What are the Benefits of a Startup Getting Acquired vs. IPO?

For many startups, getting acquired is the ultimate goal. However, many startup founders refuse to sell their venture and ultimately go public with their company. If the company is not acquired, it is rare that a startup remains privately owned well into the maturity stage. The reason regards the growth model for a startup venture.

Below we discuss the growth model for startup. Then we compare the benefits of being acquired to those of taking the company through an initial public offering.

Startup Growth Model

The founders begin the company with the objective of growing the company as quickly as possible. To maximize growth, the founders generally seek capital investment from third parties, such as friends and family, angel investors, and venture capitalists. The idea is that any growth represents continued or future revenue. As such, the company is often valued at some multiple of its revenue (or other growth metric, such as number of customers or users). 

In this scenario, the company will generally use all operational revenue to grow, as well as the capital acquired from investors. The rate at which the company uses capital is known as the “burn rate”, as the company is burning capital to generate growth. The company will ultimately incur extensive losses throughout this period. This means that starting on this path generally means going through multiple rounds of funding, as the company uses up all its capital and needs additional funds to continue growth. 

The investors seek a return on their investment within 3-5 years by either selling their interests in the startup to subsequent investors or sending the company through a public offering. In either case, the investors seek a return on investment based upon the capital gain of their stock interest during that period.

How Does Getting Acquired Work?

Getting acquired by another company is a form of merger or acquisition. The acquiring company can either purchase all of the assets of the startup or purchase all of the company’s equity. Given the nature of the startup model, it is far more common for the acquirer to purchase the company as a going concern. The exact process for purchasing all of the company’s stock can vary considerably. 

The primary reason is based upon tax considerations and avoidance planning. The acquirer may hold the startup as a separate subsidiary. It may dissolve the startup and absorb the operations into the acquiring company. Or, it may form a third company and transfer stock ownership of both companies into this new entity.

How Does an IPO Work?

An initial public offering is a fairly complicated process. It requires the filing of a registration statement with the Securities and Exchange Commission, as well as the state securities regulating body. Completing the registration statement is very onerous. It requires extensive disclosures about company operations, finances, etc. Once the registration statement is accepted, the company generally works with an underwriting to sell shares to the public. 

The company will authorize these new shares for distributions. Also, the founders will have the options to sell some of their shares as part of the offering. The underwriters create interest in purchasing the stock among investors (generally institutional investors). The underwriter will be paid in cash or receive a percentage of stock at a discount in exchange for their services. Once the stock is sold to investors, the company now has capital to continue growth or use for maintaining operations.

Benefits of the IPO and Acquisition

The IPO and the Acquisition have distinct benefits. Some of the primary benefits of being acquired are as follows:

Ease of Transaction

Getting acquires is a privately negotiated arrangement. This generally means that it is far easier to negotiate this transaction than to go through the highly regulated process of of a public offering.

Exiting the Company

Many founders seek to exit the company once the company is acquired. That is, they have no interest in going from company leader to serving as an employee of the acquiring company. They prefer to take their proceeds and pursue other professional avenues. Going through an IPO generally means that the company executives stay in place. It could mean, however, that they are now answering to a new set of directors who are elected by public shareholders.

Money to Existing Shareholders

Generally, a company being acquired will be purchased at a premium. That is, the company will be value based upon some multiple of its revenue. Companies sold in an IPO are generally value more conservatively based upon either free cash flow or profits. As such, it is possible for the existing shareholders to make more money on the deal in an acquisition.

Some of the primary benefits associated with going through an IPO are:

Keeping Your Job

When a company goes through an IPO, the existing management of the company generally stays in place. It is possible that shareholders will elect a new board that replaces key management personnel. This is unlikely when the company reserves enough ownership interest in the existing shareholders to preserve the current management structure.

Liquidity

Going through a public offering allows the company to later issue additional shares for sale on the public market. While this may also be true when the acquiring company is a public company, it is far easier to access investor capital directly for the business when the company is public.

These are just the primary benefits associated with an IPO and acquisition.