Why would an industry giant acquire your startup and how much will they pay?

My previous article summarized the exit — when investors, founders, and employees can turn their shares in your startup into cold, hard cash.

Since investors are investing not to donate to your company but to make money, in the end the only thing we actually care about is the end — the exit. But we care about some exits more than others because some types provide better returns.

For venture-backed startups, there are 3 successful exits:

  • IPO
  • Acquisition
  • Private Equity

The IPO is the best exit since the valuations of public companies are highest. But outside of pharma and fusion energy, a listing on Nasdaq or NYSE generally requires a company to be hurtling towards if not already leaving the $1B ARR milestone far behind.

If you’re a leading rocket launch company, an EV manufacturer, or a developer of GenAI, an IPO is the clear path to the highest value exit. If you’re a test tool maker or AI for bowling, an IPO is unlikely. Though IPOs make big headlines, there are only a handful each year.

At the other extreme is a private equity exit. PE will buy up any company generating healthy profits. It’s the usual exit for a smaller, bootstrapped business with consistent earning. That rarely means venture-backed startups, and exits are a small multiple of operating profits, leading to a low-value exit. It’s not the exit venture investors hanker for when they write you a check, but one we too-often have to settle for when the company’s growth stalls. Stay tuned for full details of PE exits in my next article.

The usual exit for venture-backed startups, the end goal of 95% of startups, is an acquisition by a strategic acquirer, usually an industry giant.

Why An Industry Giant?

If your valuation at pre-seed is $10M, you need to reach an exit in the $500M — $1B range to be a successful venture investment. At a $20M valuation, that’s $1B — $2B exit.

Who has a billion dollars on hand to acquire a startup? Not me. It’s usually one of the companies in the S&P 500. Not only do most of them have healthy bank balances, but public companies have tradeable stock that’s just as good as cash.

While there are exceptions, a successful exit is almost always an acquisition by a large, public company.

Why Does a Giant Want You?

Why will giant Acme Corp snap up tiny Zstartup? There can be many reasons. In fact, each strategic acquirer will have unique strategic requirements and constraints, so every deal is unique. But we can put most of the reasons into the following general buckets:

  • Expand product — this is usually the best, highest value acquisition. You’re stealing market share. You have features or capabilities that customers need that Acme don’t have and can’t add easily. They have no choice but to acquire your startup or risk fading into irrelevance.
  • Eliminate competitor — similar to expanding product, but with a twist. If you’re stealing market share or pushing them on pricing, rather than combining the products, it might be cheaper and easier for them to buy up the new competitor and shut them down. This doesn’t happen nearly as often as people think, but it does happen.
  • Enter new market — Acme Corp sells purified water. Now they want to expand upstream into water purification. The fastest and easiest way to do it is to buy up a company in the space.
  • Take over brand — you’re the leader in the exciting new market of AI-enabled bubbly water. Coca-cola wants to own the space. They could make it themselves, but you’ve already established a well-known brand name, so it’s easiest for them to buy your business than trying to start their own from scratch.
  • Expand customer base — BetaCo is strong in Europe. You’re strong in the US. For the right price, it makes more sense to buy your business than to try to expand by themselves.
  • Access to technology — GammaMega is the leader in water purification, but you own the patents for a new and more efficient technology. They might buy the company to get their hands on your technology. Most founders expect that this is the most common acquisition, but it’s surprisingly rare. Big companies don’t care about patents until you sue them and win, and think that your team of 5 recent college grads is no match for their 5000 industry expert scientists.
  • Acquire-hire — they want to develop a new AI-based product but don’t have a clue how to do it. Meanwhile, you have a couple dozen AI specialists and data scientists working on a failing product. Rather than trying to hire their own team, they can grab yours. Valuation will be based on the number of employees they want and usually only makes sense when the startup’s products and customer base have little value as an alternative to shut down.

In some cases, the answer will be a combination of these reasons.

Get that Auction Started!

The exit investors are hoping for, the ones that make the headlines, are when an industry giant pays billions for a startup.

That usually means two things: (1) you’re stealing market share from a giant and (2) there’s multiple potential acquirers looking to get their hands on the business.

Nobody wants to pay more than they have to. Your job as startup CEO is to make them have to pay more than they want.

An initial offer to acquire the business will usually make business sense for them. If you’re doing $100M in revenue and losing money at it, they might do an analysis that says they can increase revenues to $200M and generate $40M in profits. So they’ll offer $150M.

Since the VCs have valued the business at $1B, you’ll laugh at their offer (until the following year when VCs stop funding you and you run out of cash and are desperate for that $150, which is now reduced to $50M.)

If you’re growing quickly and stealing their market share, they might come back with a slightly higher offer like $200M to protect their existing multi-billion dollar cash cow. Meanwhile you reach out to their big competitor and offer them a way to grab market leadership. For a price. A steep price.

Suddenly there’s a furious auction between two giants with more cash than brains, fighting over your startup that unlocks leadership of a critical market for them. Now the price starts climbing into the stratosphere.

Checking out the Comps

How much will a strategic acquirer pay? The answer, of course, is it depends. It depends on the acquirer, depends on the type of deal, depends on the industry, depends on how quickly you’re growing, how big the potential market is, and how desperate they are.

So it seems a bit absurd for investors to ask even before you’ve finished developing the product how much the company will be acquired for. But they will. I guarantee it.

Investors need to know there are industry giants that care about this problem. Industry giants that make acquisitions and aren’t afraid to pay big bucks. If your startup is an obvious acquisition target for Meta, Google, or Amazon, that’s guaranteed to get investors excited.

A decent rule of thumb for a successful strategic exit is 5x revenues. But you need to do better than that. Create a spreadsheet of startups similar to yours that have been acquired and find out the acquirers and multiples. The ranges will be wide, but patterns should emerge. Show investors the range and the mean value, while highlight the big successes.

The challenge is that both acquisition prices and startup revenues are rarely disclosed except for the biggest deals. So finding the acquisition multiples can take detective work. Often they will have to be estimated or guessed at based on anecdotal discussions.

For bigger industries, the investment banks often publish reports listing recent M&A activity. Reach out to the analysts who wrote the reports as they might be able to discreetly mention some additional non-public information.

The best way I find to get acquisition multiples is to talk to other founders, especially ones who’ve been through previous exits. They know the numbers and though they’re supposed to be confidential, you can usually get enough partial information to piece together some reasonable guesses.

The $100M Milestone for Strategic Acquisitions

Though there can be exceptions, S&P 500 giants rarely buy startups with revenues under $100M. It just doesn’t make sense for them.

An acquisition will cost the company millions in legal and M&A fees. It will consume valuable time of top executives. It will have to go through multiple layers of approvals, all the way to the board. It’s not worth the hassle to buy up a budding startup with only $10M in revenues, even if it’s a tenth of the cost they’ll have to pay when the startup reaches $100M.

Just an important, giants don’t want to build a startup. They want to buy a finished product that they can sell immediately to their big customers. A $10M startup is still an experiment. It’s still iterating. It’s still developing the core feature set. It’s still dependent on the founders and a few key employees who are likely to leave after a year or two.

So $100M in revenues is widely considered the key milestone. Startups who haven’t crossed that hurdle are considered too immature. They may watch you and reach out to you for periodic updates, but are unlikely to bite. Once you reach that $100M mark, then you become a legitimate, high-value acquisition target. This is why every venture-backed business plan has to be about reaching $100M and getting acquired by an industry giant.

Pitfalls Of a Strategic Acquisition

Our goal as startup founders is to reach an acquisition. And yet, depending on your definitions of failure and success, somewhere around 75% of corporate acquisitions fail. (HBR estimates 70–90% failure rate in this report.)

A few companies know how to do acquisitions and integration well. The vast majority are a disaster.

Strategic acquisitions are highly dependent on the goals and incentives of the acquirer’s executive team. But big corporations are constantly changing their goals and shuffling executives. Integrating a small (by industry giant standards) startup is a far lower priority than the daily feeding and care of the company’s cash cows.

To provide incentives for the employees to stay, a significant fraction of the deal value may be structured as earnouts. These can be as simple as a requirement to remain at the acquirer for 2 or 3 years to earn large yearly bonuses or vest shares. Or can be paid upon reaching milestones such as hitting product release requirements or revenue targets.

Especially in smaller, earlier-stage deals, earnouts might account for all the payout to the founders and executive team. And that leads to obvious problems.

Can you meet those goals when the resources that you need — developers and sales team — are no longer under your control? Promises sound great during the honeymoon phase when both sides are dedicated to making the acquisition work.

But what happens when the company changes strategy? Or the executive championing your product within the company leaves? Or it becomes obvious that you won’t hit those optimistic goals?

Then the finance team comes looking for ways to save money. Cuts to staff. Cuts to marketing. Then the legal team might come looking for ways to grab amounts being held in escrow or even clawing back stock or bonuses already issued.

Did you exaggerate any of those hundreds of reps and certs you blindly signed in the massive stack of M&A contracts? Were there risk factors or skeletons in the closet you didn’t bother to document? If so, you might get a call from the legal department. Be careful to avoid anything, no matter how small, that might later be called a misrepresentation.

But the biggest problem is usually the sheer frustration of working for a big company. For the past ten years, the founders made their own decisions. Suddenly now they report to a department head who reports to a division VP, who reports to a senior executive VP, who reports to the CEO, who has a lot more important things on her plate.

Decisions that used to be made in minutes now require months of meetings. Where your product and your customers used to be of paramount importance, now those are of negligible priority to the company. You feel like you’re in handcuffs. You never learned to play the game of big company politics, have no support infrastructure inside the organization that’s probably located in a different state, and may even be resented by the corporate warriors you report to who know how much you were paid.

So the team gradually slips away to join new startups. And at some point so do you. If you’ve done the deal well, you can retire to become a novelist like me or use the money from this exit to fund your next startup.