At the beginning of the pandemic, Apple and Microsoft shared the top spot as the most active big tech acquirers with seven acquisitions each.
Apple bought the weather app Dark Sky, speech recognition startup Voysis, VR event streaming company NextVR, another VR startup Spaces, and AI-on-the edge startup Xnor.ai, among others.
Meanwhile, Microsoft’s technology acquisitions include 5G cloud startup Affirmed Networks, IoT cybersecurity startup CyberX, and Robotic Process Automation (RPA) provider Softomotive.
News about the latest startup acquisitions often declares how much one company was bought by another established company. The public is clueless on which of the two companies has the upper hand in the deal.
What is startup acquisition?
Startup acquisition involves the process of buying a newly founded company that has gained traction in the market. Generally, these startups created a buzz in the business scene and caught the attention of legacy companies.
Many large and established companies look for moving and disruptive startups they can acquire rather than start a business from scratch. Due to the many factors to consider and possible problems that can arise as a consequence of integrating the acquisition with the mothership (so to speak) and similar concerns, essential planning is key.
What makes a company attractive for acquisition?
Normally, these startups are self-made or bootstrapped small private companies, products of accelerator programs, or side projects of talented professionals working for multinational companies.
Over time, they receive an increasing share of the market and it would only take a few more rounds of funding to go public on their own unless they were scouted to merge with a business juggernaut.
Let me share some examples.
Hubspot was a side project of Dharmesh Shah and Brian Halligan. Shah started a blog that promoted products as an inbound marketing solution in 2006. In 2017, this startup became a publicly-traded company worth $2 billion.
Interestingly, Hubspot proved that blogging can help a business get its name on the map and earn income. The founders chose a niche that they are passionate about.
Lynda.com is a bootstrapped startup that was acquired by LinkedIn for $1.5 billion in 2015. Then, in 2016, Microsoft purchased LinkedIn for $26.2 billion. Lynda.com is now known as LinkedIn Learning.
On the one hand, Reddit started as a Y Combinator project in 2005. It was acquired by media giant Conde Nast in 2006 for around $10-20 million deal. Currently, Reddit operates as an independent subsidiary of Advance Publications, Inc.
Lastly, Instagram started as a whisky app before it amassed over 1 billion monthly active users as a photo-sharing app. It was bought by Facebook in 2012 for $1 billion in cash and stock.
On this note, business giants were accused of buying out their small competitors to eliminate competition but that is not always the case.
The key is the acquirer looks for startups that would generate value for them. Therefore, let’s examine the startup acquisition process using the perspective of the acquirer or the buyer.
Top Reasons for Startup Acquisition
There are several reasons why big companies are on the lookout for promising startups. These include:
1.Finding a New Market
Acquiring new customers is an uphill challenge for big companies with saturated markets. For instance, some multinational companies seek local businesses in emerging countries or regions for expansion.
The following is a list of categories for identifying new markets based on demographics and geographic location.
- Same Target Group, New Geographic Area
- New Target Group, Same Geographic Area
- New Target Group, New Geographic Area
On the other hand, small businesses attract new customers because of digital marketing, especially during the pandemic. Their growth on the internet is more noticeable because they use newer ways of marketing such as social media marketing, email marketing, and pay-per-click advertising.
Moreover, starting a blog and linking it to various platforms is easier these days. This enables small local businesses to gain traction and compete with bigger companies.
2. Capitalizing on Industry roll up
This process refers to acquiring numerous startups with a small market share in the same industry and combining them to form a large company. In this manner, the consolidated company earns revenue by using pulled resources and expanding to markets served by the purchased smaller companies.
3. Getting advanced technology
Successful companies may lose their foothold in the market if they fail to innovate or offer excellent products. Therefore, to boost market share and profits, obtaining advanced technology is the name of the game. This is especially true for companies whose investment in research and development takes years to reach fruition.
4. Anticipating for market window
This strategy refers to buying startups that are well-positioned in the market in the heart of a trend. Normally, these big companies saw this potential and invested early by acquiring these smaller companies and waited for a window of opportunity in the market.
Large companies keep an eye on market trends and when they fall short in advancing their position for a certain trend due to lack of products, distribution channels, or manpower, their next best option is to purchase a startup that can help them meet the market demands.
5. Obtaining product supplementation
Aside from product innovation, large companies improve their product line by acquiring startups that offer similar or related products.
6. Getting new personnel
Growing one’s company organically is ideal but business opportunities do not wait for companies to take the shot. Therefore, to maximize market reach with expert human resources, acquiring startups in specialty businesses is a good solution.
Also, recruiting talented professionals becomes part of the acquisition process.
7. Achieving synergy
In this strategy, the acquisition leads to the merger of two companies in the same market. They streamline operations and costs for greater profitability. After all, the acquirer knows more about the ins and outs of the business.
Some companies become unstable due to changes in the overall economy. To overcome the risks inherent in their own industry, some companies deviate from their core business and acquire startups that can help them stay afloat, if not, more successful.
9. Vertical integration
This strategy appeals to companies that would like to control everything in its supply chain. Thus, it buys the supplier companies of the key elements in its production, including the distributors and retail locations.
Top Considerations in Buying a Startup
1. Customer acquisitions cost
This term refers to the cost incurred to attract a new customer. The acquirer must examine carefully how much it takes to tap a new target market on its own compared to gaining new customers out of a startup acquisition.
2. Commercial success
Some would think that big companies could simply reproduce the technology or product developed by startups, however, the attempt does not usually lead to commercial success. Therefore, even if building better versions crossed the acquirer’s mind, buying a startup with established success is more feasible for either growth rate or market expansion.
3. Lock-up period
This refers to a fixed period of time that founders and shareholders must stay on board to complete the acquisition process. At times, there may be a need to restrict them to sell their shares as this may affect the overall value of the company.
4. Single or Double trigger acceleration clause
Acquirers must consider what happens to unvested stock options when a company is acquired.
Though it is a bigger problem for the startup seller, the acquirer’s paying options or acquisition offer may be affected since startup sellers and their key executives must get their share upon the sale of a company. This is what you call a single acceleration clause.
On the other hand, with a double trigger acceleration clause, the acquirer must check how the startup seller will uphold the special conditions for getting the full value of the vested stock of its shareholders which are usually set prior to acquisition.
5. Reporting Structure
In general, the acquirer gains total control of the purchased startup. Thus, the role of the startup CEO and its human resources must be carefully defined in the acquisition process.
6. Stock or cash purchase
Stock is easier to raise than cash but it can be devalued as soon as the company becomes liquid. Hence, the acquirer must work on convincing the startup to accept an offer favorable to its cash reserves because of cash acquisition tax implications.
7. Holdback Insurance
Transferring the money for the deal is not the end-all, be-all of acquisition. The acquirer can put on hold its payment by securing holdback insurance. Deciding on the period of time is important as this may either expedite or delay the acquisition.
The Startup Acquisition Process
Here are the steps on how acquirers buy startups.
1. Devise an acquisition plan
After selecting the target startup, the acquirer is ready to develop an acquisition plan that focuses on shaping an offer that would benefit the enterprise with the least spending.
2. Build an acquisition team
Ideally, the acquisition team is composed of the CEO, investment banker, acquisitions lawyer, human resources expert, IT specialist, and a public relations officer.
These roles were tapped to provide the company with expert advice from transferring ownership, organizing manpower, understanding the effect on technical infrastructure, and communicating with business partners and customers.
3. Exhaust due diligence
Due diligence refers to a comprehensive investigation of potential investment that influences the purchasing decision of the acquirer. The acquirer must secure critical documents that would aid in negotiation and drafting a contract.
Most importantly, this process protects the buyer from acquiring a startup with risky business deals. That’s why it may take several weeks or months. It usually begins as soon as the letter of intent (LOI) was signed.
The acquirer gathers data to understand the startup’s obligations that include debts, leases, distribution agreements, pending and potential lawsuits, employment contracts, and other similar business documents.
The acquirer may also request pertinent documents from the target startup. Then, it will be followed by a series of M&A meetings to check their compatibility for a possible merger.
4. Make the First Offer
The acquirer’s offer must be sensitive and flexible to three things: the company’s brand, goodwill, and people. The offer usually falls between 75 to 90% of the company’s worth.
With the top considerations in mind, the startup will make a counteroffer. The acquirer examines the deal breaker in the situation. In general, the two companies work around soft issues after settling the acquisition price.
6. Seal the Deal (or not)
Closing the deal with contract signing ends the negotiation but not the acquisition. This is where the emotional integration begins.
This time, let’s check the perspective of the startup owner selling their company.
Top Considerations in Selling a Startup
There are three questions that a startup founder/owner must evaluate:
1. Am I ready to sell my startup?
Some startups take up years to become stable while some want to sell their startups fast as soon as the demands pile up and the founder cannot keep up.
Handing over the anxiety, stress, and risks to another company sound practical and profitable, especially for first-time founders but letting go of the fulfillment brought by years of hard work takes a lot of courage.
Founders often face the dilemma of staying or moving on to new opportunities.
2. Is it time to sell?
One of the factors that contribute to founder burnout is the need to raise funds all the time. There are three options to get more funds:
- Continue to operate successfully
- Increase capital
- Venture in Merger & Acquisition
3. What are the consequences?
This question gave birth to more questions such as:
- Will the sale be enough to pay early investors and other obligations?
- Will I get enough savings either for retirement or a new business?
- Will the acquirer take care of my startup? (brand, employees, customers, and stakeholders included)
The startup acquisition process is a difficult and laborious deal for buyers and sellers alike. The urgency to buy or sell differ due to the considerations mentioned above.
In the end, both aspire to generate value that money cannot be viewed as an equivalent.
Allan Borch is the founder of Dotcom Dollar. With almost 10 years of digital marketing experience, he wants to help entrepreneurs and business owners build and monetize their own successful online business. Connect with him on LinkedIn, Twitter, and Youtube