Prepare your startup for the next wave of mergers and acquisitions
While these alarming headlines sound all too familiar today, each originally spanned 2007 to 2010: The Great Recession dramatically slowed venture capital fundraising for many companies, as did Recession fears are holding back venture capital markets today. According to PitchBook, Venture capital investments fell 30% in the second quarter of 2022 compared to 2021, and IPOs hit their lowest level in 50 years. While a few iconic brands, including Uber, Airbnb, and Square, successfully emerged from the last recession, most venture-backed companies struggled during this period, and many ended up pursuing recovery strategies. Mergers and Acquisitions.
When deal-making slows, venture capital dollars typically favor the perceived market leader, starving other venture-backed companies in the same capital space. While some adapt and survive, others eventually retreat and create M&A opportunities for those left standing. The process is getting off to a slow start, but as the chart below shows, venture capital-backed mergers and acquisitions fell during the recession, when venture capital investment also slowed. Early in the recovery, however, venture capital-backed mergers and acquisitions rebounded and soared: annual deal value topped $30 billion in 2010, holding steady before surpassing $70 billion. dollars in 2014.
See more HBR charts in Data and Visuals
Whether you are considering looking for a buyer or taking advantage of changing market dynamics to make a strategic acquisition, it is important to note that M&A processes typically take 12-18 months from start to finish. Today’s sharp downturn in venture capital investment suggests that a wave of post-recession-like mergers and acquisitions is on the horizon. Startup founders can start positioning themselves now to be acquired into this wave. Unfortunately, many acquisitions made by then will be in trouble. How to avoid this useless fate?
To get a head start on the process, it’s important to know how you will be rated by a potential buyer. Most will have a ranked scorecard with specific criteria, such as deal terms, strategic fit, competitive gaps closed, cultural compatibility, potential benefits, and finally “improvement” – how much Will the purchase and subsequent integration be difficult?
The last category is the most exploitable. If mergers and acquisitions are likely in your intermediate future, your task today is to reduce the impact of a potential buyer and increase your “acquisition capacity”. To do this, entrepreneurs must answer the following three questions in anticipation of the arrival of buyers:
How scalable are my systems?
You and your potential buyer may have different definitions of “scalable systems”. From a buyer’s perspective, scalable means they can grow without immediately requiring a substantial investment in infrastructure, even if they only post-acquisition direct their pipeline and relationships to your sales transactions. While the buyer may eventually integrate your back-office systems, IT stack, and supply and logistics networks, they will first consider whether they can take a hands-off approach while still getting value. As an active board member of several companies, I often advise against acquisitions that require additional investment to actualize value. The simpler the value update, the lower the lift.
In addition to providing systems with excess capacity for growth, scalability also involves audited financials and cleanup of messes. If you’ve been hesitant to shut down an underperforming division or settle nuisance lawsuits, do it now. And knock dissident shareholders — those who demand management time beyond their actual strategic or financial contribution — off the cap table. It’s a tricky message to convey, but try to phrase it like this: “It looks like the investment is no longer meeting your needs. When current and new secondary sales opportunities arise, would you like me to contact you? It is in the interests of all parties to engage and explore these conversations early.
How do I include my company in the M&A deal flow?
Getting bought out by the right partner is hard enough, but if the market doesn’t know both your company and its story, or worse, if the market has the wrong story, a successful M&A process is next to impossible. Fortunately, there are two tangible things you can do to improve your position.
If you’ve avoided the process thus far, it’s time to meet and get to know the three to five investment bankers who know your cold space and participate in the active deal flow in your industry. Introductory breakfasts and site visits to your office are a good start, followed by regular check-in conversations of 60-90 minutes. Beyond educating potential advisors, these talks often yield valuable industry insights.
When looking to hire an advisor, they will need to understand your business, your team and its strengths, as well as what you are trying to accomplish, so they can accurately articulate your story to a potential acquirer. This is an exercise in defining your plot, and while you may never activate all of these relationships, what you share with a potential financial advisor will likely inform the process later. Who knows, they may be advising your ideal buyer. This is your chance to establish the narrative.
A second non-traditional way to enter the M&A stream is to improve the strategic board. People join boards for many reasons, but one of them is to leverage their networks. Adding board members who operate in adjacent categories or who have recently retired from larger players in your industry is one of the least expensive ways to expand your profile, gain access to potential business or strategic partners.
Is my company considered a good business partner?
Buyers are busy, often evaluating multiple opportunities at once. They are human too and will naturally focus on the options that seem best primed to close deals. To make your company a good business partner, ask yourself these questions:
- Are your operating plans up to date?
- Is there a detailed version that encompasses the current fiscal year and another higher level plan for the next 3-5 years?
- Do these include detailed organizational design and hiring strategies?
- Is your IP fully planned and in digital form?
Best practices involve maintaining a constantly updated virtual data room even if the company is not actively pursuing mergers and acquisitions. It’s worth considering how quickly your company could offer this deal-critical information without stressing the organization or risking underperformance in the midst of acquisition negotiations.
The best CEOs I know keep three active lists on their desks. The first is a list of senior executives they would like to hire – a topic for another day. The second is a list of potential acquisition targets, companies that, at the right price and at the right time, would increase their long-term value. The third is shorter: companies that could be their right potential acquirer.
Knowing who is on your list and how to get on another company’s list can mean the difference between finding the right partner and settling for a lesser partner. When acquisition waves start, they move very quickly. One of the more troubling feelings is seeing weaker competitors grow stronger in a downturn by getting bought out by oversized companies simply because they were better prepared.
Many of the metrics that make your company a desirable acquisition target will also allow you to better weather economic uncertainty. Selling during a period of consolidation is not necessarily inevitable, so the goal is to create the option, allowing you to effectively decide if this is the right outcome. The proactive steps above will ensure that the decision to sell is your choice and not a necessity.