This article is written by Nikunj Arora, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Table of Contents
Introduction
Ed-tech startup Byju’s acquired Aakash Educational Services Ltd (AESL) on April 5 2021 for the sole purpose of bolstering its presence in the test preparation segment in the country. This acquisition deal was worth approximately $1 billion (Rs 7,300 crore) and was one of the biggest acquisition transactions performed by Byju’s to date. On October 25 2019, telecommunication company Bharti Airtel acquired an 8.8% stake in Bengaluru based startup ‘Vahan’ which was formed in 2016 and backed by Y Combinator and Khosla Ventures. Vahan helps blue-collar job seekers to match with employers inside a messaging app interface such as WhatsApp using Artificial Intelligence (AI). Airtel launched its Startup Accelerator Program to support early-stage tech startups and announced that Vahan was the first startup that was induced in its accelerator.
The tech ecosystem in India is currently booming and there are multiple startup IPOs, several investments flowing in, and the enthusiasm of recovering in a post-pandemic situation is quite high. The National Broadcasters Federation (NBF) which is India’s largest trade body of television news channels has recently tied up with legal tech startup ‘Webnyay’ to collect and provide complaints on content in news television channels. There are more such prominent examples of tech startups either acquiring or getting acquired. This article discusses how the acquisition is triggered in the tech startup sector.
Understanding tech startups
According to StartupIndia, which is the single largest online portal for startups and entrepreneurs in India formed by the Government of India, India has the 3rd largest startup ecosystem in the world and is expecting to witness an annual growth of 12-15%. According to it, India has approximately 50, 000 startups in 2018 out of them 8,900-9,300 of these are technology-led startups/tech startups.
Companies such as Coursera, Flipkart, Airbnb, Facebook, Uber are generally from different niches and one thing that unites them is that all these companies started developing and validating scalable business models with initial funding from their own pockets, families, and friends. Thus, they have termed start-ups.
Therefore, a start-up can be defined as a young company founded by one or more entrepreneurs to develop unique products or services into the market with initial funding from the founders or their friends and families. Over half a dozen Indian startups entered the Unicorn Club, raising $1.55 billion (Rs 11,580 crore) between April 5 and April 9, this year. In 2020, there were 11 unicorns, 900+ startups funding deals, and $11.5 billion was raised by the Indian startups.
A basic definition of a ‘tech startup’ is that it is a company whose sole purpose is to arrange or provide technological products or services to the market. These companies find and use new ways to deliver new or existing technology products or services in the market. Some of the major and known companies that were once tech startups are Google, Apple, and Facebook.
Today, the startups are either categorised as ‘High-tech startups’ or ‘tech-enabled startups’.
High-tech startup
A startup that is categorised as ‘high tech’ means that they are the companies that have to invent something if they want to survive in the market. One of the most common examples of a high tech startup can be when Steve Jobs and Steve Wozniak put together the first Apple computer (see here) where they had to come up with the new operating system, circuit boards, and order custom parts from the suppliers to make their first product. Thus, in a high tech startup there is a risk of application of technology, requires an R&D process, and then adoption in the market which is uncertain. A high tech startup comes with benefits such as an exciting work environment, return huge multiples, etc. Along with the benefits, there are some cons too, such as highly technical and market risk, the requirement of large investment capital, etc.
Tech-enabled startup
These startups are quite opposite of high-tech startups. The tech-enabled start-ups usually use the existing ones to improve the efficiency and performance of a product or service which already exists in the market. For example, Hired.com (see here) is an AI-driven marketplace that matches ambitious tech and sales talent with the world’s most innovative companies, and thus, can be classified as a tech-enabled startup it is not inventing any new tech product or service but using the latest innovative tools to improve tech existing market.
Tech startup business model
A business model is very important for any startup, therefore, the following are some examples of tech startups with their business models:
- WOLFRAM ALPHA: WolframAlpha is developed as a knowledge engine or an answer engine formed on May 15 209. It works by using its massive amount of knowledge engine and algorithms which automatically answer the questions and generate reports of the analysis. It was created by a former physicist ‘Stephen Wolfram’.
The business model of Wolfrom works on the pro-subscription membership for students, application programming interface (APIs) for startups and enterprises, Google Play or iTunes Apps.
- AIRBNB: Airbnb is an online marketplace where the connection is made between the people who want to rent out their homes and people who are looking for accommodation in that particular area. The name comes from ‘air mattress B&B’. Today, the company covers around 100, 00 cities and 220 countries worldwide.
Airbnb relies on a very simple business model making money by charging guests a service fee and giving some amount of commission to the host, thus enabling trust between guests and hosts. The growth of this tech success depends on the quality of pictures, thus, the company usually hires any freelancer that would click photos of the host’s accommodation for free, making it appealing for the guests.
- DUCKDUCKGO: DuckDuckGo is an internet search engine founded by Gabriel Weinberg in 2008. It focuses on protecting the privacy of the searchers, hence, does not track its users. Along with the 59 Chinese Apps which were blocked by the Government of India in 2020, this private-oriented search engine got banned too; however, the Government of India did not clarify the reasons as to why this search engine was banned.
The search engine made its business model based on differentiating its value proposition compared to Google using advertising and affiliate marketing. However, the business revenue was quite low as compared to Google as the company only relies on advertising and affiliate marketing without tracking its users.
- LINKEDIN: Linkedin is a professional networking online service platform founded in 2002. The online platform made $5.2 billion in revenues in 2008 and gained 630 million members by October 2019.
The LinkedIn business model is built around 4 pillars, i.e., talent solutions, learning and development, marketing solutions, premium subscriptions. The platform offers services to HR professionals that allow them to find the right people for the right job. It also offers a learning platform, thus, bridging the gap with the world of professionals.
Acquisition(s) in tech startup space
Almost every day now, we hear news of multinational conglomerates acquiring start-up/tech startups making us familiar with successful startups exiting to multinational companies. On the other hand, there is little or no news about early or middle-age startups acquiring other startups. The main reason why these small acquisitions do not make the headlines is that the headlines do not consider the small amounts paid for these acquisitions and usually large acquisitions of the conglomerates take over.
In the case where a tech startup has reached the end of its journey, i.e., if it is unable to make innovations to the technical product or service offered, or has run out of cash, or not able to adapt to the uncertainties of the market, or is facing difficulties upscaling its operational strength, then the founder(s) have only limited options, such as, either to close down the startup or to look out for an exit strategy.
Structuring of M&A in the tech space
The most important element while structuring a tech startup sale is the ‘value addition’. The value addition plays a major role in either acquiring another company/startup or getting acquired by another company/startup because as long as there is no value addition the acquirer or the acquirer cannot buy or sell the same, respectively. There shall be some innovation to the existing technical product or service or a new technical product or service is launched, making it easier for the said tech startup to get acquired or acquire another startup.
Generally, it is not common for the founder(s) to sell their startup for a nominal sum, because if this is the case, then the acquirer will not want to spend much on getting the deal done. In most cases, there is a requirement of a business transfer agreement to transfer the assets and intellectual property rights from one company to another if there is an acquisition happening in a tech startup space.
In the case where the founder is selling his startup and a major shareholding of the startup being sold, then share sale becomes more appealing, and structuring the sale through the share sale means that the founder would not be required to hold onto any of the liabilities. However, the acquirer/purchaser may not be in favour of this structure and can be hard for the founder to negotiate in this case.
According to several experts, if the startup is in a state of the plateau, then the founder(s) should consider the acquisition as it is better to gain something from the said startup which is in the state of the plateau, even if the acquisition if for a nominal sum, as the founder(s) should be realistic about their future value of the business.
Benefits to the Acquirer
There are several benefits to the acquirer if he is acquiring a tech startup for his current startup, such as:
- TEAM: Hiring the technical team can be hard sometimes and the startup which is for sale can provide an efficient and effective technical team to the acquirer for his future needs.
- TECHNOLOGY: A tech startup may have developed some useful technology even if it is not able to adapt to the uncertainties in the market or has not found any product or market fit. The acquirer can gain or generate a good source of leads from the acquired startup.
- CUSTOMERS: Acquiring a startup also means acquiring their customers or users. In most cases, customer acquisition can be expensive; hence, acquiring the startup through a business acquisition route can prove to be a cost-effective channel.
Benefits to the Seller
If the founder chooses the alternative to shut down the startup and sells a plateauing startup, then he can acquire the following benefits:
- JOB: The main reasons why startups are acquired (i.e. acquihires) is that upon the acquisition, the founder might be offered a job that can be appealing.
- EXISTING CUSTOMERS: If the founder is selling his startup to his competitors, then he can ensure that his customers are being looked after and they will have a continuing need for the product/service provided by him.
- CV: A successful sale of the startup can be more beneficial than its failure, thus, making the CV more appealing.
- INVESTOR RELATIONS: In case the founder(s) have raised some external capital and he/she has gained some amount of value after selling his/her startup, then he can repay the capital of the investors. This will maximise the relations with the current investors which can be useful for the future.
In 2020, conglomerates worldwide acquired tech startups to modernize distribution channels, or improve enterprise security, or integrate AI, or gain competitive advantage through technological convergence, whatever the case may be. There are several challenges associated with tech acquisitions such as, for large organizations a tech start-up would often mean that there is limited financial and commercial documentation available. Knowing the challenges associated, these conglomerates can be successful in making acquisitions in the tech space. The following are the challenges in a tech startup space:
- INTELLECTUAL PROPERTY: It is important for the acquirers to understand where the value of the target tech startup lies, i.e., whether it lies in the technology or the know-how of individuals. If the value lies in the former case, then, it is to be checked that the target should properly own the technology and is not infringing on anyone else’s intellectual property rights. If the value lies in the know-how, then, the acquirer should ensure that the diligence process may not become challenging.
- TALENT: It is also crucial for the acquirers to ensure that the performance of the key employees does not get affected if integration does not work out. The process of retaining the key employees might come under economic incentives, but also involve forming a slimmed-down policy environment where the tech talent is free to innovate.
- CONTRACT: The contractual arrangements, whether existing or non-existing, should be taken into consideration by the acquirer while undergoing the acquisition process. The types of contracts under this case may include commercial, intellectual property licensing, employment, other licencing contracts; hence, the acquirer should plan accordingly.
Why are industrial companies acquiring tech startups?
In 2017, several non-tech firms acquired tech-based startups as against the usual process where big tech firms buy small firms. Times have changed now, and several industrial conglomerates are acquiring tech-based startups for the following reasons:
- Technology-based business: Every business is going mobile in the 21st Century, be it buying books or cars or clothes, the parts of the buying process are done online. Technology has completely taken over the business. Every business or industry has digital footprints; hence, the acquisition becomes important. Conglomerates like Walmart acquire small retailers who have digital footprints and have developed or produced some specific technology. The reason for companies like Walmart acquiring such small retailers is that the technology developed by these small companies can be leveraged by Walmart to increase its online presence. Therefore, the tech-based startups in the industries such as Fintech and e-commerce are providing the amount of value addition to the traditional banks and conglomerates, and since these startups provide value and synergies, these traditional companies agree to pay more.
- Leapfrogging the competition: The tech startups are known for their high-end products/services and the traditional conglomerates usually do not have the potential workforce to develop or maintain such high-end products/services. These high-end tech products offer a competitive advantage these days. Due to this high demand for tech products, traditional industrial companies are trying to build their high-tech digital departments. However, sometimes building their digital departments can be time-consuming; thus, they tend to acquire tech startups. These acquired tech startups allow the companies to leapfrog ahead of the competition.
- Reduction in costs: The reason why technology companies are the most profitable businesses worldwide is that the subscription to high-technological products is quite expensive. Many companies tend to eliminate these subscription costs and to do this, they acquire tech startups which have to develop a product/service which they need to use. Therefore, it is better to acquire startups than to pay for the annual subscriptions of these tech products. This will not only lower the costs but also increase profitability, generating more revenue sources.
- Access to resources and clients: Most tech startups have access to valuable resources and potential clients, and this is the reason why the startups are being sold to big industrial conglomerates. And if the startups are acquired by these companies, the promoters would not have to worry about immediate cash flow and focus on the product design or other valuable issues which shall be important for the companies in the long term.
Apart from the above advantages of acquiring a tech startup, the following are some of the disadvantages which ought to be considered while acquiring a tech startup:
- Decision-making: The speed of any tech startup is crucial for its growth. However, the problem comes when the industrial companies acquire these startups, the number of people who are involved in the decision-making process tend to get higher, thus, the speed of the decision-making process gets slower.
- Immediate profitability: In its initial years, tech startups are known to be loss-making firms and the startup reaches its break-even only when the number of users reaches a critical mass. If the startups are focused on profitability in their starting years, then they would not be able to survive a long period. In this case, the industrial conglomerates business models are fundamentally different, and this is the reason why the formulas or policies which are considered crucial to industrial companies create disaster in the digital firm.
Why are tech businesses seeing business growth through startup acquisition?
According to a report by Deloitte in 2020 (see here), the technology acquisitions were at their high in 2020 and 17% of the respondents stated that technology acquisitions will become the driving force behind Company’s M&A strategy for the coming years.
Mergers and Acquisitions are becoming popular in the technology sector because of the following reasons:
- Different methods of Innovation: There are several methods of innovation such as venturing, incubation, internal R&D, but, the rapid pace of digital innovations and competition in the talent war is compelling the tech companies to acquire instead of building their structure. Therefore, many companies are acquiring startups to get access to their intellectual property, innovations, talent, and proprietary data. These companies are using M&A as a tool to get access to new technologies such as artificial intelligence, 5G, machine learning, cloud computing, etc.
- Growth of Software Companies: The software and online software companies have a higher rate of growth than most industries, and acquisition could be used to accelerate the growth of such companies. The serial acquirer can manage to preserve organic growth by driving more growth out of each deal. A mixture of inorganic and organic growth would let these companies grow in the industry and survive.
Following are the examples of Serial acquirers among Technology Companies:
|
SERIAL ACQUIRER |
NO. OF ACQUISITIONS RECENTLY |
RECENT ACQUISITIONS |
|
Accenture |
30 |
|
|
|
11 |
|
|
|
11 |
|
|
Microsoft |
10 |
|
- Aligning Acquisition Approach with Growth Strategy: In its initial years, tech startups need support for their growth, reach and talent, and because many of these startups would not be able to survive alone, they are acquired by large tech companies that need innovation strategy. Therefore, it is important for both parties for the long term as growth will evolve for both sides. In digital acquisitions, the synergies can be achieved by either accelerating the target’s growth or growing the acquirer’s capabilities. In the former case, the strength of the acquirer which includes its capital and capabilities can be leveraged to accelerate the target’s growth, while, in the latter case, the acquirer can develop and grow its business and can identify new ways of generating revenue by leveraging target’s capabilities.
- Protection: In the situation where there is digital disruption, the large tech companies can protect their core business by leveraging the tech startups, i.e., by acquiring their business. This acquisition will give these companies safety as well as growth.
- Transform: The tech companies can transform their product or services offered to the customers by using or leveraging the tech startup’s mindset and innovative skills. To compete with their competitors, these companies acquire startups that may transform their work culture and skills.
- Augment: Tech companies can augment or increase their value of product/service portfolios by acquiring the startups. The reason for acquiring these startups is their new products, innovations, business model, and then integrating these benefits into the company’s existing business.
EY India acquires AI start-up by four IIT alumni
EY India, which is a global leader in assurance, consulting, strategy and transactions, and tax services, had acquired Spotmentor Technologies in November 2020. It is an artificial intelligence (AI) backed human resource technology start-up, started by four (04) Indian Institute of Technology, Kharagpur alumni.
Key takeaways:
- The acquisition was done by EY during the period when several top consulting firms were heading towards deploying more AI and machine learning in their product offering.
- Spotmentor Technologies is a skilling platform that provides a platform to businesses to identify their skills for the future statement of work, i.e., upskilling and reskilling talent. EY’s purpose of this acquisition was to strengthen its advisory portfolio of digital services.
- Not disclosing the deal value of the said acquisition, Rohan Sachdev, Partner and Consulting Leader, EY India, told in an interview that this acquisition would boost the digital offerings combining strengths in skill development and delivering clients through an intelligent technology platform.
- EY Spotmentor provides real-time market intelligence on new skill sets, identification of reskilling opportunities, and measurement of skilling progress.
- EY Spotmentor also provides employee evaluation through 360-degree feedback and assessment tests.
- In 2019, EY India acquired C Centric (a leading provider of CRM solutions and services).
- In 2018, to focus on digital transformation including design thinking, user experience design (UX), acquired Fortune Cookie UX design.
Indian tech startups acquisitions and investment by reliance in 2018-19
Reliance Industries Limited (RIL) made the following tech startup acquisitions and investments in 2018-19:
- C-SQUARE: It provides a platform of software solutions, mainly focusing on the pharma sector for several stakeholders including distributors, retailers, online eCommerce, etc.
- EASYGOV: It is a SaaS startup that provides a platform where citizens can search and apply for various Indian Government schemes or services. The acquisition was done through a subsidiary of RIL which is Reliance Industrial Investment and Holdings.
- IMBIBE: Embibe is backed up by Kalaari Capital which leverages AI-based data analytics and delivers personalised learning outcomes for the students. RIL aims to connect over 1.9 million schools and 58K universities across India.
- FYND: It is a tech startup that functions through an O2O model and directly sources products across categories.
- GRAB: It is a platform that offers services like on-demand, reverses deliveries, first mile, and last-mile logistics.
Apart from these, RIL has made investments in global tech startups such as DEN, Hathway, Eros International Plc, Edcast, Vakt holdings, Kai OS Technologies, Videonetics, etc.
Conclusion
New businesses/startups have overwhelmed the world, and the Indian startup situation is no less. It has been accomplishing an amazing year on year development, and there is by all accounts no halting at any point shortly. In 2014, there were around 29,000 startups in India. Nonetheless, these numbers gradually and slowly began rising. This number will reach around 55,000 every 2020. Consistently around 3-5 startups, new startups are conceived. To investigate the biological system that exists in India, we would first be able to take a gander at the various businesses in which these new companies exist. With the significance and support given to digitalization and the Government’s campaign of Digital India, the startup pattern saw a critical ascent in the innovation area. In 2019, the quantity of tech new businesses in India developed from 8900 to 9300 with around 1300 new companies being included in the year 2019 itself. Consequently, the new business areas in India can be extensively isolated into two sections: tech-based new companies and non-tech based new companies. The tech-based portion incorporates areas like Fintech, E-Commerce, Edtech and Healthtech, while the non-tech based fragment incorporates Agri-items, Construction, Textiles, and so forth.
The M&A deals have increased in the tech startup space and the pandemic has in a way created opportunities for more investments, acquisitions and mergers. Experts say there are better chances of getting good deals right now.
References
- https://www.broadcastandcablesat.co.in/news-broadcasters-federation-ties-up-with-legal-tech-startup-webnyay/
- https://www.karllhughes.com/posts/high-tech-enabled
- https://fourweekmba.com/tech-startups-business-models/
- https://www.linkedin.com/pulse/why-startups-should-consider-mergers-acquisitions-lachlan-mcknight/
- https://www.managementstudyguide.com/industrial-companies-acquiring-tech-startups.htm
- https://inc42.com/resources/tech-companies-unlock-business-growth-through-startup-acquisition/#:~:text=Augment,offerings%20into%20its%20existing%20business
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