PS#053: Exit Analysis – Types of Acquirers (Part 2)
In the last issue of Preferred Shares, we discussed the different types of exits that are available for venture capital investments.
Today, I’d like to go into more detail on the most common types of exits, the category I defined as “Change of Control.” This category includes acquisitions, mergers, and management buyouts. For the most part as investors, this is selling the business to a new ownership group.
As we think about this exit category, we should be asking ourselves “Why?” Why would a certain company want to acquire this startup?
At a high level, there are three motives for acquiring a company…
Complementary or competitive
Adjacent or a new business
Financial returns
We’re going to dive into each of these motivations in more detail.
Let’s dive in.
Complementary or competitive.
The first category is acquiring a startup that is complementary or even competitive.
Essentially, this is a way for a strategic acquirer (typically a more mature or legacy player in the space) to bolster their position or add to/improve their current offering. They may be acquiring the startup for several reasons, including…
eliminate competition,
cost savings or efficiencies,
new or innovative technology,
intellectual property or certain patents,
top tier talent that can help grow the business,
a new or additive feature set that the startup developed,
a new customer base that fits within their core offerings or services, etc.
As you can see, there’s a whole bunch of reasons for pursuing a startup that is building in the same space as a more mature company’s core offering.
Adjacent or a new business.
The second category is about expanding a business.
Legacy or mature companies may look to acquire a startup to enter a new market or create a new business line for their company.
Acquiring a startup can be a way to quickly enter new markets or customer segments that the acquiring company may not have expertise in. This is often a much quicker path to entering these new markets vs. starting from zero within a mature organization. Sometimes, it can just be much easier to incubate a new idea or build a new business outside of a mature corporation (allowing you to avoid all the internal bureaucracy).
The startup will likely already have an established brand and/or a loyal customer base that can help support the acquirer as they start expanding into new markets. Even better, this can help the acquirer diversify its current revenue streams and mitigate the risk to the whole company (if one of those revenue streams struggles).
Financial returns.
While strategic goals are often the primary motivation for acquiring a startup, the potential for financial returns, including revenue growth and increased valuation, can also be appealing.
More often than not, this is where private equity (“PE”) firms come into play. PE firms acquire businesses in the hopes of making a financial return. In the case of acquiring a startup, the PE firm may be buying a “platform” business (i.e., the main or core business) or a “bolt-on” acquisition (i.e., a smaller business that adds to the platform business).
In either situation, the main goal is to build and grow the business to make a financial return.
Map out the options.
When I’m thinking through the potential exit options for a startup, I will often map out the different acquirers, highlighting the different categories (listed above) and their motivations for this particular startup.
Not only does this help me visualize success for this startup, but it gives me a strong understanding of the overall landscape. As I mentioned in my issue on deal newsletters, I’m typically building these maps and categories as a part of my overall thesis.
In the next part of this series, we’re going to discuss the extreme upside (i.e, a startup with public company potential) and the extreme downside (i.e., a liquidation event).
