The Dilemma of Every Startup Founder: Acquire, Be Acquired, or What Else?

Will on

October 10, 2022

A little more than three decades of working with startup founders, I’m often called in to help with some of their more vexing challenges. One such challenge is around how to approach the broad topic of mergers & acquisitions. After many engagements with founders who are new to the M&A arena and are gearing up to go after their first target, I’ve observed that the fundamental reasons for which they want to pursue an acquisition are not always well analyzed. Often, the CEO loses sight of the objective in the glory of anticipated benefits, and glamor of the acquisition without fully understanding why the acquisition should (or perhaps should not) take place.

Here are the seven tenets to think through when considering an acquisition, one or more of which may apply. Being clear about which are the most important will help ensure the right deal is struck and the right resources are brought to bear both before and after closing the deal:

Business expansion with immediately accretive revenue
Accessing a wider customer base and/or increasing customer wallet share, is usually a leading objective of a business expansion acquisition. Your target business likely stands on its own and has new customers, distribution channels and market access points that are complimentary to your business.

Product line expansion with products ready (or nearly ready) to go to market
This entails extension of the products and services your business already offers. A target business may not yet be profitable and/or may have an under-developed go-to-market ability. Acquiring this business brings you products or services that fill gaps in or extend your product line.

Core technology / IP acquisition to support existing products and businesses
Getting ownership of the intellectual property of a company can be a key objective. Patents, trademarks, copyrights, industrial designs, geographical know-how can help grow your moat and give you freedom to operate in areas that could be otherwise blocked or hindered by competition.

Geographical expansion to new regions / countries with associated new customers and sales channels
A company might be doing excellent in its own geographical area, but it may not be achieving traction in a neighboring area or may be slow to enter a new market because of the lead time required to build a local team. To tap such attractive markets, a careful acquisition of an existing player can jump-start new market growth years faster than building from scratch.

Low-cost talent acquisition
Generally termed acquihire, this involves obtaining quality staff and addition of advanced skills to your team via acquisition of a company that has this talent in place but does not have a viable business. For instance, 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 if the skills and business are complimentary. Acquihires and be a win for the acquirer and a face-saving somewhat-remunerative option for the seller, but many things can go wrong, from cultural clashes to misaligned incentives.

Competitive elimination
This type of acquisition is aimed to eliminate a direct, (or future) competitor. The goals of such acquisitions are to either decrease head-to-head competition, or to consolidate market power. The elimination of competition allows the acquirer to grow market share, raise (or avoid lowering) prices, increase velocity of closing deals, etc.

Consolidation for purposes of leadership and fundraising
As markets go through typical evolution of rapid innovation and growth, they also go through periods of contraction and consolidation. Being seen as an early leader in the consolidation phase can help distance you from competitors, attract better talent, and attract follow-on investment commitments.

While these are the groundwork and analysis that helps in determining the strategy behind an acquisition or a merger, founders must immediately get to analyzing the critical aspects that come next. Once these critical factors are evaluated, making a clear roadmap leading to the deal and managing post-closing will result in fewer unexpected surprises. Let’s dive into the three critical factors to weigh out.

Cost of acquisition
Fully analyzing the costs of an acquisition is harder than most people think. I have often come across situations where a large and often unplanned cost will be felt after closing a deal, during the Venture Integration stage. There are three significant areas that should be at the top of consideration when planning an acquisition. This first is to enable leadership and cultural alignment by ensuring that there’s no conflict with top leadership and that the acquiring team is properly compensated for any bandwidth pressures that may arise from acquisition activities. Also, ensuring seamless integration of teams and overall business continuity often require integration advisory services from external providers. These costs need to be planned as they can be material – typically 2%+ of deal value.

In addition, there will be a rebrand of the acquired product or service line, unless you’re thinking of creating a group of companies. The bigger the acquisition target, higher the rebranding costs.

Return on Investment
In the end, the objective of an acquisition comes down to future earnings, and how much of those earnings are available as a return on the initial hard and soft costs of the acquisition. Return on investment involves forecasting out the cash flow of the acquisition versus the initial investment and calculating the rate of return. Before you take the plunge, evaluate metrics such as near-term revenue accrued from combining the services of another business, reduction of competition, and faster time-to-market. For instance, adding features of the acquired product/service, and addition of new talent and tech to your existing one can speed up the product or service’s time to market.

It is also important to evaluate returns in terms of cost savings in talent acquisition, enhanced brand and market perception, and expansion of the customer base. When companies combine, they get access to each other’s clients, markets, advertising channels, promotion strategies, marketing agencies, distribution channels. Go-to-market can become a much more efficient and effective function, translating into increased sales volume and better overall ROI.

In an ideal situation, a business would gain the entire customer base of the acquired business. While this isn’t always the case, realistically looking at customer retention issues of both companies can help ensure that the merger or acquisition will result in a significant increase in the overall customer base.

Alternatives to Acquisition
Acquiring companies is attractive for many reasons but is not the only possible route to accelerating growth, or establishing a new market presence, or extending a product line. There are other ways in which a business can build and grow organically, while gaining significant benefits without the management distractions and financial costs of acquisitions.

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

Inorganic growth through mergers and acquisitions is faster but with more complexities and challenges compared to the generally slower organic growth path. In the face of global economic turbulence, startup CEOs may be at crossroads figuring whether translating headwinds to tailwinds through M&A-backed inorganic growth would be an ideal proposal for their stakeholders. The answer –If taking the acquisitions route, focus on getting the deal done thoroughly well to minimize unwanted surprises.

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