Ever noticed how startups are increasingly consolidating their business instead of going public? It’s becoming an all too familiar story, and it goes like this: Start-ups are acquiring other startups in a flurry of Mergers and Acquisition activities, aimed at countering the drop in investments from traditional startup financing houses.
So, how is the rise in M&A in startups reddening the market? Could this be the start of a disruption in startup financing?
How lack of financing drives competitiveness in the markets?
That’s right. Change is coming to how startups raise funds. Traditionally, startup funding requirements were fulfilled by angel and seed investors, working alongside venture capital firms. Beyond that, hedge funds and private equity firms would also raise funds for investments from their clientele. But one thing for sure, this financing route can get vastly affected in the event of a global slowdown. Like everything else, funding dries up for emerging startups. Hence, the majority of the financing during this time falls in the hands of top players in the market.
Now get this; these top players usually hold a significant share in their respective sectors. Make no mistake about it; when funding gets restricted to a few players, startups start finding it increasingly difficult to raise funds and continue in business. In the end, the startup scene becomes increasingly competitive and driven solely by profitability instead of innovation.
What makes M&A in startups standout?
Before we go any further, let’s break down the startup M&A management. In essence, multi-fold and mid-tier startups, with lesser market presence, prefer getting acquired by other startups. The result: Investors get the chance of enhancing their investments by consolidating market share. Hence, considering the nature of such M&A activities, these transactions tend to vary significantly from traditional M&As.
Throughout history, the primary driver for M&A has been predominantly business consolidation, synchronizing operations, and achieving greater efficiencies. But time is changing, and investors want to stay ahead. Strictly speaking, most startups lack a viable business plan, which can guarantee investors returns by the fourth or fifth year of investing. What’s the solution? Investors push for the preservation of their holdings by encouraging the acquisition of the startup by a bigger entity. As a result, the startup is saved from shutting down, and the investors enjoy a total write-off of their investments.
What does the acquiring entity get from such a deal? No doubt that many of these deals are driven by established firms’ need to acquire young and skilled staff. Looking at it from the perspective of the founders of a struggling startup, approving an M&A is sensible compared to closing up shop due to lack of funding. In the meantime, most startups remain unprofitable, mainly due to increasing operating costs with decreasing revenues. In addition to that, the uncertainty of the lifetime and anticipated value of the customer base, talent, and other parameters, makes traditional M&A valuation processed unsuitable when deciding on valuation. Thus, firms have to establish different parameters for valuing startups.
The consolidation of the business
All in all, the rise in M&A activity in startups is redefining the exit options, which investors have been accustomed to for some time now. In the past, investors could only exit through an Initial Public Offering (IPO) or private sales. To illustrate, take a look at the failed attempt at merging Flipkart and Snapdeal. Investors want to preserve their investments through the consolidation of the business. Unlike these traditional modes of exit, which are characterized as complicated exit routes, Mergers and Acquisitions are much more viable exits modes and require far less third-party involvement.
Going ahead, it seems that struggling startup will be more open to consolidation to long-established firms as a mean of survival. But what about the legal framework? Maybe policymakers will introduce legislation to keep up with how a rise in M&A in startups is redefining the market.