A Founders’ Guide To Startup M&As

With a little more than three decades of experience working with startup founders, I’m frequently called in to assist with some of their more difficult challenges. One such challenge is determining how to approach the broad topic of mergers and acquisitions (M&As). 

After many interactions with founders who are new to the M&A arena and are preparing to pursue their first target, I’ve noticed that the fundamental reasons for pursuing an acquisition are not always well analysed. Often, the CEO loses sight of the goal in the glitz and glam of the acquisition, without fully comprehending why the acquisition should (or should not) take place.

Here are the seven tenets to consider when considering an acquisition, one or more of which may apply. Knowing which are the most important will help ensure that the right deal is struck and the right resources are brought to bear both before and after the deal is closed:

Business Expansion With Immediately Accretive Revenue

A primary goal of a business expansion acquisition is typically to gain access to a larger customer base and/or increase customer wallet share. Your target business most likely stands on its own, with new customers, distribution channels, and market access points that complement yours.

Product Line Expansion With Products Ready (Or Nearly Ready) To Go To Market

This entails expanding on the products and services that your company already provides. A target business may not yet be profitable and/or may have a limited ability to go to market. Acquiring this company provides you with products or services that fill gaps in your product line or extend it.

Core Technology/IP Acquisition To Support Existing Products And Businesses

Obtaining ownership of a company’s intellectual property can be a critical goal. Patents, trademarks, copyrights, industrial designs, and geographical know-how can help you expand your moat and allow you to operate in areas that would otherwise be blocked or hindered by competition.

Geographical Expansion

A company may be doing well in its own geographical area, but it may be struggling to gain traction in a neighbouring area, or it may be slow to enter a new market due to the time required to build a local team. To tap such enticing markets, a careful acquisition of an existing player can jump-start new market growth years faster than building from the ground up.

Low-Cost Talent Acquisition

Acquihire refers to the process of acquiring quality employees and adding advanced skills to your team through the acquisition of a company that has this talent but does not have a viable business. 

For instance, if the skills and business are complementary, a mediocre business with a strong tech team, or a small and fast-growing business with an innovative sales and marketing team but limited tech, can offer disproportionate value to the acquiring party. 

Acquihires can be a win for the acquirer and a somewhat lucrative face-saving option for the seller, but many things can go wrong, from cultural clashes to misaligned incentives.

Competitive Elimination

This type of acquisition is intended to eliminate a current (or potential) competitor. Such acquisitions aim to either reduce head-to-head competition or consolidate market power. The acquisition allows the acquirer to increase market share, raise (or avoid lowering) prices, increase the velocity of closing deals, and so on.

Consolidation For Purposes Of Leadership And Fundraising

Markets go through periods of contraction and consolidation as well as the typical evolution of rapid innovation and growth. Being seen as an early leader in the consolidation phase can help you distance yourself from competitors, attract better talent, and attract follow-on investment commitments.

While this is the groundwork and analysis that will help determine the strategy behind an acquisition or merger, founders must immediately begin analysing the critical aspects that will follow. Once these critical factors have been assessed, creating a clear roadmap leading up to the deal and managing post-closing will result in fewer unexpected surprises. Let’s take a look at the three most important factors to consider.

Cost Of Acquisition

Fully analysing the costs of an acquisition is more difficult than most people believe. I’ve seen many cases where a significant and often unanticipated cost is incurred after a deal is closed, during the Venture Integration stage. When planning an acquisition, three major areas should be prioritised. 

The first step is to enable leadership and cultural alignment by ensuring that there is no conflict with top leadership and that the acquiring team is adequately compensated for any bandwidth pressures caused by acquisition activities. 

Furthermore, ensuring seamless team integration and overall business continuity frequently necessitates the use of integration advisory services from third-party providers. These expenses must be budgeted for because they can be substantial — typically 2% or more of the deal value.

In addition, unless you intend to form a group of companies, the acquired product or service line will be rebranded. The higher the rebranding costs, the larger the acquisition target. 

Return On Investment

In the end, the goal of an acquisition boils down to future earnings and how much of those earnings are available as a return on the acquisition’s initial hard and soft costs. Calculating the rate of return on investment entails forecasting the cash flow of the acquisition versus the initial investment. 

Before you make the leap, consider metrics such as near-term revenue generated by combining the services of another company, reduced competition, and faster time-to-market. 

For instance, adding features to an acquired product or service, as well as adding new talent and technology to an existing one, can reduce the time to go-to-market with the product or service.

It is also critical to assess returns in terms of cost savings in talent acquisition, improved brand and market perception, and customer base expansion. Companies that merge gain access to each other’s clients, markets, advertising channels, promotion strategies, marketing agencies, and distribution channels. Go-to-market can be made much more efficient and effective, resulting in increased sales volume and a higher overall ROI.

In an ideal world, a company would acquire the acquired company’s entire customer base. While this isn’t always the case, realistically examining both companies’ customer retention issues can help ensure that the merger or acquisition results in a significant increase in the overall customer base.

Alternatives To Acquisition

Acquiring companies is appealing for a variety of reasons, but it is not the only way to accelerate growth, establish a new market presence, or expand a product line. There are other ways for a company to build and grow organically while reaping significant benefits without the management distractions and financial costs associated with acquisitions.

Strategic partnerships, for instance, in which a contractual business arrangement is formed to support parties who cooperate or collaborate, either in close or loose affiliation, are a good option, particularly for younger companies with less cash to invest in acquisitions and venture integration.  Joint ventures, in which two companies agree to create and run a business entity with its own executive team, can work well in some cases instead of pursuing an acquisition. However, most joint ventures fail, so don’t get too excited about this option.

Inorganic growth through mergers and acquisitions is faster, but it comes with more complexities and challenges than organic growth, which is generally slower. In the face of global economic uncertainty, startup CEOs may be at a crossroads, deciding whether converting headwinds to tailwinds through M&As-backed inorganic growth is the best option for their stakeholders. The answer — If going the acquisition route, focus on getting the deal done thoroughly and correctly to avoid unpleasant surprises.