This blog is the first in a series intended to bring transparency to the acquisition process for startups.
When it comes to one company buying another, you have likely heard the term “Mergers and Acquisitions” (or “M&A”).
A merger is when two entities are combined to form a new, joint organization. Typically, this happens when large organizations combine, like when AOL merged with Time Warner back in the dot.com days.
In virtually all cases, the process startups are involved in is simply an “acquisition.”
The folks responsible for managing this process are members of the Corporate Development team. The Corporate Development (or Corp Dev) team usually is a small group within larger organizations that works closely with the finance, legal, and operations teams.
Their remit is typically described as “inorganic growth.” That is MBA-speak for activities that grow the company’s business in some way other than investing in existing operations.
There are three common ways that the Corp Dev team can accomplish this:
- By establishing a partnership with another company.
- By making an investment in another company.
- By acquiring another company.
The simplest way a company can utilize a startup’s product is simply by becoming a customer. They can sign up and pay to use the service. In many cases, this will be sufficient. In some cases, it will make sense to go further and establish some form of partnership.
If the company’s interest goes beyond partnership, but they are not prepared to make an outright acquisition, a “strategic investment” may be considered. This is effectively a venture capital-style investment from the company into the startup.
A strategic investment may be a precursor to an acquisition, though this should in no way be counted on as a certainty.
In the hierarchy of roles, the startup community can sometimes perceive Corp Dev professionals negatively. They think of them as bankers or lawyers, “sharks” who are only interested in doing deals. For the most part, this isn’t correct.
While there are certainly financial and legal aspects to the deal process, almost all Corp Dev professionals will be vested in their company’s goals and will genuinely care about finding the right technologies and talented people to support achieving those goals.
It is also important to understand that Corp Dev’s main role is not just making deals, but really in creating the bridge between the internal and external worlds. About half of their effort is dedicated internally — that is, meeting with executives and product leaders to understand the needs of the business and the challenges associated with the product roadmap.
The primary headwind Corp Dev faces is that a company’s first instinct will always be to try to solve these problems itself. Given both the time and the budget, they can replicate a technology. They can hire a similarly skilled team. They can even compete for and acquire similar customers.
The questions are always: Just how much time will it take? How much will it cost? And how much risk is associated with the effort?
Ultimately, acquisitions are a way for a company to exchange cash for velocity.
Rather than building a thing from scratch, that thing (or a similar thing) can simply be bought already-made.
However, making an acquisition is also a source of distraction which can, in turn, reduce the company’s velocity. It is useful for founders to appreciate this trade-off.
Some founders think that if their product is a good fit, an acquisition should obviously be considered. However, they believe this without understanding the full “cost” to the acquiring company.
This cost is more than the dollars involved or the effort associated with executing the deal. It is also the distraction to the leadership team; the overhead associated with taking ownership of a new code stack, developed under a different set of standards; and the disruption related to integrating a new product and team into the company.
If it is not immediately obvious that the benefits derived from doing a deal will far outweigh the costs, a proposal to make an acquisition will never get off the ground.
Of course, a scenario where the internal requirements are clearly understood and an acquisition is agreed upon is a “best case” version of how the process happens. In reality, the pieces of the jigsaw rarely line up so neatly. As a result, the other half of Corp Dev’s effort is focused externally.
This is where they go out and directly engage with startups, to understand what startups are out there in their particular market segment and what it is that they are doing.
They can then take this information back to the company’s leaders to see if this team or technology could be applied to the internal problem set. Could any of these startups help the company achieve its goals faster? Do they create an opportunity to take the company’s roadmap in a new direction?
It should be easy to see how this process is naturally iterative.
Paul Graham (the YC founder) wrote a notable blog a number of years ago advising that startups should avoid talking to Corp Dev, as these interactions can be excessively distracting. While there is an element of truth in this, I believe this point to be overstated.
Of course, startups do need to be thoughtful about managing any process they’re engaged in. They need to make sure they don’t get dragged along in the wake of some company initiative with a bunch of open-ended exploratory meetings.
However, this process, like any other, can be managed. Keeping in mind the need for some give and take, this recurring set of interactions should still be beneficial to both sides, even if it doesn’t result in an acquisition (or partnership or investment).
If the company is, or becomes, interested in making an acquisition, they will have a definite preference to work with startups they already have a relationship with — known quantities, in other words.
Given that in the real world, the timelines associated with wanting to acquire and wanting to be acquired rarely line up exactly, it tends to be worthwhile for startups to ensure that a relationship is already in place. At the very least, this increases the probability of receiving a future acquisition offer.
This blog is an adaption of one of the chapters from my recently published book “How to stick the landing. The M&A handbook for startups.”
If an acquisition is a potential exit option for your company, you should definitely check it out!
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