M&A and startup roll-ups are expected to increase in fintech and this already appears to be the case. protester. However, recent events like Thrasio’s impending bankruptcy offer a cautionary tale.
The opportunities, pitfalls and risks of technology M&A are real. When does it make sense to do M&A as a tech startup? And how to avoid the most common pitfalls? We dive into both.
Rationale for Mergers and Acquisitions: Before you begin, make sure the whole is bigger than the parts
As Simon from Marqeta told me: “I always say that M&A is a tactic, not a strategy. For Marqeta, we have a North Star that we are heading towards and if acquiring a company can get us there faster, we would look at it. Smart, well-built and well-managed modern technology that can contribute to a larger mission will always be in demand.
This is crucial.
Startups need to ask themselves the tough questions around the rationale for mergers and acquisitions.
Do mergers and acquisitions expand product offerings to existing customers?
In other words, do mergers and acquisitions increase cross-selling of new products in order to expand the relationship with the customer. In unit economic terms, this means that the average order value per customer (AOV) or lifetime value (LTV) is increasing, with a stable CAC.
As Ross Buhrdorf, CEO of ZenBusiness and founding CTO of Homeaway, told me, “At HomeAway and now at Zenbusiness, we view roll-ups as an opportunity to accelerate growth through increased distribution, whether are known brands in a market or an organic SEO position. » (Disclosure: I was previously an investor in ZenBusiness at my previous company).
Are mergers and acquisitions extending their reach beyond existing customers?
Some acquisitions allow companies to better serve existing or new customers with the current product line in a more sustainable manner. This impacts the cost of customer acquisition (potentially reducing it) or market size (potentially extending customer reach). Square’s purchase of Afterpay is an example of this.
For example, acquiring a similar business in a different geography or customer segment.
Are mergers and acquisitions creating a divide?
Mergers and acquisitions can help increase a company’s moat or defensive positions.
Some transactions must be held lest others own them. One of the reasons Visa offered so much for Plaid was likely because it would be too burdensome for a competitor to own.
Many M&A deals increase internal capabilities (e.g. today’s topic: artificial intelligence and pending acquisitions) to better serve customers – and make it harder for others to steal from them.
Constellations Brands
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So you want to execute mergers and acquisitions. What should you keep in mind?
A fair price is essential
Price determines the value created versus the value paid.
Some roll-ups are built on a multiple expansion thesis (by increasing the size of the company, the roll-up will be valued at a premium). Getting the entry price right is essential.
Mergers and acquisitions are often based on the promise of “synergies” – operational efficiencies derived from a combination.
But remember that both of these can be uncertain: multiples change and synergies often take longer to materialize, if at all. The transaction price should reflect this uncertainty.
Incentives matter
The deal has to work for everyone. For sellers, cash is often what they are looking for. But buyers may want to keep sellers. They may also want to mitigate adverse selection (is the asset as good as the sellers claim).
This is why incentives are important. One solution is to structure part of the buyout as equity to keep sellers engaged.
Earnouts can also be powerful tools for bridging valuation expectations among sellers who believe the company is worth more than buyers. For example, if sellers believe that certain future pipeline transactions will materialize and should be cleared, an earnout can resolve this gap.
Create a margin of safety
Price and transaction structure are success factors. But the risk is real and must be recognized. For example, one of Thrasio’s problems was its variable rate debt, the cost of which exploded in a rising interest rate environment.
Allow for a margin of safety so that even if everything doesn’t go perfectly, everyone wins.
Create the playbook
Buying a one-off business can be difficult, especially if it is large. If you want to roll-up, you need to create a playbook.
This means a structured way to map the ecosystem, prioritize targets, conduct due diligence and execute deals. As Ross emphasized to me: “It’s essential that you have a well-established strategy playbook at every stage of an acquisition, from research to the final stages of technology and brand integration. »
This is often the easiest part. The most difficult thing is to add value to what you have built. Some have argued that Thrasio was strong in the first case, but in the second was a challenge on a platform dominated by Amazon. Ensuring inventory is stocked at scale while forecasting demand in a dynamic environment is not simple.
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Roll ups can be huge opportunities. But they also pose significant risks. Go ahead and ride!