ExpertCEO

We are a startup and have a shipping product with few early adopters and good strategic partners and resellers.

Our cap table is 100% owned by founders and management team. Balance sheet is also clean. Recently we have been working on our first institutional round of financing.

We starting discussions with a large VC firm (who has over $2bn in Management) and dialog progressed very positively. After they took few references, they have put forward a very different option for financing the business that we did not expect. They would like us to merge with one of their portfolio company who are very complimentary. Basically the deal will be Cash + Stock + Earnout. The details will be discussed in next meetings

The portfolio company claims to be profitable but their target customer is SMB as opposed to Mid-Size to Enterprise market where we are focused on. They feel that go to market strategy for Midsize to enterprise for any startup is very difficult, risky and enterprise customers do not like to take risks with startups, although we have seen many startups succeeding with Midsize to enterprise customer acquisitions.

We also have another firm who are genuinely interested in funding us and are in early due-diligence phase. They are moving at their pace. Partner has given us permission to use his name with other funds we are meeting.

Founders and team are interested in building our own organization. However looking at the tough funding transactions and given the fact that we dont have any termsheets from someone else, it is proving to be a tough decision

I would like to seek advice from fellow expert CEO members

Thanks

One important element you've omitted is your company's ability to continue to operate without VC funding or the merger. Is this something you must do soon to survive?

With the merger option, if you end up with a small amount of cash, mostly stock and no control, you're really rolling the dice. Private-to-private mergers with VCs on the other side can be very complex in many ways.

My sense is that the key distribution strategies for SMB companies differ markedly from mid-size and enterprise companies (inside sales and distributors versus more direct sales). This makes the compatibility of the two companies an issue, ignoring the product and technology compatibilities.

While this is a decision you've got to make yourselves, if you have the luxury of time and runway, IMHO, you should really pursue the other funding options or conserve your cash and stay the course. If you must go the merger route, get a really good attorney. There will be a myriad of issues that could impact you and your team financially both in the short term and the long term.

You have both an opportunity and a dilemma. Please keep in mind that the VC does and should have a higher loyalty to maximizing the value of one of their existing portfolio companies, your proposed merger partner, rather than creating primary value for you. Under best circumstances this can be a win-win, but proceed with caution and do your own due diligence.

Two items that you may want to understand is that the long-term survivability of a merged management team is not high. Secondly, the stock you receive in the combined company will be common shares or options. Assuming the new company will need additional rounds of growth financing in the future, your percentage of the company will be progressively diluted and may ultimately have little value.

Only you and your management team can determine if redefining your market from mid sized enterprises to SME's makes sense. Keep an open mind, do your home work, but remember the VC's primary objective is to increase the value of their own portfolio company not your's. An alternative proof of concept may be to partner with your prospective merger company for joint sales into the SME market. Dating before marriage will either confirm or raise questions about the benefits of a full merger.

As others have indicated, there's a lot of risk involved in a startup merger situation where the bulk of your compensation is tied to the performance of the merged entity rather than cash. Mergers are often a distraction for the management team and employees, founder/team dilution is likely to be significant, and you might inherit a less clear stock ownership situation due to preferences or other factors.

But the right thing to do depends a lot on the situation of your company, the state of the other startup and it's leadership team, and the terms of the proposed deal. If a pre-IPO Google offered to acquire my company, I would be a lot more inclined to accept significant stock compensation that if it were an earlier stage startup with a less orbital future.

I wonder a little what the motivation of the VC is to merge the two companies, rather than fund them both and then encourage them to partner? What's the market force the VC is solving for that justifies a merger?

The recent discussion on this topic here adds some color:
www.quora.com/Why-are-there-seemingly-so...ers-between-startups

I agree with the general caveats posted by others. If you have a clear business model and the VC backed company's model does not mesh with yours, then you have a very real problem. Go to market strategies are critical for a startup and having a mixed model will probably not work.

Further, as mentioned, valuation is a critical issue here and commitments on resource injection for growth (cash, people, etc.) will make or break your situation.

You need an expert to help your team out, and that is not likely to be an attorney or accountant.

Good luck. Feel free to contact me directly on this complex situation.

Thanks for the excellent advice.

To give you a VC perspective... Private VC-funded company mergers are extremely difficult to execute (from a deal perspective) and carry through (from an operational perspective.)

From the other comments you have received, it is clear that we're all advising that you tread with extreme caution. Ultimately, the VC will be looking for the best interest of his current portfolio company, and hence will be negotiating on its behalf. So you need to make sure you are getting the best deal you can get.

The problem with figuring out what's the best deal is that most of the terms are tied to the current value/cap table of the VC's company and the hyped-up expectations of the VC's company's prospects/valuation.

My recommendation would be that you actively pursue other VC options, and get yourself at least one other VC offer (to invest directly in the company). This would give you a market-based valuation of your company to negotiate the merger with.

Better yet, don't raise any money and stay pure...

Good luck...

Firas Raouf
OpenView Venture Partners
bit.ly/aIWlOQ