Here’s how can tech founders can prepare for M&A
Jonathan Simnett, a director at Hampleton Partners, explains how tech entrepreneurs can prepare for M&A.
In today’s economic climate, mergers and acquisitions (M&A) activity is an integral part of the normal business cycle.
For technology businesses, it’s not only integral but essential as tech marches to its own globalised, highly competitive tune driven by unprecedented rates of fragmentation, consolidation and high expectations of growth.
Failure can come quickly in such a disruptive environment. Larger or fast-growing companies, which may have not existed a few years ago, have limited ability to innovate from internal resources. They often need to acquire to ensure they are not left behind in the race for technological change.
M&A is the new R&D
It’s generally not appreciated that tech giants like Amazon, Microsoft and Google have been built mostly on the technology innovations of others.
Tech M&A activity peaks when disruption accelerates. Disruption may occur when new or high-growth markets emerge, when new players enter from other markets or as a result of regulation – or often a combination of these as we are seeing in the current electric and self-driving vehicle goldrush.
Current financial conditions are driving tech M&A, too. Interest rates are low, share prices high, and tech companies are generating mountains of cash. Hampleton believes that the amount currently available for acquisition in technology company’s war chests is around $1.6bn.
Top of mind from the outset
That’s a lot of money looking for a good home. I say good because, even in a time of such abundance, acquiring firms and investment funds remains tricky as both strategic and financial buyers are competing for the best deals.
With this in mind, regardless of why the founded their company, tech entrepreneurs must ensure M&A strategy remains at the top of their mind from the outset – either as an acquirer or the acquired. M&A is now simply ‘business as usual’ in any growth strategy.
By this, though, I don’t mean that entrepreneurs should hold on to romantic fantasies of being acquired by a West Coast behemoth for an improbable sum a few months after inception. These sensational deals form the tiniest proportion of M&A activity – most M&A goes unnoticed – and usually involve companies from the close technological, financial and academic community of Silicon Valley. In fact, the majority of European tech firms will be acquired by a company from the same geography.
Reducing potential risk
Successful tech M&A is about reducing potential risk for both the acquirer and the acquired.
With this in mind, it is crucial for founders to understand how their company may integrate into a selection of target acquirers and vice versa.
Acquirers want to see steady, predicable revenue, EBITDA growth, a blue-chip client list or a hyper-growing top line based on cutting-edge technology that offers revenue development opportunity for their firm or investment.
Another element of risk reduction is the presence of a solid, loyal management team behind the founders or majority shareholders, preferably each with a shareholding. Avoid giving out many small parcels of shares, though, as that just creates difficulty down the line.
The assessment of risk comes into sharp focus in the due diligence process where hundreds of documents may be given up for examination in a ‘data room’.
Start like you mean to go on
Make sure that you are ready form the outset. Record and minute every board meeting, file every contract, every employment agreement, shareholding structure, ownership details, tax payments and liabilities.
Ensure that you enforce your trading terms from the beginning so there is no evidence of poor payment records and as little bad debt as possible.
If you can build a business with recurring revenues, contracted months in advance, that’s great. But, failing that, create long-term customer contracts or ‘sticky’ consumers.
Don’t underestimate the importance of marketing in building a valuable, recognisable brand – no matter whether you are in a B2B or B2C segment.
Timing and focus is paramount
But, as in all things, timing is paramount. Our research shows that enterprise value to sales multiples paid for technology businesses decline very sharply during the first six years of their life.
The amount you may realise for your firm will of course depend on ratios. So, while you might be increasing turnover and EBITDA over time, the multiple applied is likely to be falling – you could be in danger of spending years building up a firm for it only to be worth the same as it was when it was a much smaller entity.
Overall, getting everything above right from the beginning will be vital when you inevitably enter the M&A process. Particularly if, over the many months that the process will take, you are able to ensure the efficient day-to-day running of your company and meet your budget projections.
If you fall short of your numbers during the process, you could, after years of effort, bring the whole process to an abrupt end.
For more advice on how you can prepare for M&A, watch this video.