After a slow year for startup acquisitions in 2023, dealmaking is expected to pick up as private equity firms and corporates find themselves sitting on growing piles of cash to use for acquisitions.
With VC funding still hard to come by, many cash-strapped startups will be looking for acquirers as they struggle to raise capital. Muted valuations due to the more challenging VC environment have also made startups more attractive targets than in previous years.
“2023 was a very low year [for acquisitions] so, statistically, we’re likely to see a rebound,” said David Jegen, managing partner at F-Prime Capital. “But I also think it’s qualitatively going to rebound because both PE firms, who will be among the more active buyers, and strategics have seen a floor in a sense and they’re ready to get back to work.”
With more buyers in the market for startups, what can founders do to improve their chances of selling?
The early bird catches the worm
According to Revolution Growth partner Todd Klein, founders need to be thinking about the possibility of an acquisition long before they actually want to sell.
“From a strategic standpoint, you can never start too early,” Klein said. “You need to think from the beginning about where ultimately your industry is going and how your business is going to fit into it, and that includes a potential sale. From a tactical point of view, 12 to 18 months is when you need to get serious and do the things you need to do to prepare.”
Planning early gives founders the time to build relationships with potential buyers in the market. Large corporates are unlikely to acquire a company they’ve never heard of and being on their radar can make the difference between them choosing you or a competitor when they’re in the market to buy.
Cultivating relationships with potential acquirers in advance can also provide insights into their preferences, which in turn may guide a company’s strategic decisions to align the startup with buyer expectations. Proactive adjustments to market changes based on industry trends will also boost a startup’s attractiveness.
Contrary to popular belief, Klein said, existing investors should also be brought into early conversations around acquisitions to ensure they’re on the same page.
It’s not about you
Having decided to sell, one of the most important things for founders to do is determine why their startup is being acquired, Mark Achler, managing director at Math Venture Partners, said.
“[Being acquired] is not about you, it’s about the buyer,” Achler said. “You need to do your homework and find out what is important to them. Doing that will allow you to demonstrate that you understand their business and how you can help them grow. And that’s how you get a deal done.”
By understanding the buyer’s needs, founders can emphasize how their startup can add value, be it through product, technology or team. If founders can demonstrate how their offering complements the buyer’s existing business or fills a gap in their portfolio, it can make the startup more valuable to the buyer.
An acquirer may be willing to pay a premium for perceived long-term value, so founders need to show how an acquisition can contribute not only to immediate gains but also to sustained growth and profitability over time.
But, according to Jegen, most discussions around valuation will come down to financials.
“The No. 1 thing you can do to make your startup more attractive is to become cash flow positive,” Jegen said. “In some cases, that won’t be doable but you’ll lose a lot of acquirers if your burn is too high because they’re the ones that will have to fund the losses. Your fundamentals will be what ultimately drives the valuation.”
Acquirers are more interested in startups with a proven and scalable revenue model. Financials will be of particular importance to private equity firms, Jegen said, so if they are the ideal buyer, founders need to make sure that they can show healthy numbers.
Hired help
Increasing competition can result in a higher valuation for startups. Hiring an M&A adviser can be a good way to increase both the number and quality of bids, Klein said.
With extensive industry networks, advisers can help identify suitable buyers and craft a compelling narrative that clearly articulates a startup’s value proposition. As an advocate for the startup, M&A advisers can often negotiate better terms while also taking the burden of the sales process off of a founder’s plate.
“One of the key mistakes I’ve seen when selling a business is that founders get so distracted by the sales process they underperform,” Klein said. “Buyers are looking for predictability, so missing numbers or goals can have a deleterious effect on value. Having an intermediary to create a perception of a competitive environment and manage the mechanics of the sale can be advantageous.”
Achler cautioned that hiring the wrong M&A adviser can do more damage than good, potentially jeopardizing a deal. If using an adviser, founders need to have clear communication surrounding what type of deal they want and what is important to them to ensure that their interests are properly represented.
Life after selling
Acquisitions do not end on the day the deal is signed. Post-acquisition integration is a critical phase that will impact the long-term success of the combined entity.
“Experienced M&A leaders are very good at saying: ‘Here’s a two-page term sheet, and we’ll figure out the rest later,’” Achler said. “If something is left unsaid in the term sheet then it can be hard to renegotiate once the ball is already rolling. Founders need to ask the hard questions upfront because once the term sheet is signed, leverage is lost.”
First and foremost, founders should pay close attention to the cultural fit between the two organizations. Significant disparities in company cultures can lead to high employee turnover and lower productivity if not properly dealt with before a startup is acquired.
Compensation and benefits are other essential elements of post-acquisition integration. Founders should work with the acquiring company to align these aspects, ensuring that employees from both organizations feel valued and fairly treated. Where possible, Klein advised that founders should avoid earnouts at all costs as they have the potential to create long-term conflict in cases where the acquired startup is not given adequate resources to meet its goals.
Achler advised that founders talk to employees or leaders of previously acquired startups where they can to gain insight into the corporate culture of the acquiring company and the integration process. This will provide an overview of the challenges faced and successful strategies implemented to ensure a smoother transition.
Featured image by rob dobi/Getty Images
Learn about our editorial standards.
