Shopping Spree

In the coming months and years, I suspect we will see increased M&A activity move through the technology industry. And while there could be a fair number of large strategic purchases (think Facebook buying WhatsApp or Microsoft buying GitHub), I sense an uptick in “smaller” acquisitions, those that could range anywhere from $10M-$500M. Investor Elad Gil calls these team or technology /product buys. 

Several forces could drive this M&A cycle:

The universe of software & technology acquirers rapidly expands

Good acquiring businesses in technology require a couple key ingredients — significant market capitalization, growth as an integral part of their valuation narrative, and the combination of cash and cheap equity to dole out. The conditions are ripe for an increasing number of businesses. The public markets have been generous to software companies, and high-growing SaaS businesses command serious premiums with buoyed stock prices. And you’re starting to see CEOs capitalize on this. Jeff Lawson of Twilio comes to mind — Segment is the notable purchase, but he also recently bought Zipwhip for a cool $850M. On the private markets side, it feels as if there’s a new unicorn minted daily. If you look at the CB Insights list, there’s a flood of businesses now in the $1B to $10B valuation range. Except for the rare few, acquisitions will be essential for the next leg of growth investors are banking on. Private darling Hopin (at a rich $7.75B market cap) has already purchased a string of businesses.

The digital transformation story has a new look

To say that every company is now a software company is to beat a dead horse at this point. Most recognize the importance of digital and its value inside of legacy enterprises to customers, employees, and shareholders. Yet, “the digital transformation” (don’t blame me, blame McKinsey) story to date has focused on large enterprises as purchasers of software, thus the high growth of companies like Zoom, MongoDB, DataDog, etc. Buying tools is still a band aid. Many large businesses recognize the importance of in-housing technology assets in order to revitalize companies, and will up the frequency of acquisition. To my surprise, manufacturing has been an interesting case study — large industrial giants like Rockwell Automation and Emerson Electric have emerged onto the software M&A landscape. Another example — John Deere bought a startup called Bear Flag Robotics for $250M.

Talent fragmentation and consolidation

This point might be the most under-discussed of the three. Companies that truly break out (north of $100B market cap) are gravitational centers of talent for years. Their systems not only distribute products at massive scale, but also consolidate talent and energize them to reach their full potential. Getting to this level is the aspiration of many of the previously-mentioned acquirers. Startups are easier than ever to start (this is good!) due to the global distribution of company-building ideas (CS183B and Paul Graham’s essays are free!) along with cheap capital and infrastructure like AWS and Stripe. However, this has led to talent fragmentation at the early end of company life cycles. Talented groups of friends & peers don’t band together to start companies; they all start their own because there’s little friction. Over time, there will be a move back to consolidation and “acqui-hires” (even in the $50M - $100M range) can be an effective way for a growth business or young public company to quickly scale up engineering and product resources.

If this M&A cycle materializes, there will be plenty of downstream effects. One of the largest will be in capital markets. The entire business model of venture capital is predicated on a certain distribution of outcomes — one that is driven by extreme outliers and high loss ratios. One does not return megafunds on < $B outcomes. However, a surge in small to mid cap M&A could be a boon for ownership-sensitive pre-seed / seed funds, who have been a bit crowded out in this current funding environment. Their original models derive from an era where companies like Google and Facebook were more acquisitive, so owning 10% of a $400M was meaningful for a fund of a certain size. 

What could halt M&A activity?

Increased founder liquidity in secondary transactions

Anecdotally, I’ve seen more secondary shares coming off the table earlier and earlier (sometimes even in the Series A). Founders normally waited until growth rounds to sell their secondary positions. I won’t exhaust the secondaries debate (it’s a market!), but I will say that increased founder liquidity in a company’s lifecycle diminishes the likelihood that they would take money off the table with a sub-scale exit. 

The valuation multiples of target companies are untenable

Frothy valuations are the topic du jour, and you’ll hear of many companies that “raise past their skis,” meaning that there’s limited traction that lines up with the company’s valuation, which usually looks at it on a relative basis to historical precedent. These just become messy transactions for a variety of reasons — founders are anchored to a higher price, common stock wipeouts, etc. 

I’m excited and curious to see how the M&A environment plays out in technology over the coming months and years. If it does in fact escalate, it will also be quite exciting to see recycled liquidity come back into the system to drive forward the next generation of startups.