How founders should think about M&A exits

Summary

The Indian tech ecosystem is second to none when it comes to innovation. Indian SaaS startups have caught the attention of larger companies worldwide. How should Indian startups assess and navigate the process if they find themselves the subject of an M&A proposal? It is important to understand some basic aspects of valuation, culture and deal structures in a cross-border context in such a case.

Indian founders are increasingly building global businesses. They’re making world-class products with more considered go-to-market strategies that are ready for the much larger and more mature US market. It is for these reasons that Indian SaaS companies are now second only to the US in scale and maturity, with their total annual recurring revenue (ARR) growing four times to $12 billion–$13 billion in 2022.

In the current scenario, it goes without saying that the Indian tech ecosystem has evolved, and is in demand. Over time, as products get recognised, some companies may find themselves the subject of interest for an acquisition as M&A activity picks up.  

There are various reasons why companies look at M&A, but the top three are:

1. Consolidation: When two companies have gone toe-to-toe for too long and realise that a merger would give them an opportunity to have a larger market share, spend less money and drive a larger return for all stakeholders. 
2. Bolt-On: You have a product that fits well within a large company, and a large company desires what you have. Typically, large companies always have the option to choose between build and buy. In some cases, building a product, cornering the market and then beating competitors can be more expensive than just acquiring that competitor 
3. Cross Selling: You realise your product would find better synergy with another company. Sometimes you build a product that’s super useful, but as you build it, you realise that the total addressable market (TAM) that you hypothesised is smaller. But in combination with a different product, the TAM could be large and the best way is to sell.

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A successful M&A is a mix of several factors, and there is no sure recipe for success. The dynamics of how such offers play out would vary across startups, depending on what stage they’re at, how well-funded they are, and so on. But when there is an added dimension of talking to a potential acquirer in a geography such as the US, there are certain things founders can keep in mind before they take a final call on the acquisition proposal. The deal, if it goes through, should be beneficial for both parties.

Anuj Bhargava, Managing Director, Lightspeed, has seen M&A activity evolve over the years across both India and the US. His understanding of business is of great help to not just our portfolio companies, but also people in the larger startup ecosystem, including potential acquirers.

Here, Anuj talks about the things early-stage founders should keep in mind when approached by a potential acquirer in the US. 

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The approach

It can come about as part of commercial discussions with an existing customer / partner or an outright approach from an interested third party. The discussions can then go two ways:

1. The founder(s) does not wish to engage:

“Our experience is that in an overwhelming majority of these scenarios, founders being approached have tremendous conviction in their long-term value creation story and thus are unwilling to cut their ride short,” says Anuj. 

This conviction is understandably higher in a bull market, where everyone assumes there will be funds on the table. But they rarely factor in the fact that it will be extremely difficult to continue to build in a bear market.

2. The founders decide to take it ahead and see where it goes:

The founders should sign an NDA (non-disclosure agreement) and provide some basic information. The potential acquirer evaluates the merits and synergies of a potential combination. This stage involves an intense amount of work in building conviction for the acquirer around the value proposition of a potential collaboration. However, what is equally critical at this stage is for the founders to ascertain whether the buyer is the right one for them, and will provide the correct ecosystem for them to achieve their scale. At no point should the founders get distracted. 

 "A call for acquisition is a great call to get. It is a source of external validation of the value and potential of the business." - Anuj

Anuj says that irrespective of the outcome of this initial discussion, a call for acquisition is a great call to get. It is a source of external validation of the value and potential of the business. It demonstrates demand, and the potential to be complementary or augmentative to another business. What matters for a first-time founder at this stage is to adopt a measured approach towards the entire process and assess any offers with a fine-tooth comb.

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Understanding valuation

There’s no denying that any M&A activity is a financial and strategic transaction. Your capability as a business is valued based on several parameters, not just your last funding round. And these negotiations and valuations apply equally to a potential acquirer as well. 

“As a young company, you have to look at the forward looking outlook for your business, and recent and comparable transaction that have happened to support your valuation. These are M&A transactions for companies similar to yours. Or they could be financing transactions for companies similar to yours. So look for anything that can help validate some sort of valuation,” says Anuj. The next step is justifying this value to the acquirer.

"Information sharing is a gradual process. You don't want to be shy when asking for the right information and making the right decisions." - Anuj

But things get slightly more complex when you talk of a deal in terms of shares. An acquirer is very likely to inflate their value, and it will take a lot more digging to understand the real valuation of the acquiring company’s equity you’re getting into. 

“These (share transactions) become a little tricky because then it's not just the buyer doing diligence on the target, but also vice versa. Because now the business being acquired is going to get the acquirer’s shares, and it is important to understand what the one being acquired is really getting,” says Anuj. 

Since you want to make a decision that’s best for you and your business and employees, asking reciprocal questions from an interested buyer is also important. “Information sharing is a gradual process. You don't want to be shy when asking for the right information and making the right decisions,” says Anuj.

Acquirers will want you to sign a term sheet early on, but Anuj advises against signing anything binding until completion of due diligence on the acquirer.

Structuring the deal

There are several ways to structure M&A deals, and considerations such as whether you are getting an offer from a private or public business, and how and on what parameters the deal is structured, play a big role. 

At a broad level, some things the business being bought should keep in mind in an acquisition are:

• How much of the combined company will the company being acquired actually own after this transaction?
• What is your ultimate objective in this transaction? Is it to build your business as part of a larger entity? Is it to monetise eventually? 

In the second case, founders can look at a two-stage transaction to make the most of the deal. “Instead of selling a small company for cash from day one, you might trade it with shares in a bigger company. And that bigger company may have a better opportunity to monetise the IPO and hence you get cash,” reasons Anuj. 

There is also something called an earn-out. It’s basically a deal where there is an upfront payment, and future payments depend upon the achievement of agreed-upon milestones. It’s usually a way to sweeten the deal when there is a mismatch between the offered valuation. 

“How it usually works is that the acquirer says I'll give you ‘x’ amount for your shareholding, and I will then give you ‘y’ amount as an incentive package to stay on with me for the next three years to build this out properly,” explains Anuj.

It may be natural for founders, especially first-time founders, to be in two minds about selling or integrating a business they have helped set up from day one. A question that often gets asked is: Is there a good time to back out of a deal?

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Mind the culture 

Like with anything that involves two continents, a business deal is also equally likely to face cultural hiccups. And it's not just about a geographical difference. Even within the same broader market, companies can have very different ways of working, and it is important to take that into account when new management takes over. 

It’s the acquirer’s job to ensure the integration goes smoothly. “You need to have a clearly defined roadmap, which should be in place up to the day the deal is signed. Who's doing what? What is the leadership going to look like? If you really find something that's worth buying, you want to make sure that you retain the DNA of the culture of that institution. So retain the people, and have a clear role for them. Don't come in and start firing. Have a steering committee that oversees everything,” says Anuj.

"You need to have a clearly defined roadmap, which should be in place up to the day the deal is signed. Who's doing what? Don’t come in and start firing, have a steering committee that oversees everything." - Anuj

Here, founders should do more work around the acquirer’s M&A history to see if they have a strong track record of being able to integrate new businesses and scale. 

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Best practices

There is no set playbook for M&A because businesses and industries are vastly different, but here are some things Anuj recommends that will help founders through the entire process:

• Take advice from a trusted, experienced advisor early on.
• Keep things structured, not random.
• If you have multiple offers, make the process competitive.
• Your bankers and advisors should position you as having attractive options on the table, which may or may not take the form of M&A. 
• Weigh your options and do what’s best for your business. 

Acquisitions are not once-in-a-lifetime opportunities, but they are interesting instances during which you can give yourself and your shareholders a large, lucrative exit. Founders need to be open to these opportunities while being mindful of the traps they bring with them. 

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#M&A #Acquisitions #synergy