Withum Sounding Board

Podcast: Life Cycle of a Technology Company – Exit Strategy

Podcast: Life Cycle of a Technology Company: Episode 3

Jim Bourke, Withum Partner and Technology Services Group Practice Leader and Chris DeMayo, Partner and Startup and Emerging Growth Team Leader, discuss how to prepare your technology company for an exit strategy.

  • Emerging Growth Companies
  • Exit Strategy Preparation

<strong>This podcast was transcribed through a third-party application. Please disregard any misrepresentations.</strong>

Speaker 1: Thank you for joining us for this segment Withum Sounding Board, a practical audio based information for today’s on the go professional production of Withum Smith and Brown PC.

Speaker 2: I am Jim Bourke practice leader of the technology nich here at Withum Smith and Brown and I’m here with Chris DeMayo team leader of the startup and emerging growth technology group within the technology niche here at Withum. Third part of our series today we’re dealing with getting ready for that exit plan. The things that you need to do to prepare your technology company or realizing that event and that event could mean so many different things. That usually means exit of the existing CEO, the existing entrepreneur to either emerge or up going public. Chris, you and I are asked very often to help our clients through that process help get them ready. So let’s think about that. Let’s talk about it from an accounting perspective. Some of them are small tech companies. All we’re doing, we’re doing tax returns, we’re doing the bare bones minimum compliance stuff that they need to survive.

Speaker 2: Then again, they may get the friends and family round in. They may get that. Let’s say the angel round in and maybe the angel asked for compiled financial statements, may be reviewed financial statements. But you know, getting ready for that big exit, we are usually asked to go in and prepare audited financial statements. So tell me about the importance of the audited financial statements on getting a company ready for that event or that exit. Yeah, absolutely. And you know, again, it’s a similar timeframe that CFO where you’ve raised a really a meaningful a round or meaningful B round and, and you now have the capital to really push into a different place in your life cycle of being a little bit more institutionalized and ready whenever you have an exit. You know, there’s two very fundamentally basic exits. It is either a private exit or somebody comes in and acquires your company or it’s an IPO.

Speaker 2: And in either case you have to prepare for that transaction. And it’s a very intense process. And what happens is an outside company, but outside acquirer is going to hire professionals to do due diligence on your company. So they’re going to hire an accounting firm to come in. And most simple way by I like to put is they’re going to poke you, they’re going to continue to poke the company, they’re going to see how the company exists, how prepared the company is, if it has any potential risks in acquisition. And some of those risks are strategic and some of them are just mechanical, which is, you know, have you been following sales tax returns? Have you been following corporate tax terms. Our client’s stuff are the financials that you have presented to us accurate. And that one key area is where the audited financial statement comes in as your service provider.

Speaker 2: So for example, hypothetic Withum Smith and Brown, on an annual basis, we could audit your financials. And what that basically means is we go through the financials ourselves and we test them and we determine whether or not they’re accurate. Are you recognizing revenue accurately? Are you recognizing your equity transactions accurately? Are the things that you say in your financials. True and that is preparation of an audited financial and generally from an accounting standpoint, an audited financial statement is the starting point of where diligence happens. That is the outside company that’s acquiring you or the IPO. That’s the starting point of where they’re going to look at your financial stuff to determine the viability of the company. Think about that year. I agree with you. So that’s the starting point where diligence happens because generally your financial statements are the starting point in determining the purchase price of a company.

Speaker 2: You know, as a rule of thumb, many companies are going either for a multiple of revenue, a multiple of bottom line. There’s some metric that is financially driven that is driving purchase price. The reason why we suggest that if you’re contemplating an event and exit plan, a merger or something like that, that you look for audited financial statements is because when you go through that negotiation process in your mind, say you’re concealing your company for 20 million, 30 million, 40 million, 50 million, well that’s in your mind. It was based upon some metrics driven from your financials. I will tell you the last thing that you want to happen is 30 60 90 days after a sale. You go back and let’s say a company hires a firm like us. We go in, it’s going to be our job to poke holes in the financial statements. I’m going to try, if I’m representing a buyer, I’m going to try to poke holes in the seller’s financial statements to try to say, you know what?

Speaker 2: Maybe revenue recognition issues exist. Maybe revenues were overstated. If revenues were overstated in the financial statements, that gives us a basis for lowering that purchase price. Okay? 99% of the time there are whole backs in sales of technology companies. I always tell my tech clients, if you’re going to sell your company, button your financial statements up, be happy with your walking away with on the day of sale because all the rest is gravy on it because again, they’re going to hire firms like us to come in and try to poke holes in those financials. So again, two audited financial statements. They’re are the highest level financial statements that a CPA firm can provide, right? The lowest level compilation, middle is review, highest is audit. So again, can’t emphasize more the importance of audited financial statements in preparing for that exit plan. And I think when you broaden it out our niche within our firm, we talk a lot about the concept of transaction readiness and even goes beyond audits, which is are you ready to sell your company?

Speaker 2: And part of it is our audited financial statements are in place and our numbers are good. The other part of it is a, from a tax perspective, have we been doing the things that we’re supposed to do? So where I see a lot of deals fall apart or I see a lot of tension and deals and changes in purchase price and increases in hold backs or things like sales tax. And you know, companies grow really quickly and you know, I’ve seen companies go from pre-revenue to $10 million in revenue in 12 months. I mean, I’ve seen that happen and if throughout that process going a thousand miles an hour and you’re not thinking about the fundamentals and the things that you need to be concerned about, the risks that are out there, like sales tax, when you go to exit this company, that diligence team that comes in and they’re poking at you, right?

Speaker 2: They’re going to find that low hanging fruit and all of a sudden you have a big issue. Hey, we have been collecting sales tax. We owe $1 million to the state. You’re talking about a massive purchase price adjustment that may make the economics of your deal no longer viable. Yeah, absolutely. So Lonnie, yourself with the right professionals to give you the best advice, the right advice, those individuals that know the marketplace, real cure reticle, you heard throughout the entire lifecycle of a technology company from birth and entity selection, all the way through realizing the event. Let’s talk a little bit about as we sort of get towards the end of the life cycle. I’m an entrepreneur. I’m a CEO. I started this tech company. I worked with my professional. I realized my exit. I am so freaking happy. I made a ton of money. I got a lot of money parked in the bank.

Speaker 2: So Chris, I don’t need a professional anymore, right? I don’t need to align myself with a, let’s say professional at Withum Smith and Brown that knows tech space, right? I, I couldn’t disagree anymore. It’s funny when you exit, it’s not the end. It’s simply a new beginning. And when I think about our entrepreneurs, none of them let the grass grow under their feet very long and you know, they exit and none of them seem to be saying, Hey, I’m 30 years old and I’m just going to go fishing for the next, you know, 40 years of my life. They want to start something new. They want to be creative. They’re inventors. So I think what’s really important is spending some time with your professionals and thinking about what your future is, what you want to do, and then how to deploy maybe some of the proceeds that you got from that exit in a logical way, in, in a smart way to be able to fund the next thing.

Speaker 2: I tell you some of the most satisfying meetings had I have professionally or when I sit down and totally relaxed with some of our entrepreneurs that have realized their exit plans. We talk about what’s going on in the marketplace. We talk about what’s hot. We talk about those verticals that we see, whether it’s ad tech, health, tech, FinTech, any of those hot verticals that we see out there in the marketplace today. They’re looking to invest. They want nothing more than to do it all over again. It’s like this addiction they have. So many of our entrepreneurs are addicted. They’re addicted to that exit plan. They’re were addicted to that growth, are addicted to building something that they can take to the next level and sell for something. It’s huge. So, I mean, some of the best meetings we have, some of the best relationships that we have today are entrepreneurs that we introduced into newly formed technology companies.

Speaker 2: Yeah. I think what’s really fun about those types of entrepreneurs is they start so many of their sentences with what if you could write, I mean that’s the way they view the world. The world is a place where you can invent and change and make things better. And what I think is kind of fun about that chapter of an entrepreneur’s life is many times they change their place in that life. So the first time through, they were the founder, they were bootstrapping and they were the one building. And now the second time through, they want to be the investor. They want to find that next founder and they want to find that next idea and they want to fuel it and then buys it. So think about that. That is so valuable. So let’s think about this. If you’re listening to this, you’re an entrepreneur, you’ve got a startup company, and you’re looking, who is that ideal investor?

Speaker 2: There’s no, in my opinion, there is no better investor than an entrepreneur that has previously realized his exit plan. They realize the exit plan, they’ve been down the road before you, they hit all the issues with the sources of capital, friends and family being bootstrapped, the angel guys, the, the a rounds, the B rounds, dealing with all the complexity that comes about. Uh, when you’re, you’re preparing for an exit plan, having someone like that by your side as an investor, to me that’s priceless. That’s sometimes that value they bring to the table is more valuable than the capital that they bring to the table. Absolutely. You know, we’d have a lot of discussions with our clients when they’re raising money about, Hey, do you just want money or do you want strategic money? There’s a real difference when you’re going out and thinking about who you want to take money from.

Speaker 2: Go find the guys who’ve been through it. Go find the people that have, that have exited, that have gone through all the pieces of the puzzle that you’ve gone through. Cause that money to me is substantially more valuable than somebody who’s just willing to write a big check. Absolutely. So you heard us go through the entire life cycle of a technology company from startup to exit dealing with the entrepreneur. And really the recurring theme is surrounding yourselves with the right professionals, whether they’re accountants, whether it’s attorneys, and also keeping those same relationships all along Chris. So here at Withum we tried to provide a lot of free content to our technology companies, a lot of the startups, a lot of those that may not have the resource internally. We have a whole white paper concept that you were instrumental in starting. We’re putting a lot of those white papers out there on our website.

Speaker 2: So if you haven’t visited our website at witum.com and hit up our technology or startup sections on that website, come back to the website. Again, tremendous amount of content. Chris, you want to just share some of those white papers that are good subject matters for a lot of our tech clients? Yeah, absolutely. And you know, we like to think of ourselves as fully ingrained in the technology community. And I think when you are ingrained in the community like that, one thing you have to recognize is that it’s a giving and a sharing community, right? So we don’t, we don’t want to hold back information. We want to help people regardless of whether or not they’re our clients. If we have stuff that we can send out to you that might help you, that might give you some direction, we’d love to share it. And in our site we cover the gamut of topics and whether it’s, you know, on an accounting issue, how to account for an issue, a beneficial conversion feature, a warrant, revenue recognition, changes in the industry.

Speaker 2: You know, we have different white papers that are out there. We have questions all the time on, Hey, do I capitalize software, do I not? We send out really good plain English explanations. The things you need to consider. And now on the tax side, Hey, should I make an 83 B election? How does an incentive stock option work? Whether it’s for the guy who’s getting it or the employer that’s giving it all of those day to day questions. I call them the constantly recurring nonrecurring issues. We’d like to send content out there to share to the group to share the industry so you can get some plain English answers and then hopefully you either understand the answer or you might ask us more questions and we’re always happy to follow up and answer those. So that’s great content and if you want to stay abreast of the issues, we come across issues all the time and what one of the things that we do, we try to blast those important issues out to our clients. So if you’ve not subscribed to our tech group newsletter, I encourage you to do so. You can hit up on our website and request a subscription to that newsletter, or if you have any questions regarding the whole tech sector you want to talk to Chris or I, you can reach me and I’m Jim Bourke at [email protected] and you can reach Chris at [email protected] Thank you for your time.

Speaker 1: You’ve been listening to Withum Sounding Board, practical audio based information for today’s on the go professional. How can Withum help put you in a Position of Strength. Contact us with your feedback or suggestions for future podcast topics. Visit withumold21.wpengine.com for additional information. Send an email to [email protected] or follow us on Facebook, Instagram, or Twitter @withumCPA, thank you for listening.