Tech Startup M&A | Outsourced Corporate Development

With Covid as a huge accelerant, many traditional business leaders are finding that they need to use M&A to move faster with their digital efforts, and tech startups can be the perfect catalyst.

Tech startups and traditional enterprises share a great deal of synergies, but traditional enterprises can struggle to understand how to value them. Internal corporate development departments are good at performing DCF analyses and buying businesses that are similar to the existing enterprise. However, many enterprises are finding the need to outsource corporate development for external technology M&A advisory as it relates to startups.

The Perfect Storm: Tech Startups are Ready and Waiting to Partner with the Enterprise

For the past 5 years, first financings in tech startups have been declining year over year. That means, fewer and fewer new startups being created. Yet, overall VC investment is increasing.

Investors are putting more capital into the later stage tech startups and that has created a financing gap for earlier stage startups, generally those under $500 million in valuation. With the impact of Covid-19, younger startups with promising tech and talent are facing an even harder fundraising environment. Yet, large enterprises have an even greater urgency to embrace digital. The combination of the two worlds, tech startups and traditional enterprises, makes sense for both sides.

Traditional enterprises can bring scale, brand equity and capital. The startup can bring digital tools, hungry talent, and new business models that can drive incremental revenue for an enterprise’s core business.

Evaluating a Tech Startup and Building the Business Case: Proof of Concepts

Young startups are much riskier than typical investment opportunities that a corporate development team would evaluate. The business model is foreign, the technology and IP is relatively unproven, culture clashes abound and much more.

One of the best ways to validate a potential investment opportunity is to setup Proof of Concepts (POCs) with a shortlist of promising tech startups. POCs will help the enterprise realize the capabilities of the team, IP and culture fit, as well as benchmarking the startup’s capabilities against its peers.

This process is a new one for most large enterprises, so an external technology M&A advisor can help define the scope of the POCs, set them up with the appropriate startups, execute them and then evaluate them. This outside resource can function like an outsourced corporate development department for tech startup deals. Collaborating with an enterprise’s internal corporate development team, the group can come to consensus about the results of the POCs and build a business case with strong conviction and real external validation.

Structuring Tech Startup Deals: Balancing Risk and Reward

There’s a range of transactions that can be structured with a tech startup, from a strategic partnership, to an investment to an acquisition. You can also get creative with a joint venture, minority vs. majority investment and a whole slew of other approaches. The key, in any model, is to understand how the tech startup will drive value to the enterprise in Year 1 and beyond – and vice versa.

If there isn’t material synergy that can be realized to the organization in the immediate term, the deal won’t be successful. Instead, maybe the transaction should be viewed through the lens of corporate venture capital, where the investment is analyzed over a longer VC-like time horizon. Realizing two-way synergies is hard and it takes a committed work effort from both organizations. That’s why Year 1 synergies are important to get the enterprise motivated to execute and see through the integration efforts.

With a mutual understanding of Year 1 and beyond synergies to both the enterprise and the startup, tying future dollars to minimum levels of performance becomes a more straightforward practice. For example, in a partnership model where the enterprise gets a revenue share for up-selling the startup’s products, the revenue-share rate could increase as certain volume thresholds are met.

For an investment, additional options could be issued to the enterprise. For an acquisition, portions of the founders’ earn-out could be paid out. These examples are obviously oversimplified, but the key is to figure out how the startup can help the enterprise drive incremental revenue or margin growth.

With a deal structure in mind, determining the optimal valuation of a tech startup is another challenge. If your team lacks expertise evaluating tech startups, this challenge is best solved by relying on an outside expert advisor that has experience with tech startup investments or acquisitions. This person or firm will be able to help ensure your enterprise gets the best value out of a transaction, while also helping to build consensus internally on whether to go forward with a deal. If the rest of the executive team and board of directors doesn’t share confidence in the team responsible for doing the deal diligence and deal execution work, then the transaction will fail before it’s even started.

Moving Mountains: Getting Enterprises to Take Action and Execute Effectively

These kinds of transactions need the involvement of the enterprise’s CEO and need to be led by a member of the C-suite. Inherently, these tech startup transactions will result in incorporating different technologies and business models. As the organization builds muscle memory doing tech startup transactions, then the CEO’s direct involvement can lessen. However, in the earlier days, direct involvement will be a key determinant of success.

The Chief Digital Officer, CDO, is a common role that could run point on these kinds of transactions, as can a CIO or an innovative head of M&A/corporate development/strategy. These executives still need the participation from the CEO because ultimately another member of the executive team will need to change his/her department’s priorities to work with the new tech startup. The CIO/CDO/Head of M&A doesn’t have the authority to tell the President of a business unit or the head of sales and marketing to reallocate their resources and priorities. This is where the CEO is able to level set the priorities across the executive team to ensure that the new tech startup initiative is setup for success.

Integration and Scaling Up

Integration efforts are where 90% of M&A transactions fail. Assuming the right organizational alignment is in place, execution and integration risk are still very high. An outside team of that has experience integrating tech startups with traditional enterprises will help the startup move more quickly. One of the biggest challenges for these transactions is for the large enterprise to match the pace and cadence of a tech startup. A week in the startup world can feel like a month in the enterprise world. Startups move fast and it’s difficult for an enterprise to be nimble and give the startup what it needs, when it needs it. An experienced integration firm can help the enterprise be more agile by providing additional startup-friendly resources. Even with the CEO’s directive to act, existing teams inside an enterprise have multiple competing priorities and it’s hard for them to provide enough dedicated cycles solely to the startup. An external partner can help augment an enterprise’s internal teams and ensure a more seamless integration with the new tech startup partnership.

The Holy Grail: EV in the Startup and Multiple Growth in the Enterprise

If all goes to plan, not only will the enterprise’s startup investment be accretive and create additional enterprise value, but the enterprise’s valuation multiples will also increase. This increase will be derived from faster revenue growth, margin improvements or increased defensibility as a result of the startup partnership. If the gains can continue to compound upon themselves, the tech-enabled synergies will ultimately increase the traditional enterprises valuation multiples – the holy grail of M&A.


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