5 types of a successful startup M&A
On your way to success, gaining the capital from the seed/VC fund, you will receive Term Sheet where, as well as in the investment agreement, there will be a provision concerning the investor’s dream: the opportunity to exit the investment whose value has increased considerably over time.
For the fund it is the essence of taking the investment risk, namely: ‘What will be my potential profit after X time, if I invest Y today.’ Nowadays one can try to type several kind of ‘exits’, but In my opinion, only two of them matter:
Mergers and Acquisitions (M&A)
Initial Public Offerings (IPOs) — a stock exchange debut.
The geographical and industrial specificity is very important at this point, as it does not always happen that a given industry or location allow for an optimal exit. For instance, the costs of medical companies’ operation on the American market or the costs of the technological companies’ debut on NASDAQ versus the debut on the Warsaw Stock Exchange.
Today I would like to tackle the issue of M&A, because in the vast majority of cases it is the most common way of exiting the investment. One of the main reasons for such a tendency is the fact that IPO requires that a company has a very high value so that a successful debut can occur. In the case of M&A it is easier to achieve the return on the investment. Therefore, in the world of ‘exits’, each start-up has a M&A potential, whereas only few companies possess potential for IPO.
There is no magic formula.
There is no magic formula for an effective M&A process. As any business process, acquisition has to be justified and might result in either a success or a failure. In corporations, M&A is the same process as marketing, sales, distribution or R&D. The most successful acquisitions are the ones which contribute a real, very measurable value to the current or future processes occurring in the company. Those acquisitions which are less successful or entirely unsuccessful are often justified by ‘extending the portfolio’ or ‘building the third leg’, which indicates large companies’ inability to be innovative and build the company’s value around the financial results in the nearest year.
There is no one way to categorize the types of acquisitions. Their variety, reasons, motivations and sizes are too diverse. However, as McKinsley company provides in one of its works, there are certain archetypes which can be distinguished and thanks to which there might be a strategic justification for an acquisition or an investment in a start-up. If your M&A process does not fit into one of these archetypes — there is a huge risk involved that it will not succeed (the transaction will not be completed or it will simply be unsuccessful afterwards).
5 archetypes of successful acquisitions
The acquisition of your start-up must have its justification in the strategy of the acquiring company and it cannot fit into something uncountable, like ‘ there will be growth thanks to us’ or ‘thanks to sue you will be innovative in this field’. Every purchase has to translate into something tangible, which exerts a measurable and real influence on the functioning of the acquiring entity.
5 archetypes of successful start-up acquisitions:
Improve the target company’s performance
Consolidate to remove excess capacity from industry
Accelerate market access for the target’s (or buyer’s) products
Get skills or technologies faster or at lower cost than they can be built
Pick winners early and help them develop their businesses
Improve the target company’s performance
One of the most common reasons for the company acquisition. It is a very simple motivation for M&A: someone wants to buy your company because they think that it will enable them to lower costs, improve the existing margins or financial flows of their company.
It is very important to remember that the highest value that your company/service can contribute to another company (in the process of product sales or the sales of the entire company) is the ability to prove that you can do at least one of these things:
a) help someone earn more money
b) help someone lower the cost
c) change the aspect of a certain business/company’s culture — in the case of start-ups by the means of technology
Such a strategy is fulfilled in the most effective way by Private Equity Funds. They are able to increase, in a very successful way, the efficiency of companies with low margins and low return rate son the invested capital.
Private equity — this name stands for investments on the non-public capital market made in order to achieve medium- and long-term profit from the increase in the capital value. Private equity can be used for the purposes of developing new products and technologies, increasing the turnover capital, taking over companies or improving and strengthening the company’s balance. Venture capital is one of private equity varieties.
Consolidate to remove excess capacity from industry
Mature markets come to face the moment when demand for specific products or components is really high. Therefore, processes of effective optimization of production processes or product distribution can occur which find their way to mature/saturated market. Nowadays it is, for instance, ‘smart home’ market.
Accelerate market access for the target’s (or buyer’s) products
It is one of the most commonly occurring archetypes for the takeover of technological companies. On the one hand, large companies/corporations possess relationships, distribution channels and sales networks on their markets. On the other hand, young, not large but extraordinarily operationally efficient companies, while making use of technology and talent to build innovative products, very often face problems with launching them into the market in such a manner so as to guarantee for themselves effective and profitable distribution channels which large companies which have had a longer presence on the market already possess.
In the case of this archetype, the purchaser wishes to use your product for entering already existing markets so as to thanks to already developed processes/relationships be able to offer something new which would allow, for example, for the increase in the purchaser’s income.
There are numerous examples of such operations and certainly, some of them fail to succeed. The examples of the successful ones: Google purchasing DoubleClick or YouTube, Facebook purchasing Instragram or WhatsApp. Unsuccessful ones: Microsoft purchasing Nokia.
Get skills or technologies faster or at lower cost than they can be built
In my opinion, Cisco excels in such acquisitions:
Between 1993 and 2001 Cisco purchased 71 enterprises at the average price of approximately $350 million. Cisco’s sales rose from $650 million dollars in 1993 to $22 billion dollars in 2001, with over 40% of the income from 2001 coming directly from these purchases. By 2009, Cisco had had over 36 billion dollars of income and approximately, 150 billion dollars of capitalization.
It’s innovation through acquisition. Large corporations have their R&D departments and spend enormous money on them. Simultaneously, the product implementation cycle from such R&D is so long that these companies are very often surprised by their competition or some new company (Apple vs. Nokia, MySpace vs. Facebook, MS Office vs. Google Docs, Intel vs. ARM). Start-ups, thanks to their innovativeness are able to offer new products quicker and of better quality than corporations. It makes them inclined to meet the decisions to purchase a company/technologies because they notice the potential (they have got their R&D) but after the acquisition they will be able to sell it ‘tomorrow’ and not ‘in 3 years’.
Pick winners early and help them develop their businesses
The strategy of betting the winners. It consists in early purchasing companies or a new product line, notice much earlier than the majority (the competition) how considerable is a given company’s potential. It is a difficult task for a corporation — it requires that large companies understand where the market will be in x time and that company’s managing staff becomes convinced to this vision. What is very interesting is the fact that the majority of large companies plans for years ahead in their strategies but particularly in Poland (although it is a global problem) few of them can understand, estimate and show the influence of technologies and innovations on their business, trying to think in such categories: ‘if technology does not influence my business, it will be exactly the same in three years’. Nothing could be more wrong.
Many large companies do not understand the notion of ‘corporate entrepreneurship’ and do not allow their teams/innovators/ talented employees in the corporation to make the technology influence the existing processes. It is usually explained with security issues, integration costs. Unfortunately, the most common reason is lack of understanding of innovation and technological backwardness of the decision makers themselves.
The ability to convince a large company that in this race for the market and with such a significant influence on the technology of people’s lives — it is worth betting on that particular horse, that is your start-up, is essential.
This strategy of acquisition requires that the managing staff adopts a disciplined approach in three dimensions. Firstly, the ruling bodies of the corporation have to be willing to invest early on, long before the competition, and see the potential of the market in the industry or company years ahead. Secondly, one has to make many gambles on the future and expect that some of them will simply be unsuccessful. Thirdly, one needs skills and patience to be able to take care of the companies acquired taken over within the corporation, so as not to destroy the spirit of innovativeness and entrepreneurship in the company which is taken over.
There are also other strategies which are more difficult and riskier and which are applied much rarely:
roll-up — consolidation of very fragmented markets where currently, competitors are too small to achieve economies of scale. This strategy works when enterprises, as a group, can gain considerable costs or generate higher income than single enterprises.
consolidate in order to improve competitive behaviour — in very competitive sectors there is a hope that consolidation will lead competitors to the situation when they will not focus on the price competitiveness
transformational merger — the desire to transform the acquiring company into the manner of the acquired company’s operation. Transformational mergers are rare and due to circumstances and difficulty level they need to be prepared by the managing team in a very precise way and executed very efficiently.
buy cheap — the last suggestion for the creation of takeover value is to buy cheap, in other words, at the price below the company’s internal value. However, as far as my experience is concerned, such opportunities rarely bring results, although in the case of VC funds, it is very often one of the ways to regain some of the money if the investment fails.
In the perfect world your start-up is constantly getting stronger and more developed — entering the ‘break even’ stage. Then the income allows you to support you and your company for years. I wish you that scenario. However, it usually happens that technological companies need investments, technological progress is enormous, changes which occur on both consumer markets and B2B are so significant and rapid, and a way to IPO is long (currently, it is approximately 10–12 years) that one of cards on the table is the fact that your start-up can be bought and developed further within another group. This is also the scenario that I wish for you.
PS. Companies do not buy companies. People ‘buy’ people. In my opinion, it is the most important lesson in the process of successful acquisitions.
