing M&A processes, etc.) is almost irrelevant.

You will do the job of presenting your company (especially if it is a complex technology startup such as Clustree) and managing all the Q&As and conversations with the buyer because they are buying YOU as well (of course, it is different if you are running a larger, traditional company with 10 Private Equity firms lining-up to send an LOI for a deal).

If you find a banker who can introduce you (at the right level) at 50% of your Tier 1 potential buyers (because he/she has worked in that industry or just spoke to all those guys recently for another deal) and can really get the attention of the right champions there and get you to present your company to them, then simply hire that banker and don’t worry about the rest.

On our front, we hired Torch Partners mainly because we wanted to work with Sanu Desai whom we had known for a long time. Sanu is a senior, smart, elegant, and sophisticated banker with a lot of experience in the Tech sector, a Stanford MBA and he is based in California where the vast majority of Clustree's potential buyers are located. We knew that if Sanu was to hold initial meetings or negotiation meetings with C-level from San Francisco-based companies such as LinkedIn, Salesforce, Ultimate Software, Workday, SuccessFactors, etc. he would be like a fish in water and Clustree would thus appear to be “closer” to those guys, looking like an international company (and not a remote French startup).

To increase our chances of having access to the right people at our targeted partners, we decided to hire an industry veteran, next to Torch Partners, in the person of Thomas Otter. Thomas is an ex Gartner analyst and the former VP of Product Management at SuccessFactors. He personally knows the members of every Executive Leadership Team at pretty much every HR software vendor in the world and he managed to get us meetings with those people in a matter of minutes.

Be prepared to negotiate with EVERYONE

In the last mile, founders should not necessarily expect to get help from other shareholders in the negotiation with the potential buyers. They should actually be ready to negotiate with everyone (potential buyers, VCs, co-founders, investment bankers, management team, business angels, etc.).

We think it is critical for the founders to centralize all negotiations with the buyers (to avoid any cacophony) and to understand that the interests of all stakeholders are not necessarily always aligned.

Let us take a few examples of things that can happen in the last weeks of an M&A deal and lead to serious “internal” negotiation.

• Let us pretend that you receive a $35m offer for your business (you own 10%). Payment is happening at closing and you are only required to do 3 months of consulting (for the post-merger integration), at $50k/month. And you also get a second offer that is $35m + $5m earn-out, 2 years from now, forcing you to stay on board in role you don't really like and to move to the US. There is a chance you would prefer the first offer while your VCs will prefer the second one for sure.
• Now, imagine that you receive an offer for $200m for your business, after raising a seed round at $10m pre-money and a Series C from a VC, that invested $30m on at $150m post-money. That means that everyone should be converting their preference shares into common shares to calculate deal proceeds (the Series C VC has 20% of the company and is making $40m with that exit valuation vs. getting its $30m back). But there is a 50% escrow for 6 months. Thus, if there is a problem with the IP and the buyer gets to retain the $100m escrow, the Series C VCs would receive less money (only $20m) than for a $100m sale (they would get their $30m back thanks to the liquidation preference) because they would have given up on their preference shares. Given that situation, they might ask the early-stage VCs and the founders to deal with the escrow and request to be excluded from it.
• Now, let’s say that, after the signature of the term sheet, some of your company’s key people (identified as such by the buyer) come to you and tell you that they are not happy with the package they are being offered to stay and that they would rather look for a job at another startup.

Those non-exhaustive examples show you that you need to be ready to negotiate with everyone.

With the buyer to get the best possible terms but also with your VCs so they accept the offer you prefer, and the deal terms you have been negotiating (including the escrow), with your advisors (accountants, bankers, lawyers, etc.) so they don’t get too greedy and capture too much of the proceeds with their fees, with your key people so they accept to stay onboard and agree on the packages you have been negotiating on their behalf, etc.

Remove potential deal breakers upfront

When we found ourselves in the early days of our M&A process, we decided to speak with a few friends who had sold their company recently. One of them told us that, during his due diligence process, some challenges on the security front (of which he had been aware for months), were identified by the buyer and became a deal breaker. The entire technical team had to work for 3 weeks, day and night, to fix this and enable the deal to go through.

You obviously don’t want to find yourself in such situation and take the chance to see the potential buyer pull off after term sheet signature, once you have given exclusivity to that potential partner (and rejected all the other candidates). It could mean the end of your company.

Use “inversion” (very good article on that kind of thinking process here: https://jamesclear.com/inversion) and imagine that you are at the end of a due diligence process and that it failed. Why was that? What were the reasons? What did they find that killed the deal?

Think about all your dirty secrets, all the stuff you never fixed, all the sensitive topics (outside of your product / technology and your financial performance which will obviously drive the interest of a buyer) and take care of those items before launching the M&A process (or at the very beginning of it).

Here is a non-exhaustive list of items: terrible Glassdoor comments, lawsuit with an important player from your industry, conflicts with former employees, exclusive partnerships, data privacy issues, IP ownership and/or infringement, litigation with suppliers or with a key customer, unusual accounting practices, etc.

Take the ownership of the data room, build it early, with great care and full transparency

It took Bénédicte 3 full days of work to build Clustree’s data room (although Clustree is a small company where she knows every legal, HR, tech, or commercial aspect of the business).

At the end of our M&A process, our data room contained more than 1,800 annotated and indexed documents and it had been accessed by over 30 employees from Cornerstone OnDemand.

Start preparing the data room as soon as you can. Get most of it ready at the beginning of the process and the rest in the final days of term sheet negotiation, when you know you will sign that term sheet. Things get extremely intense after term sheet signature. You don’t want to lose momentum for a week, appear like a non-organized or unstructured company or be underwater, gathering HR, legal, commercial contracts and finance items while you need to train your managers for all the due diligence work streams (tech, commercial, data, etc.).

“Another important advice is that you put EVERYTHING in the data room. You do not hide anything”.

You prepare, in advance, an answer (and some perspective, reinsurance, complementary materials and even a legal opinion if needed) for every ugly item in your data room but you don’t hide anything from the prospective buyer because 1) if you break the trust / transparency with the prospective buyer by hiding even one anecdotal element, the buyer may think there’s more than this to worry about and the deal is dead (that’s an advice from our lawyer, David-James Sebag) and 2) things that are not in the data room literally won’t exist for the buyer when you will be negotiating representations, warranties and exclusions to those warranties in the final transaction documentation.

Start your M&A process with 18 months of cash ahead of you

M&A processes do take time. It is true. 6 to 12 months. Because you need to prepare properly, reach out to (and entertain discussions with) several prospective buyers while everyone (including yourself) needs to keep operating a business; because you will need to travel, take the time to build trust and socialize and because there are a lot of people involved in the process on the buyer’s front (CEO, CFO, lawyers, bankers, corporate development department, legal team, product team, engineering team, HR team, communication team, etc.).

Between the first call with Cornerstone and the announcement of the deal, we have been in touch with approximately 50 of their employees.

In particular, you have a period of approximately 2-3 months between term sheet signature and the actual closing of the deal, during which you need to manage due diligence (very different from fundraising due diligence), drafting of legal documentation, and executing the transaction. You will ALWAYS underestimate the length and complexity of that period until you have experienced it.

You should not be in a position to find yourself 3 months away from running out of cash when you negotiate (or when you are in the due diligence phase) because it will impact your bargaining power. Being a few months away from running out of cash might also be a big concern to your employees and you might lose some of the best guys (which might be a reason why the potential buyer is interested in your company in the first place).

Ideally, you plan for a one-year process. And if, post due diligence, your potential buyer pulls off and the deal is cancelled, you need to still have 6 months to figure out something else. So that’s 18 months.

We did not have that in our case and the level of stress we faced in the last steps of the deal was unbearable.

Manage confidentiality internally

You absolutely need to keep the M&A process confidential for as long as you can (i.e. until your managers need to participate in follow-up meetings and due diligence meetings) and to involve as few people as possible.

You already have SO MUCH to manage that you cannot afford to be exposed to leaks and be dealing with worried customers, competitors spreading gossip about you and concerned employees (becoming less efficient or simply leaving). It is really tough not to be transparent from the start with to your key people and not to benefit from their help and support, but we believe this is a key success factor.

Equally important is the need to choose the right moment and the right way to communicate about the M&A process with those key people. They will be critical to the process and will likely have to stay with the buyer (for at least one year). So, after you crack the news, you need to be there for them, be fully transparent, answer their questions, train them, coach them, make them shine, etc.

They need to be onboard, fully motivated, with the right incentive in place.

Prepare for schizophrenic moments

You might receive an unsolicited offer out of the blue or proactively start an M&A process after a board decision. It does not really matter. The process will take time anyway and you will have to manage that process and your business, at the same time, although they might have diverging interests.

You will need to find the right balance between operating the business in a normal fashion and not spending cash on irrelevant (from a timing perspective) activities.

During the 6-12 months that your M&A process is going to last, your team will come to you to hire people a few days before you sign a term sheet or to pay €40k to attend a conference which is taking place 9 months from now, probably 4 months after your expected closing date...

Your business development team might also be looking at closing an exclusive partnership with a company while you negotiate a sale with their n°1 competitor.

Some of those things will happen for sure.

Be ready to carry it all by YOURSELF

They say that it is lonely to be an entrepreneur and that it takes resilience. It is even worse during an M&A process. You will need to absorb most of the stress yourself, do most of the things yourself, be a control freak and deal with hundreds of different actions from a very eclectic spectrum.

Why?

Absolutely no one cares even 10% as much as you do about making this a successful exit and has even 10% as much at stake as you.

• Your VCs do care about selling one of their portfolio companies, but they have invested in dozens of startups, are diversified and their track record and personal wealth will not be impacted like yours (in most cases).
• Your lawyers and bankers work on a success fee basis, but you are one of many deals for them. Actually, they are working on 3 or 4 other deals at the same time and their sense of urgency won’t be like yours (we were lucky that our lawyer and banker were personal connections who were OK to endure the extreme level of pressure they got from us ??).
• Your employees obviously do not have their track record, ego, personal wealth, career evolution, etc. at stake like yours and might be disappointed to end the journey or not want to join the acquirer. 

One word of conclusion: take good care of yourself after the closing

The few weeks following the sale of your business are weird and somehow tough for founders.

No one really speaks about this phenomenon (although we have discussed it with a few friends who sold their business as well and they did feel the same and warned us) probably because it is not politically correct and somehow hard to understand. After all, you have sold your business. That was your "dream". That is what you fought for during several months. You made a few millions in the process. You don't have any pressure anymore. What's not to like?

First of all, M&A is an extremely long process. A few weeks before the closing, you know it is likely to materialize but you need to stay focused. So, your satisfaction is quite “diffuse” when it actually happens. You are somehow proud. It is a relief. But it is not the burst of emotion related to a single moment. It is like winning a championship. Not like winning a finals. It is a marathon. Not a sprint.

Secondly, you are exhausted. Like never before. The level of control, stress, workload you had to face in the 3-4 months prior to the closing is EXTREME. So, once you are done, decompression can be violent.

Thirdly, you cannot really celebrate, and your life does not really change. You sell your company, but you do not really get the chance to take a break, throw a party, to reflect on your accomplishment and appreciate it. The day after the closing, you are likely to have to focus on the integration, on PR, on taking care of your employees who will all be worried. You wake up like every other day and you go see the same people, in the same office, to do the same things. You have a bit more money but no time to enjoy it, yet. You have been fighting extremely hard to succeed at something that seems to have no impact on your actual life.

Our recommendation is to take a 1 to 2 months break after selling your company, to regenerate and properly celebrate (buy a great present to your co-founders, travel with your family, indulge yourself, etc.) and think about what you have accomplished (because it goes very fast when you are actually experiencing it).

“After the closing, do something you could not have done without the sale of your company.”