In earlier days, entrepreneurs dreamed of founding an innovative start-up and building it into a big company. After many years of solid sales and profits, the company might be acquired, with founders and investors earning a capital gain.
But in today’s fast-evolving technology marketplace, growing a small start-up into a big company may not be the best strategy. An increasing number of promising start-ups are exiting early at very attractive valuations – sometimes before a single sale has been made.
An excellent example is Pacinian Corp., which began in 2007 and sold in 2012 to Synaptics, before ever releasing its first product. Here’s how the pre-revenue start-up was sold for $30 million, thanks to a modern strategy and some expert assistance in selling a pre-revenue company.
Pacinian Corp. was founded in 2007 by Jim Schlosser and Cody Peterson in Coeur d’Alene, Idaho. The pair had worked together at keyboard maker Advanced Input Systems. At AIS, Schlosser notched a decade of sales and manufacturing experience, serving major customers including the U.S. Army. Schlosser also had experience in sales with military contractor Isothermal Systems Research, known today as SprayCool.
Schlosser met Peterson when the innovative engineer joined AIS as an applications engineer. During his 7-year tenure, Peterson helped conceive the first medical-industry keyboard that could be sterilized, the Medigenic Keyboard. His leading-edge devices sold to clients including G.E. Medical Systems and British Telecom.
“Cody has a disarming, gentle demeanor that belies his true nature, which is one of disruptive brilliance,” says Spokane-based patent lawyer Kasey Christie. “He has a knack of innovating in areas where conventional wisdom has it that no more innovation is possible.”
Mission: Better Keyboards
Schlosser and Peterson formed Pacinian with an ambitious goal: To bring disruptive innovation to the staid computer-keyboard industry, which had seen little change in two decades.
During that time, computers had slimmed down, gone wireless, and become highly portable, but keyboards hadn’t kept up. Most were still heavy, clunky, and easily damaged.
Standard keyboard mechanics are simple: Each key is mounted on a small plastic, criss-crossed “scissor” mechanism, which allows the key to move down when pressed and pop back to its original position when released. This typing “feel” mimics that of an old-fashioned typewriter, and helps people type accurately.
But as anyone who’s accidentally spilled coffee on their keyboard knows, this keyboard design has serious drawbacks. Traditional keyboards are often ruined by spills and accumulated dirt, and the delicate key scissors are easily broken. Building keyboards with enough room for scissor-mounted keys also makes keyboards thick and difficult to integrate.
The challenge: Make a thinner, more reliable keyboard that seals out contaminants, yet still gives users the feeling of typing. Schlosser and Peterson reasoned such a keyboard would offer a desirable competitive advantage to computer and peripheral manufacturers.
Innovation and Prototypes
The company’s first year was spent exploring various materials, methods, and approaches to making a next generation keyboard. The first innovation Peterson developed was the HapticTouch™ system. This method uses electrostatic impulses and tiny springs to simulate the normal feel of pushing down on keys, even on a flat screen.
Another solution for keyboards was also developed. The ThinTouch™ keyboard uses tiny magnets and a small ramp to generate the desired typing feel. Pressing the keys makes the magnets separate and allows a tiny depression of the key. Users feel they are pressing down keys, but in fact the keys barely move – less than 1 millimeter. The smaller key depression meant keyboards could be skinnier – barely more than the width of two credit cards.
One prime advantage: the typing feel of the ThinTouch keyboards could be “tuned” to suit the user by changing the ramp and magnet strength, from a hard “snap” to a gentler touch.
To fund the company’s early research and prototyping phase, Pacinian raised money from angel investors including funding from Frontier Angel Fund, a Montana angel fund that included the famous angel investor Bill Payne, who also became a board observer.
While it may not have been this clear during the first angel round, by the time Pacinian was raising its final round, Humphreys had come to believe: “It’s important to have an exit strategy during the funding round. Angels are more focused today on getting their money back. Probably the most exciting thing we had to say to them about the company was what our exit strategy was.”
Angel investors liked the early-exit strategy, and contributed another $2 million in late-stage funding, even as Pacinian was marketing itself for sale. In total, Pacinian raised about $6 million from angels.
Building up the Board
As the company prepared to test and market its keyboards and seek investor funding, a professional board was recruited. Among the new board members was Johnny Humphreys, who became chairman.
Humphreys had served as CEO and later chairman of Itron, which makes devices for the utilities industry. With a storied career that included stints at National Semiconductor and Texas Instruments, Humphreys had wide-ranging engineering and management experience that made him a key asset to the board.
Testing and Pivoting
The company’s initial focus was on its HapticTouch product, but the direction changed after getting feedback from prospective customers, particularly at the Consumer Electronics Show in early 2011.
Customers were most excited by the ThinTouch technology – and wanted to know just how thin Pacinian could make a keyboard. The company switched its focus to developing ThinTouch and pushing the envelope of keyboard thinness.
Discovering the Early Exit Strategy
In his own business experience, Humphreys recalls, selling a company was something that occurred after you’d built a profitable company. “Someone taps you on the shoulder and says, ‘Hey – I like what you’ve built and I’m willing to pay a premium for it.’ You create something good, and something good will happen.”
But Pacinian investor Bill Payne had read Early Exits, by M&A advisor Basil Peters, and was aware of the accelerating trend toward earlier acquisitions. He encouraged Humphreys and company CEO Jim Schlosser to attend one of Peters’ Exit Strategy Workshops in Vancouver in November 2010.
There, the Pacinian executives learned that major technology companies weren’t waiting for startups to build a sales history. Instead, big players were snapping up startups at substantial purchase prices shortly after “proof of concept” or “proving the model”.
Also, sale prices were significantly higher when the selling company controlled the sale process and actively marketed the business to a number of qualified buyers.
“You don’t really want to negotiate one-on-one with someone and end up in a bear-hug, with them telling you how much they love you… and how cheap they can buy your company,” Humphreys realized. “The valuation is at least 50 percent higher when you control the process.”
Given the daunting road to successfully building and marketing its own products, Humphreys and Payne felt an early exit was the optimum strategy. “Our thinking was it would take a large investment to build a one-product, one-application company, and a lot of time,” Humphreys recalls. “To avoid execution risk, an early exit was a better option.”
Exiting early allows start-ups to play to their strength – innovating and creating new products. “The larger company has the muscle to take it to market in a big way and make an impact,” says Peters.
An early exit also allows the start-up to capitalize on what is often a small window of market opportunity. Delays pursuing patents and securing manufacturing capacity can doom an innovative start-up.
After attending the Exit Strategies workshop, Humphreys presented the early exit idea to Pacinian’s management team and board. Not everyone was enthusiastic – the sales staff had strong interest from potential customers, and wanted to see products licenses or manufactured. But selling licenses to a variety of companies could close the door on selling the company to a single buyer for exclusive use.
Over the course of a few months, the board came to a consensus: Immediate product sales should be forgone in favor of an early exit.
In early 2011, Humphreys began actively targeting possible buyers, with a goal of selling within 12 months. The focus was on major PC makers that might have become customers, but instead could be sold on the benefits of buying the company outright to capture the technology and team exclusivity. Major component suppliers to those computer giants were also investigated as possible buyers.
Finding Sale Expertise
To help Pacinian with its sale process, Humphreys turned to M&A advisor Basil Peters. His advice proved invaluable in hammering out details of Pacinian’s sale strategy, says Humphreys.
“There was quite a difference of opinion among the board on whether to have an asking price,” he says. “But if you want to convince someone you’re serious about selling, you have to have a price. It’s also a good way to avoid wasting time with people who’d like to steal the company.”
The company’s position was strong, because Pacinian didn’t have to sell. There were firm offers from prospective customers to license the technology, as well from a venture-capital investor willing to provide cash for production. Other investors, including Payne, felt going the licensing route would lead to “a much longer and much smaller exit.”
“It’s an unnatural act for salesmen to educate prospects on the product and then say, ‘No, I don’t want your license agreement,’” says Humphreys. “There was skepticism we could make a company sale happen, and a natural desire to show the world we have customers. It took leadership to keep everyone focused.”
With guidance from Peters, Humphreys presented Pacinian to the CEOs of target companies. Humphreys’ main selling point: The winning suitor would gain a competitive advantage if they bought the company outright, instead of being one of many licensees of Pacinian’s groundbreaking products.
What’s a Pre-Revenue Company Worth?
There was considerable skepticism around the boardroom table that a pre-revenue company like Pacinian really could be sold for a significant price.
But with the board having decided to sell, an asking price needed to be set. From what he learned at the Exits Workshop Humphreys set a goal of getting at least $20 million. Peters’ analysis of the marketplace had showed this was the price range at which major buyers were purchasing tech start-ups that had yet to produce their product.
“A lot of people wouldn’t think it possible to sell a company without a production prototype,” notes Peters. “But it’s a reflection of today’s marketplace. Big companies with cash are buying up companies earlier, because if they wait longer, they’d have to pay more – or might have a competitor beat them to the acquisition.”
With Pacinian’s technology at a point where big-company engineers could evaluate it for possible purchase, it was time to move. A $20 million sale would deliver a 6-times return for the company’s early investors.
Holding out for more was tempting: “If we remained independent, we might be worth $50 million within a couple years,” says Humphreys. But the risks inherent in ramping the company to that level convinced Pacinian’s board to vote for an early exit.
Let’s Make a Deal
Soon, several serious buyers were in discussions with Pacinian. One of them made a substantial offer for one key asset. This was tempting, but not the deal structure the company wanted.
“It takes some courage to say ‘no’ when a company is offering an 8-figure check, but we just said ‘no,’” Humphreys says. “And they changed it to the offer type we wanted to see.”
The company rode a rollercoaster as they vetted offers for nearly a year. Promising offers evaporated suddenly, and companies that had turned Pacinian down initially later re-emerged with offers.
Once an offer for $20 million was received, Pacinian’s board decided on a bold strategy: The asking price was raised to $25 million, and finally to $30 million. Predictably, suitors voiced objections to both price rises. But Humphreys held firm – he’d seen enough market interest from multiple suitors to feel confident the higher value was justified, and that one of the bidders would pay it.
And the Winner Is…
Eventually, the Pacinian board selected Synaptics of Santa Clara, Calif., as the buyer in a deal that closed in August 2012. A global maker of touchscreens and other computer peripherals, Synaptics’ found Pacinian’s technology a good fit with the company’s other offerings.
The sale terms: $15 million up-front, plus $5 million in near-term earn-outs when the product found its first major customer, and the final $10 million over three years, paid out on a per-unit-sold basis as Pacinian’s keyboards shipped to customers.
Angel investor Bill Payne says M&A advisor Basil Peters’ involvement was key to the successful sale. “Basil was the spark,” he says, “with the book, the workshop, and then providing M&A coaching throughout this process.”
“Angel investors have big smiles on their faces when they talk about Pacinian,” says Peters. “It’s a prototypical 21st century early exit.”
For more on the Pacinian exit, watch video interviews with Johnny Humphreys and lead investor Bill Payne. I am very grateful that they agreed to share what went on behind the scenes.