Getting key investors onboard with your exit

"This is a terrible deal. There is no way I will sell on these terms"

We had just signed the LOI with our buyer.

I was still basking in the relief at having passed the first major milestone in the deal. And I was really pleased with the terms we had agreed. 

I was happy that the investors were getting a great deal. Most were getting a 10x return on their investment after a few years.

On the night that we signed the LOI, I sent an email to the group of 50 investors, summarising the key terms of the deal and the rationale for exploring a sale of the business. 

I expected pats on the back and congratulations. This was a happy conclusion to a journey with plenty of ups and downs.

Most investors replied, and nearly all were pleased and really supportive.

But a couple were very unhappy, and they wanted their dissent heard. I was scared that would cause a domino effect, which could threaten the whole deal.

Remember – if your buyer wants to take 100% ownership, you need all of your shareholders to agree to the deal (unless a drag-along right can save you... see below).

There is real skill to building support from your investor base, to make sure that you get everyone across the line without hiccups.

Let’s explore...

Understanding incentives

Differing incentives is the root cause of the conflict here.

Founders and investors often have very different motivations when it comes to an exit.

Every case is slightly different, but most commonly... Founders tend to be more inclined to sell sooner and at a lower valuation, whereas investors want to 'shoot for the moon' and push for a bigger exit later.

As a founder, you might have most (or nearly all) of your wealth concentrated in the business. That’s a risky financial position. So you want to take money off the table.

And you have poured your heart into the business from the start — you (and your family) might just be tired and ready to move on. 

And if you have a larger ownership stake, the exit can be still be life-changing at a lower valuation.

For investors, you are likely just a small part of a diversified portfolio.

The maths of venture capital investing means that many deals fail, so the winners need to deliver huge returns to offset the losses. So they want you to ‘go long’, take more risk and roll the dice for the chance of a much bigger exit later. So you have conflicting objectives.

In my deal, the investor who sent me that note felt exactly this. He had lots of his investments shut down during Covid, and he had earmarked us for a mega (50x) return to bring his whole portfolio back into the black. So for him, 10x felt like a big disappointment.

That’s common — their views are usually more reflective of the performance of their other investments than yours!

What control have you given away?

You should understand how any contractual clauses might set who needs to approve a sale of the company.

You might have agreed to these a long time ago when trying to get some funding over the line, so it's worth re-visiting them.

A common one is to give investors the power to approve major decisions, including a sale. That can happen through a Board vote (where they may have a voting majority) or through a direct right need for "Investor Approval".

Make sure you understand these clauses before you start negotiating with a buyer and talking to shareholders, and they will impact your strategy. Your buyer will ask you this fairly early in the conversations too.

Can a drag-along save you?

Drag-along rights can be life savers if you have dissenting shareholders who won’t agree to sell.

This forces minority shareholders to sell their shares, if a percentage of other shareholders have agreed to a sale.

It's designed to 'mop up' any small dissenters, and help a buyer get to 100% ownership without minority shareholders blocking it. They get 'dragged along' even though they don't want to sell.

In the UK, drag along rights typically kick in once holders of more than 80% or 90% of shares want to sell. To get your deal over the line, you need to pass this threshold... then the dissenters are dealt with through this mechanism.

They are included in standard form articles of association, so are quite standard.

Now, let’s look at how to manage investors to get them over the line. There are different approaches for your key (cornerstone) investors versus the long tail of minority holders.

Key investors

If have a cornerstone investors (with 10-15%+ ownership each), it's really critical that you get them on side.

If the buyer wants to own 100% of the company, you need these investors to sell. They have large shareholdings, and smaller investors will tend to follow their lead, so you are unlikely to reach your drag-along threshold without their support.

How you communicate, and the timing, are critical.

You should communicate early. They don’t want to get news out of the blue and feel like they haven't been consulted.

You should treat them in the same was as you would your co-founder. That means getting them on board early in the process.

What are the triggers to start the conversation?

When you feel you might have a potential buyer interested, explain that you are considering a deal and ask for their views. They may have strong opinions on valuation or deal, which you want to incorporate into the conversation with the buyer.

If they are supportive, that's great. If there's really strong pushback, you need to know that early too.

What if you don't get have a buyer interested, but are keen to start the process of exploring a sale? That's also a great trigger to start the conversation with your key investors.

If have an active Board process, with they key investors attending, this is usually the best forum to have this discussion. Put it in on the agenda, and prepare supporting materials to explain your thinking and pitch the deal to them. Make sure you are clear that you think a sale is the right decision, and come armed with evidence on potential buyers, valuations and so forth.

What if they strongly push back? You will need to explain why they should accept the deal:

• This is the right time for the business to sell. Perhaps there are difficult times ahead with competition or regulation, so you are now in a sweet spot to sell now. Wait, and you might not get a better valuation.
• This is a generous valuation (if you have one at this point), with strong and willing buyer and lots of competition in the deal.
• This is the right time for you to sell. Maybe you’re burnt out, and don’t have the energy to push for another 5 years.

The principles are the same as we break down in The Time is Right: When to sell your company.

Hopefully this gets them over the line. 

If the deal is moving ahead, you should consider setting up a regular call with advisors and investors to keep them updated and get their feedback.

These investors will have seen many deals (likely many more than you), and tend to be well connected so can help find buyers. Deals can be lonely, so having some people to support and guide you can be really helpful. So use them!

Minority investors

Depending on your funding history, you may have a long list of smaller investors who in aggregate hold a large chunk of the total shares.

In my deal, with had over 50 minority investors in total who held almost half of the shares. Individually they were small fish, but in aggregate we couldn’t do the deal without their support.

As they each have smaller stakes, they are usually more easy going than a majority investor who might have multiple millions on the line. But you can’t be complacent, and you still have to manage them carefully.

You tend to communicate with them much later in the deal. Usually the first time you mention the deal will be once you have signed the Letter of Intent with a buyer and gone into a period of exclusive negotiations.

Then you share the key terms, and your rationale for doing the deal.

Why hold back? You need to manage confidentiality, and it’s a tremendous amount of work to get advice and input from too many people whilst the terms of the deal are still unclear.

But they still need to feel like their opinions matter and they voices are heard...

In my note, I set out the terms of the offer, the background to the buyer and why we think the deal is the right option for them as minority shareholders.

I also offered to make myself available for 1 on 1 calls to run through their questions or concerns personally. Only a handful took me up on this, but I think everyone appreciated the offer.

There are a couple of profiles of minority investors to look out for, who merit special attention.

The Leaders

These are the investors that others turn to for advice.

They are often the angel investors who pulled together other investors from their contacts, or acted as the lead within a mini-syndicate.

You will see lots of herd mentality, where the long tail of smaller investors just defer to these people for advice. If they support the deal, the others will usually fall into line without much fuss.

So you should communicate with these leaders as you would the key investors. Tell them early and bring them along through the discussions, and agree with them how and when they should pass information to the wider group.

The Troublemakers

You might have one or two investors who have been difficult since they joined the cap table. Those who tend to grumble even when you send positive updates!

These are the most likely to make a fuss when you are ready to sell. They might take extra effort to get over the line. Consider reaching out personally before you send information out by email, and make sure they feel heard to minimise their impact on other shareholders.

The last thing you want is them to spread concern and start a domino!