News & Analysis

driven by the PitchBook Platform
gettyimages-1090969206.jpg
M&A

‘Put up the for-sale sign,’ more VCs tell founders as market sours

After years of telling their portfolio companies to grow at all costs, investors are dishing out an entirely different type of advice.

Request access to M&A data

After years of telling their portfolio companies to grow at all costs, investors are dishing out an entirely different type of advice.

Cut expenses, borrow venture debt, or raise additional capital at a flat or even slightly lower valuation than the previous round.

But if after trying to take those steps the startup is still at risk of running out of cash in 12 months or less, then some investors are telling companies to resort to even more drastic measures: try to sell to a strategic buyer at a discount rather than risk going out of business.

“I’ve called founders [to say], ‘I think you should sell,’” said Chris Farmer, a partner and CEO at early-stage firm SignalFire. “A sale could be attractive to founders because they don’t have to lay off everyone, and investors can get some or all their money back. It’s a soft landing.”

Some startups that are short on capital are trying to raise a financing round and run a sale process simultaneously, said Wayne Kawarabayashi, a partner and head of M&A at Union Square Advisors, a technology-focused investment bank.

“There are a lot of these dual-track conversations now,” Kawarabayashi said.

So far, there haven’t been many low-priced acquisitions in this market cycle. But we may soon see more sales like that of Tile, in which investors barely make their money back. Tile, a developer of tracking devices for personal items, was sold to Life360 for $205 million. Prior to the January sale, the company had raised a total of $150 million from investors like Bessemer, GGV and Khosla Ventures, according to PitchBook data.

Indeed, M&A activity appears to be on a decline so far in 2022. In Q2, 230 acquisitions of VC-backed companies were announced or closed, which is the lowest deal count in over a year, according to PitchBook data.

 

Farmer has advised some of his portfolio companies to start discussions with buyers now because the M&A process could take up to a year, and it may be too late to have that conversation when a startup is several months away from going belly up.

Potential acquirers often first want to try out a strategic partnership. If the startup’s product cross-sells to the larger company’s customers, then there will be greater acquisition interest, Farmer said.

“I am telling a lot of my companies to go talk to every corporate and see if they’ll tag money on to the last round,” he said, referring to extension rounds, which are done at the same valuation and terms as the company’s most recent funding deal. “You’re not going to them with a sale sign on your head.”

In certain cases, corporations could decide to buy the startup after or instead of making a venture investment.

While some VC-backed companies are starting to have conversations with strategic buyers, very few startups are desperate to sell at a depressed valuation now, according to Kawarabayashi.

In the meantime, many corporations expect acquisition prices to fall even further.

“I think both sides are not aligned yet,” said Sheila Patel, a vice chairman at venture firm B Capital Group.

Most startups still haven’t run out of cash runway, she said, and strategic acquirers are still figuring out what companies they would like to own.

But Patel expects a significant pickup in M&A activity in the fall.

Farmer agrees that an increase in acquisition announcements won’t come until later this year or early 2023.

While he doesn’t foresee many large deals in 2022, he says there will likely be a wave of small acquisitions known as tuck-ins and bolt-ons. In these transactions, the larger company buys a startup for its product instead of building a similar offering from scratch. Such deals are especially advantageous when company valuations drop vis-à-vis what it would cost to develop the product in-house, Farmer said.

But acqui-hires, a deal type in which a company is purchased for its headcount, will likely become rarer. Since a number of large companies, such as Meta and Uber, have instituted hiring freezes, the need for talent acquisition is not nearly as pressing now as last year.

It may seem that strategic buyers are sitting on sidelines for now. But Farmer is sure that they are gearing up for action.

“There are a lot of corporate development groups aggressively coming up with their wish list of acquisition targets.”

Featured image by Gwengoat/Getty Images

  • m-temkin-low-res-round.png
    Written by Marina Temkin
    Marina Temkin covered the venture capital ecosystem from 2021 to 2024, based in San Francisco. Previously with Venture Capital Journal, Marina wrote about the VC industry, and she was a reporter with Mergermarket in New York and San Francisco. She also has been a financial analyst and is a CFA charterholder. Marina received an economics degree from the University of California, Davis, and she attended the CUNY Graduate School of Journalism.
Join the more than 1.5 million industry professionals who get our daily newsletter!