This post is part of a series of case studies Exitround is publishing about companies that have used the Exitround platform.
Bangalore-based Attribo had built a service for companies to manage their cloud resources and spend across all their various accounts. The company was interested in an exit but did not have suitable buyer contacts, particularly in the U.S.
Meanwhile, Portland-based Cloudability provides technology for companies to manage the costs of their cloud services. Cloudability was looking to expand its business through M&A in the cloud management space, and but it didn’t have quick ways of identifying and targeting acquisitions. The two companies each joined Exitround and the Genome M&A engine paired them up. Soon after, a deal was completed.
Founded in 2011, Portland-based Cloudability provides technology for companies to manage the costs of their cloud services across a company’s finance, engineering, product or executive teams. The company has raised $15.8 million in venture capital funding. Cloudability has major customers such as Uber, GE, Adobe, Imgur and Cengage Learning.
HOW IT HAPPENED
Prior to discovering Exitround, Cloudability had recently consummated another acquisition in the cloud management space, CloudVertical. Cloudability founder and CEO Mat Ellis was interested in ramping his acquisition strategy to quickly expand in the market, but his nimble team needed leverage to ramp his corporate development processes. The Exitround platform enabled Cloudability to quickly get a sense of the market and move swiftly to consolidate the space.
Attribo was a competitor to Cloudability and the CEOs did not speak regularly. The Exitround platform and M&A engine identified the high degree of relevancy and intent between the two companies and suggested that they connect. The recommendation was helpful as Cloudability would not have known Attribo was interested in exploring an M&A option.
After both agreed to connect, an introduction between the two parties was made. Because of the efficiency of the Exitround platform, they were able to get a deal done quickly. “We wouldn’t have been able to do another acquisition so quickly after our previous one,” CEO Ellis said. “But with Exitround we could.”
The deal came together rapidly — 60 to 90 days after connecting on Exitround. On June 24, 2015, Cloudability announced the Attribo acquisition. That deal allowed Cloudability to further expand in the market and also expand internationally. The company has since gone on to do another acquisition in the space, Portland-based big data company RipFog.
The Exitround platform directly enabled the Cloudability team to efficiently and intelligently identify M&A opportunities, greatly contributing to the company’s rapid growth.
Data has confirmed what many in Silicon Valley have been saying for months: venture capitalists are pulling back. M&A and IPOs also dropped in Q4 2015 from the prior quarter.
VC-backed M&A dropped to 120 deals worth $15 billion in Q4 2015, which was down from 135 deals valued at close to $16 billion in Q3 2015. On a year-over-year basis, the drop was even greater, due to a massive Q4 2014, according to Dow Jones VentureSource.
The largest deal of Q4 2015 was Bristol-Myers Squibb Co.’s acquisition of Cardioxyl Pharmaceuticals for $2.1 billion.
Overall for 2015, the number of VC-backed M&A deals dropped 26% to 473, down from 639 deals in 2014.
The IPO market remained relatively slow in Q4 2015, with 15 deals worth $1.3 billion. The number of deals ticked up to 15 from 12 in the third quarter, while dollars raised dropped 17% to $1.3 billion from $1.6 billion in the prior quarter.
Venture Capital Investment
VC investment into U.S. startups dropped in Q4 2015 from the prior Q3 quarter. VC invested in 902 U.S. deals valued at $17 billion in Q4 2015, a 11% drop in capital raised and 4% drop in deals from Q3 2015.
Meanwhile, compared to the year-ago period, the number of deals dropped 10% while dollars invested dropped 7%.
For the full year of 2015, there were 3,916 funding deals worth $72 billion, a 4% drop in deals and 24% increase in dollars from 2014.
Median pre-money valuations dropped 6% from the prior quarter as massive unicorn rounds dropped.
Venture funding in North America also dropped in Q4 2015. Funding was $14.1 billion in Q4 2015, a drop from $20.8 billion in Q3 2015, according to CB Insights. The number of deals from from 1,220 to 1,026 in Q4 2015. In particular, the number of deals worth $100 million or more dropped from 39 in Q3 2015 to 18 in Q4 2015, the lowest quarter of last year. Meanwhile, IPOs have been listing at market capitalizations below their prior private market valuations. That’s causing late stage investors to rethink some of the massive late stage funding deals that had occurred last year.
Acquihires are a recurring lightning rod in Silicon Valley. From million dollar packages for engineers to secretive soft landings, these peculiarly Silicon Valley transactions are shape-shifters, changing to the tastes of various parties at different market conditions. Like a political issue that draws passionate debate, acquihires are represented by icons that stand in for larger issues, even if the icons aren’t always accurate—such as engineers getting million dollar packages or young 20-somethings driving fancy sports cars.
This article analyzes the history and context of acquihires as a way to explain technology mergers & acquisitions and Silicon Valley’s startup ecosystem. By doing this, we’ll also explain where acquihires are today. Acquihires haven’t gone away, contrary to some reports, and still happen. But their purpose and prices have changed significantly, as the market and industry have changed. While they were once hyped in the media, now they are largely out of sight.
Acquihires can best be understood as a function of Silicon Valley’s tech startup and angel and venture capital system. They touch many parts of Silicon Valley: big name tech companies and small startups, venture capitalists, wealth creation, entrepreneurs’ reputation, public relations, and deal making.
Since 2005 and especially since 2008, the growth of seed funding has generated a massive ecosystem of seed funded startups. Today, the growth of sites such as AngelList has made raising seed funding more accessible than ever. There were 976 companies seed funded in 2014, per CB Insights, compared with 309 seed deals in 2010 (Seed funding dropped in 2015 , but remains much higher than in earlier years). Meanwhile, there has been much less growth in Series A and B funding, which has left a gap for seed startups. Even without the growth in seed funding, there is a whittling of seed-funded companies as venture capitalists pick off the cream of the crop for larger funding rounds as they bet on the next “unicorns.” While seed startups search for funding, there is simultaneously a shortage of top engineering talent in Silicon Valley. As a result, large companies are in search of top talent through acquihires, which gives companies the opportunity to scoop up top talent, for a relatively cheap price.
The benefits of acquihires for sellers is that startup founders and some portion of their employees (often not all) can join a larger company and receive some cash or equity compensation, which can be a signing bonus, retention package or other package. Also, importantly, the founders can then say they were “acquired by Google” or some other large company. In addition to potential tax benefits, this is a face saving measure. It gives them cultural capital, and a leg up in starting a future startup. This is an important marker of success in this entrepreneurial ecosystem, even if a founder’s colleagues know that the startup essentially failed.
The benefits for buyers are threefold: first, they can can hire a large number of engineers quickly. This is no small achievement for companies with large product roadmaps, or for their recruiters, who have marching orders to hire dozens if not hundreds in the next several months. While an acquihire is rarely simple, the work that goes into it can be justified by the addition of a top team. Secondly, an acquihire brings a team that already has worked together. So they should be able to work together well and quickly get up to speed on a project. That kind of team can take much longer to build when hiring individually.
Third, as will be discussed below, prices have fallen dramatically for acquihires and have been down for some time. So, some large companies have realized that, if executed right, an acquihire can bring in top talent at a relatively cheap price. These teams can be acquired at prices that are not much more than what the individual hires would have cost through a traditional hiring or recruiting process.
Hiring Problems and Perception Issues
So what are the potential problems with acquihires? The main arguments: First, they’re bad for buyers: Acquihires don’t solve the talent problem for a buyer, particularly in the long term. Top entrepreneurial talent will leave as soon as they can, some argue. While it’s true that entrepreneurial talent may leave, there are many that have been acquired and stayed under the right circumstances. Facebook and Twitter, for example, have been successful in keeping some of their top acquired talent.
Secondly, according to some, existing employees at a buying company get resentful of acquired startup employees making tons of money to do essentially the same job. This can incentivize existing employees to leave to work at a startup. This scenario is possible. But not acquiring any companies seems unrealistic for most fast growing companies. Instead companies can have strong incentive programs for existing employees. A company doesn’t have to choose between these options.
Third, acquihires perpetuate the lack of talent by making failure too easy by providing “soft landings,” the argument goes. But few of the thousands of entrepreneurs starting companies each year are doing so with a soft landing in mind. They start companies because 1) they have an entrepreneurial itch or work better in a startup environment; 2) they’re willing to take risk; and 3) they’re interested in a larger financial payoff. Soft landings do make it easier to take risk and start a company. But on the list of reasons people start companies, soft landings are low, if there at all. And even if this is a fallback option that entrepreneurs keep in their mind, is that a bad thing? Is it bad that entrepreneurs are incentivized to take risk to create and innovate?
Finally, some say acquihires are bad for the market and are just fake. Entrepreneurs shouldn’t be able to claim a victory by listing “acquired by Google” on their resume, when they were acquihired in a last ditch effort to save face before shutting down a company. This isn’t little league, where all sides of a game get trophies, the argument goes.
This is about perception, which is important to founders, VCs and many others in the industry. Whether you agree with them or not, to eliminate the face-saving and resume-building and “branding” effects of acquihires (putting aside the other tangible benefits listed above) seems difficult without dispensing with the entire system of media, reputation and “branding” in Silicon Valley. That is, the tech industry’s many companies’ and venture firms’ generation of press coverage with the help of many public relations firms. To be “acquihired” is part—a relatively small part—of this much larger system. This isn’t a judgment for or against.
Each group is affected differently in acquihires: Venture capitalists, for example, are often loath to accept an acquihire. While investors get to claim their startup was “acquired by Google,” this can also mean they lose money. Sometimes VCs get pennies on the dollar for their investment or nothing at all, while an entrepreneur walks away with a nice employment package at an acquirer. Today, these kinds of situations are less common (and VCs can at least get their money back), but they still happen. Many buyers, even those who are known for offering these deals that cut VCs out, know that they should consider VC interests if they ever want to do a deal with those VCs again. Still, many VCs, who want to be known as “founder friendly,” will ultimately support an acquihire if it’s the best outcome available for the founders and team.
A related reason VCs dislike acquihires: they’re associated with entrepreneurs who just want a “quick flip” and are not building a company for the long term. In other words, founders just give up and don’t stick it out, but instead just opt for the easy acquihire. VCs are right to be concerned about this. But at the same time, founders can be trying to build a massive business and still come across a strong offer early in a company’s existence. There are often good reasons to sell at this point.
11 Years Later
The first use of the word “acqhire” (online at least) was on May 11, 2005 on Rex Hammock’s Rexblog, which coined the term to describe Google’s acquisition of the tiny two-person New York City social location startup Dodgeball. Hammock noted that a $62 billion company buying a two person company and asked, “isn’t that more like a ‘hire’ with a signing bonus?” The startup was otherwise notable because Dennis Crowley was one of the two founders who, after leaving Google in 2007, later went on to found Foursquare. (Language expert Ben Zimmer analyzed the origin of the term “acqhire” here.)
Google was known for acquihires in this period of rapid growth. (It’s notable that a number of Google corporate development executives have gone on to work at other fast growing Silicon Valley companies such as Square, Pinterest and Facebook, taking similar methods with them.) Not all of these early Google deals shut down the acquired product immediately, though many were shut down later.
The rise of Facebook brought the next large wave of acquihires. The New York Times in May 2011 chronicled the phenomenon of “acqhires,” the largest of which was Facebook’s $47 million 2009 deal for startup FriendFeed, which was the equivalent of costing about $4 million per engineer. Bret Taylor, cofounder of FriendFeed, became CTO of Facebook, while Paul Buchheit, another cofounder and a key former Google employee, also joined Facebook. The story also cited Facebook’s 2010 acquisition of drop.io mostly just for its founder Sam Lessin, who went on to hold key roles at Facebook. Facebook’s head of corporate development pegged the price of acquihires at $500,000 to $1 million per engineer. Later, another notable deal was in March 2012, when Google acquired Milk, a small startup cofounded by Kevin Rose of Digg fame, and its team of designers at a substantial price.
This pre-IPO Facebook period was a key moment. The listing took place on May 18, 2012. In the lead up to it, Facebook was hungrily snapping up startups. At the time in early 2011, Facebook’s private market valuation was a staggering $50 billion, so the company had equity to acquire top talent.
Acquihires during this pre-Facebook IPO time were a high-end commodity, a product of an overheated market and highly capitalized buyers. While Facebook’s use of acquihires followed and continued Google’s approach, Facebook became more well known, whether true or not, for splashy deals paying high prices for acquihires—and made acquihires a more common term in the industry. Facebook needed top talent, particularly in the mobile sector as it transitioned to mobile. Meanwhile, others such as Google, Yahoo and Twitter were also trying to keep pace—by acquihiring top talent as well.
A Change in Use–and Perception
Today, some, have declared the “end of the acquihire,” citing a slowdown in these deals among Google, Yahoo and Facebook, three of the most active in this space from 2005 to 2012. But acquihires actually haven’t disappeared, they’ve just changed. Several things are going on:
First, acquihire prices have dropped—since the Facebook IPO, prices have come way down. Facebook’s appetite for acquihires has dropped since its IPO, as is common with companies after an IPO and after a period of rapid growth. Since its IPO, there have been few media stories about Facebook or anyone else doing acquihires with $1 million-per-head deals. The truth is, these high-priced acquihire deals were always fairly rare. Since 2012, they have become even more rare. So really, prices on acquihires have been lower since 2012. The “end of acquihires” if that means lower prices, has been here since 2012. Another reason prices have dropped? Besides, Facebook’s IPO, there is:
Second, buyers have become much more savvy about acquihires. They generally don’t see acquihires as Facebook saw them in 2011. Large buyers want to buy very specific teams with specific product skills. They don’t want to pay high prices and they know that there are enough startups looking for acquihires that they don’t have to overpay for them.
Third, as the same CB Insights report noted, large private companies like Dropbox, Pinterest and Airbnb have taken up some of the slack that previous pre-IPO companies filled with acquihires. There are a number of other large private tech companies that have used their valuable stock to snap up startups. This is an increasingly common tactic for a company seeking to grow quickly or consolidate a sector or market. If valuations of unicorns continue to drop as the market weakens, this may change, but up until now these companies have been quite active.
Fourth, as noted above, venture capitalists generally dislike if not outright oppose acquihires. They particularly oppose them if the founders and/or team walk away with cash and investors lose money. Investors will go along if all other options have been explored and/or the deal pays investors back at least some of if not all their investment dollars. As a result many founders are much more careful about taking an acquihire deal unless investors get substantial considerations.
Fifth, perception is still a major factor in acquihires. As a result, many acquihires are not identified as acquihires in news coverage—they’re often simply reported as $10 million or $25 million or $50 million acquisitions. Prices that are reported are often wildly inaccurate. So to accurately and precisely measure acquihires (which Exitround has been doing) is quite difficult. To say they’re gone, when the majority are not reported publicly in the media or anywhere else, is hard to believe.
Finally, as mentioned earlier, large buyers are still very active in looking at and consummating acquihire deals. Virtually every major tech company in Silicon Valley is still open to, if not actively doing, acquihires–with varying levels of interest depending on the sector and type of team. Very few will hear about a talented team on the market and say, “No, I won’t look at that.” There are so many startups that large companies know that there are many options for these deals.
Acquihires are a unique and revealing product of the Silicon Valley startup and venture funding system. Until another solution comes along, they’re a pragmatic part of the startup lifecycle, as entrepreneurs cycle through founding, building, selling and often, later, starting a new company. And perception is a key part of this system. Whether you think they’re good or bad, they show how much perception and reputation matters to every entrepreneur and venture capitalist in Silicon Valley, be it on social media, press or among colleagues. Silicon Valley is a place where “personal branding” is a thing discussed without irony. In this wider context, acquihires are considered a relatively modest and pragmatic measure that many take.
Meanwhile prices of these deals have dropped as their usage has changed over the years, from what were glamorous in earlier years to much more mundane and pragmatic in recent years. Interestingly, acquihires are a legal and transactional device, while also accomplishing a social goal, in a way that few other types of deals are in Silicon Valley. While successful venture rounds, M&A deals or IPOs evoke simple “success stories,” and “down rounds” or company job cuts or “shut down” stories are also relatively simple failure stories, acquihires are much more opaque and complicated. They have multiple, often conflicting parties (even among the same venture firm or startup or board), which is perhaps why they are so little understood, despite how often they happen everyday in Silicon Valley.
 What “small” is has changed over the years from a few hundred thousand dollars to now sometimes up to $2 million or more.
photo credit: rogerbarker
The market for initial public offerings in 2015 had its worst year since 2010.
In 2015, 79 companies VC-bakced companies went public, raising $9.2 billion, according to Fortune. That’s the lowest total value by dollars raised since $8.08 billion was raised in 2010. Last year, 117 companies raised $15.5 billion in public listings.
This year, IPO interest was hurt by a number of factors, including global economic uncertainty, anticipation of Fed rate hikes, and disappointing performance of some IPOs last year.
In terms of performance, more than half of the 79 VC-backed IPOs are trading below their IPO price. However, on the bright side, the winners performed well, with average price of IPOs rising 5.27%.
The two largest deals of the year were fitness tracker Fitbit with $841 million and enterprise software provider Atlassian with $462 million. Atlassian, which went public December 10, is expected to be the last IPO of the calendar year.
While IPOs were down substantially, mergers and acquisitions continue to look strong this year.
There’s a saying, “Good companies are bought, not sold.” This is true — for about 1% of companies. For everyone else, the company is sold. Talk to any founder or investor who’s successfully done an acquisition and listen to how much work they put into making it happen.
Over the past three months we’ve seen a marked increase in inbound demand for people exploring exit opportunities. Just this past week I’ve talked to eleven separate founders, one of the most prolific angel investors in the US, and the head of corporate development from one of the world’s largest venture portfolios who are all actively looking to find exit and liquidity options for their companies.
2016 is setting up to be the most active year for technology M&A in the history of the industry due to some key contributing factors:
- Large amount of supply – thousands of companies are coming to the end of their vintage fundraises from 2013 and 2014, which were the most active years of VC investing since 2001.
- Concern about easy access to private capital – venture investors have slowed down.
- Devaluation of private markets, as demonstrated by large institutional investor write downs.
- Concern about world markets and general macroeconomic stability.
- A weak IPO market for technology company liquidity.
- Huge amount of demand: every company is now a software company, whether they sell sugar water or build buildings.
Last week at the #PostSeedConf, Kleiner Perkins’ John Doerr remarked that 2016 is looking to be a big year for M&A. Many companies are beginning to mimic Google’s archetypal M&A strategy as a means of growth — Doerr claimed the search giant has done nearly one acquisition per week since 2010. (But note, only 5 of them have been over $1B.) His comments we’re recently echoed by Redpoint’s Tomasz Tunguz who blogged last week about the tremendous cash – $380B – in the coffers of the 60 largest publicly traded software companies — all of which will contribute to a very acquisitive 2016.
Here at Exitround, we have the largest data sets of real-time Buyer “intent data” for technology M&A. As the most active hub of technology M&A — where thousands of Buyers and Sellers are connecting on a monthly basis — the proprietary data gleaned from the network provides leading indicators of “buyer intent” well before buyers actually acquire those companies.
What’s Hot in M&A for 2016
- Dramatic increase in M&A interest for companies focused on Content, Content Management and Content Production.
- On the technology side, Machine Learning is showing increasing demand. Companies focusing on Analytics are also seeing strong interest.
- Consistent M&A interest in companies focused on Mobile Monetization and Mobile Advertising.
- Over time, the most dramatic decrease of M&A interest in companies is focused on media and design.
In one recent case, two Thursdays ago a well known startup with tier 1 VCs joined the Exitround network. In the past 10 days, this startup has connected with more than 10 potential acquirers and they are expecting a Term Sheet today.
Over the past 12 months the Exitround network has helped facilitate more than two dozen M&A transactions with deal sizes ranging from $250,000 to $80,000,000. The bulk of these transactions are in the $5M to $25M range.These deals have been privately matched with over 3,120 unique and relevant companies, including public serial acquirers such as Google, Facebook, Twitter, Yahoo, Box; quickly growing unicorns such as Airbnb, Pinterest, Dropbox, GitHub, Palantir; and large traditionally non-tech companies actively looking to get into the game such as Red Bull, Westfield, Capital One, Fender, Target, Home Depot, and many many more.
2016 is the year of industry wide M&A activity. Don’t miss the boat.
Join us on Thursday, January 21, 2016 for a one hour webinar covering the quick and dirty facts on learning a framework for how to think through M&A: expectations, process and structure of today’s dynamics in M&A.
This will be the beginning of a content series preparing founders and investors for what they need to know in today’s rapidly changing M&A environment. #ExitTalk
Here’s the latest in what was a busy week for tech M&A.
Yahoo is said to be considering whether to continue with its spin off of its Alibaba stake or to sell its core Internet business. Read More
Commercial real estate firm JLL (NYSE: JLL) is buying Corrigo, a cloud-based facilities management software company. Terms weren’t disclosed, but Corrigo raised $20 million from Amicus Capital, Sierra Ventures and others. Read More
Nokia has closed its EUR2.55 billion deal to sell Here, its mapping division, to a consortium of Audi, BMWand Daimler. The deal was first announced in August. Read More
Welltok, a health management firm, has acquired Silverlink, which makes a messaging tool for healthcare companies. As part of the deal, Welltok has raised $45 million from investors including Georgian Partners EDBI and Flare Capital. Read More
Rdio, the bankrupt music startup that was recently acquired by Pandora for $75 million, is laying off 123 people. Pandora says it plans to hire about 100 of them. Read More
Mobile ecommerce company Mobify is buying Donde, a location services startup. Terms weren’t disclosed. Read More
Perk.com, a mobile rewards startups, bought Corona Labs, a mobile app development platform, for $2.3 million. Read More
Atlassian has set its share price for its IPO, and could raise up to $370 million in the deal. Read More
Chip maker eASIC Corp. has dropped plans for its IPO. Read More
Overall, IPOs are tracking to raise $30 billion, the lowest level since 2009,per Renaissance Capital.
Meanwhile, these are the IPOs most likely on the horizon for 2016. Read More
Private Markets Investing:
Public market investors have marked down their stakes in Jawbone. Read More
Meanwhile, Fidelity has raised its valuations of Dropbox and Snapchat after marking down these and other late stage companies. Read More
The New Normal in Seed Funding, via WSJ.
The State of Startups, from First Round Capital. Read More
Venture investor Aileen Lee on how to look beneath the surface. Read More
Who has the right to access personal data across international borders? Read More
Venture Capital disrupts itself, says Cambridge Associates. Read More
Bill Gates, Mark Zuckerberg and others are investing in clean energy through the Breakthrough Energy Coalition. Read More
Who wrote “Iterating Grace“? Read More
Watches and pens are selling this week. It’s time for this week’s technology M&A report.
Watch maker Fossil (NASDAQ: FOSL) has bought Misfit, a wearable tracker and watch startup for $260 million. Misfit had raised $64.4 million from Founders Fund, Norwest, Khosla, Xiaomi and GGV Capital in a competitive space. The acquisition continues a trend of health and fitness apps and wearables being targeted by traditional non-tech brands, which we’ve covered recently. Read More
IAC/InterActiveCorp makes an unsolicited bid for Angie’s List for $8.75 per share, but the board of Angie’s List rejects the offer. Read More
After raising $68 million, Livescribe, a digital pen maker, was acquired for $15 million by Anoto. Read More
Microsoft acquires Israeli security firm Secure Island for $77.5 million. Read More
Could the Dell – EMC deal fall apart due to tax issues related to VMWare? Read More
Deliv, a same day delivery service, acquired Zipments, another company in the space. Terms weren’t disclosed. Read More
Blue Coat is buying cloud security startup Elastica for $280 million. Read More
Rumor Mill: Did ecommerce startup Wish reject a $10 billion offer from Amazon? Read More
Google has acquired Fly Labs for its video editing apps. Read More
Four IPOs priced on Wednesday, including three biotech companies, with just one pricing below its range, compared to 85% doing so in October. Read More
Xtera Communications, an optical transport company, priced its IPO at $5 per share, raising $25 million (NASDAQ: XCOM). Read More
Meanwhile, Square, Match Group and Atlassian are planning closely watched IPOs. Square is reportedly planning to price below its last private valuation.
Atlassian filed for an IPO reporting $6.8 million in net income on $320 million in revenue for the fiscal year ending June 30, 2015. Notable: Atlassian only raised outside funding via secondary deals. Read More
Match, the owner of Match.com and Tinder, which is spinning out from IAC, plans to raise up to $466 million and would have a market cap of $3.1 billion at the middle of its range. Read More
Global M&A has topped $4 trillion is now at $4.06 trillion, its highest level YTD recorded, per Dealogic. It’s up 38% from the same year-ago period in 2014. Driving this: deal sizes greater than $10 billion, which are 37% of deal volume, compared to 21% over the last five years. Technology is the leading sector with $631.7 billion, 53% higher than the previous YTD record–in 2000. Read More
Goldman Sachs’ co-head of investment banking David Solomon, says shareholder pressure and low interest rates are sparking M&A market Read More
Tomasz Tunguz: The exit market for software startups will be much better next year, as private and public market valuation metrics start to come closer together. Read More
Sign of the Times: Shareholders are cashing out of startups. Read More
Brett Bivens: What Talent Wants. Read More
Fidelity is marking down its private company investments–and not just Snapchat Read More
Fred Wilson: Why it’s still so hard to make it as a consumer mobile app. Read More
This article is co-authored by Will Quist and Lindsay Sharma of Industry Ventures.
After a prolonged absence, investors more traditionally focused on the public markets have recently played an increasing role in venture capital. Over 50% of the current 108 unicorns (>$1B valuation) have been financed by public investors; while 7 of the 9 “decacorns” (>$10B valuation) have institutional investment.
It’s no secret why companies are increasingly drawn to this source of capital. Public-market investors have longer-term investment horizons, deeper pockets and, most importantly, different motivations and return targets than most VC firms. Many have cited public investors’ emergence in the asset class as an indicator that we may be in a period of “irrational exuberance,” with valuations soaring relative to historical precedents.
While we would agree that we are in a valuation environment unlike any we have seen for 10+ years, we can also see why the emergence of public-market investors may be perfectly rational—as will be their eventual retreat.
Not the first time public investors showed interest
While the absence has been prolonged, this is not the first time public-market investors have actively participated in the VC market. Prior to the mid-’90s, the technology capital markets worked in very clear ways, with everyone playing their roles and getting their fair share of the gains. Venture funds were smaller and could only fund companies through the launch of products and early sales efforts. Once the sales model was proven, venture-backed companies were forced to tap the public markets for necessary growth capital. This meant that time to IPO was typically less than 5 years, and companies were going public with market caps of $125-250M—a far cry from today’s 7-10 -year journey.
As the tech markets moved onward and upward, both VCs and mutual funds increased in scale dramatically. In 1999, the VC community had invested over $40B of capital in investments, and mutual funds had expended AUM to over $6T (a growth of $5T since 1990). The ability of venture funds to privately finance their best companies, and the sheer scale of the public investors fundamentally changed the IPO landscape. In the wake of the market correction in 2001, the time to IPO nearly doubled, and mutual funds quickly sold out of their positions in private companies as they faced redemptions.
As recently as 2009, the NVCA was publicly concerned about the lack of interest in venture capital from public investors. How quickly things change. What has driven public investors back into the private markets? First, investors have accepted that the public offering has been transformed as IPO-ready companies choose to stay private longer, accessing growth capital through late-stage rounds. The average VC-backed IPO now raises close to $90M in capital prior to IPO, compared to $31M back in 1999. Much of the capital appreciation that used to accrue in the public markets is now accumulating while a company remains private. Second, in today’s environment with interest rates close to zero, public investors are hard-pressed to find many opportunities to drive outsized returns. As a result, public investors have dipped into the venture capital asset class.
Capital & Returns Shifting from Public to Private Markets
The increased competition to gain access to later-stage companies and pre-IPO rounds has driven up pricing, as public investors angle to get an allocation. Matthew Walsh, managing director in BAML’s Technology Equity Capital Markets team, has observed this trend, noting that “in low-interest rate environments, investors typically move out on the risk curve in search of return. Valuations of higher-risk asset classes, including private technology companies, have benefited. Many companies have taken advantage of the relatively inexpensive private capital and delayed an IPO. The resulting lack of tech IPOs has driven more public investors into the private markets, pushing valuations further.”
This surge in pricing has fueled bubble discussions and even drawn into question whether mutual funds and hedge funds have the required skills, context and motivations to be rational actors in the market. However, on a relative basis, their participation may in fact be quite rational. With time to IPO over 7 years and the average offering size less than $150M, if institutional investors want to gain access to a company’s rapid growth and build a meaningful position, they almost certainly have to get involved prior to IPO. Furthermore, public investors are measured by total annualized returns relative to benchmarks, not by an investment multiple and IRR. Therefore, what may be an irrational valuation to a venture investor may actually be quite rational to a public investor, especially when contextualized against the investor’s overall portfolio.
Have they been right?
It’s too early in the cycle to start calling winners and losers, but the data would suggest that the strategy has been more successful than the popular narrative would lead you to believe.
The average year-end gains for IPOs in 2013 and 2014 were 47% and 24%, respectively, greater than returns obtained from most other sources. It’s even higher in the more sizable IPOs, with an average return of 56% in IPOs with valuations greater than $1B. In 2014, 73% of the previous venture rounds were priced at a discount to IPO, resulting in even greater gains to those public investors who dared to invest in companies while they were still private.
Mutual funds and hedge funds go to great lengths to protect their downsides by primarily targeting later-stage private companies with revenue and real business models, where binary risk is limited. Furthermore, institutional and other late-stage investors have also started incorporating ratchets and other structures in high value transactions, which companies are willing to accept in order to join the unicorn club.
Box has been consistently highlighted as an example of what can go wrong in high-priced, late-stage deals. At face value, Series F participants priced the last private round at $20 per share, well north of their $14 IPO offering price. But according to the S-1, these investors in an IPO were guaranteed to convert at a share price of $20, and if the offering price was less, they would be granted that difference in additional shares, plus a 10% premium. At the stock price today of $17.50, without the ratchet, the Series F would have lost 12.5%. However, with the ratchet, the Series F investors converted into common stock at a 1.6 ratio and are now up 40% on their position.
Since private investments only constitute a small portion of an institutional investor’s fund, even if some of the unicorns are unable to go public or decline after IPO, the impact on overall fund performance is limited and the risk/reward trade-off is still in their favor.
How does this impact the VC landscape?
The VC investments that mutual funds are making have a limited impact on their overall fund performance, but the impact mutual funds are having on the VC landscape is far-reaching. The top mutual funds that are participating in late-stage funding have over $300B in AUM, and even a 1% allocation means $3B of additional funding flowing to late-stage companies. The success Fidelity, T. Rowe Price, and Blackrock have demonstrated by investing in the space in the past several years has driven increased interest among other mutual funds, with pre-IPO crossover volume increasing significantly in 2014 and 2015. The most obvious and acute impact these investors have had is on valuations. Late-stage valuations continue to grow as investors compete for access to transactions, with growth premiums outweighing any illiquidity discount. With the increased valuations and structured preference, the potential concern is whether many of these companies have given themselves little room for error when it comes to execution and potentially have priced themselves out of M&A exit opportunities.
When does the party stop?
It’s difficult to predict how this will end. However, there are several potential drivers that could steer institutional investors away from the private markets. Mutual funds have the liquidity and flexibility to chase outsized, risk-adjusted returns; so any relative market changes, such as an increase in interest rates, could result in better returns elsewhere. When the dot-com bubble popped, mutual funds exited the market as quickly as they entered. Absolute changes in late-stage, venture-backed businesses could also drive a shift, especially if revenue growth slows prior to an exit and requires continued external funding to sustain growth. This could quickly spiral if mutual funds continued to pull out, resulting in reduced growth capital available for companies at the moment they need it most.
This article was previously published by Square 1 Bank.
THIS POST IS WRITTEN BY NIC POULOS
2014 was a landmark year for tech exits, which increased around 60% year-over-year by both volume and value, with double the number of “unicorn” exits over $1 billion. Most press attention was focused on WhatsApp—in a class of its own as a $20 billion acquisition—along with Nest, Beats, Oculus and Twitch. The excitement around these deals makes sense given their magnitudes (all broaching the hallowed 10-figure mark) and their media-friendly value propositions: the next generation of lifestyle and entertainment tech. This spate of consumer M&A was also interesting because the list of acquirers reads like a who’s who of tech titans, all of whom have been sitting on historically high mountains of cash: Google, Apple, Facebook and Amazon.
But what about the B2B side of the story? In 2014, enterprise received its due press largely around IPOs in the category. Box and New Relic added to the “unicorn” exit list; Zendesk, HubSpot and MobileIron posted solid $600-800 million EV offerings at around seven times revenue; Five9 and Workiva priced somewhat under the radar with smaller deals; while Hortonworks clocked in at a banner time-to-IPO of only three years. The year was another strong showing for enterprise in the public markets, continuing the steady flow of pricings at high revenue multiples (eight to 11 times).
B2B acquisitions didn’t get nearly as much attention as consumer exits or IPOs outside of one or two big buyouts. That’s particularly interesting because despite all the big consumer developments, 2014 was an even bigger blowout for enterprise. By my calculation, approximately 110 B2B companies were acquired for $30MM or above, up nearly 100% year-over-year. That includes 11 “unicorn” acquisitions, versus just five in the prior year. But the makeup of companies doing the buying wasn’t quite the traditional lineup of big tech players you might expect, as was the case for the consumer counterparts. The changing face of the enterprise acquirer, in my view, is the truly interesting trend to note, and one theme in particular stood out to me.
In 2014, a range of enterprise buyers made their vertical M&A strategies clear. Healthcare IT was a particular highlight, with Siemens Healthcare/Cerner, Aetna/bswift, GE Healthcare/API Healthcare and 3M/Treo Solutions at the top of the list. Blackbaud—now the 800-pound gorilla in non-profit management software following its acquisition of Convio—continued to consolidate its position by acquiring two companies for approximately $200MM total.
Even more interesting, however, was increased acquisitiveness from traditionally non-tech businesses. One interesting example is transportation and logistics; legacy players in that space, C.H. Robinson and RoadRunner, each closed deals valued at over $100MM. A few others include Banco Bilbao/Simple, CEB/KnowledgeAdvisors and Kaufman Hall/Axiom EPM. I expect vertically oriented buyers will continue to invest in M&A as industry-oriented SaaS startups mature and traditionally offline businesses seek to subvert competition from lower-overhead tech-enabled offerings. It’ll be interesting to see how these trends (as well as overall enterprise exit activity) play out as we progress further into 2015.
This post was originally published by Square 1 Bank.
Nic is a Principal at Bowery Capital, an early-stage venture capital firm investing in B2B technology.
Hunter Walk is a seed stage investor and cofounder of venture capital firm Homebrew. Previously, he was at YouTube running consumer product management. He joined Google in 2003 and managed product and sales for contextual advertising. He was previously a founding team member at Linden Lab, maker of Second Life. We caught up with Hunter to get his thoughts on the current M&A market and venture capital valuations in the private markets.
Q: Are you seeing a slow down or pull back of any part of the VC investing market in recent months? Is it caution, valuation sensitivity, fear of the market, LPs, or something else?
HW: Homebrew is a seed stage fund and we haven’t seen any softness in seed stage financings. Additionally, startups we’ve backed are being well-received as they raise A Rounds and B Rounds. We’ve always focused on the notion of substance over noise, so startups we work with tend to go to market when they’re ready.
That said, I do think certain verticals are being looked at differently than they were a few years ago, with more of an eye towards margins than just growth for the sake of growth. Certain on-demand segments come to mind as well as ecommerce companies that are nothing more than resellers/aggregators with narrow margins.
Q: What are you seeing with M&A activity recently? Any indication that companies are more (or less) open to acquisitions recently?
HW: The days of companies just indiscriminately acquihiring teams of generic engineers are over, especially if the cap table wants to see any money returned. Specialized technical teams (Artificial Intelligence, Virtual Reality, Natural Language Processing) seem to still have buyers for talent and tech.
Upmarket there are going to be an increasingly large number of $50 million – $250 million acquisitions by large tech players, Unicorn startups and F500 corporations. The challenge for the venture community is that in 95% of cases, the acquirer is going to come to their own valuation for the startup and not base their offer on the last overheated financing round.
Q: Do you want your companies to have an idea of potential exit strategies when you invest or later on after you invest? What, if anything, would you like your companies do to proactively prepare for a potential exit?
HW: No, I hate talking about potential exits as part of seed stage funding. We want to invest in teams that think there’s a large, urgent, valuable problem to solve and it’ll take them years and years to solve it fully. Create a great technology, build an amazing team, scale an awesome business and they’ll always be exit opportunities. We do think proactively with our companies about funding paths and if it reaches the point where an exit may make more sense than pushing forward as an independent company, we work to help them through that decision.
Q: Do you have an idea of what your companies’ exit sizes could be, who’d buy them etc? Do you have a target metric or size for your exits? For example, some like Dave McClure are happy with 3x or 5x on a small investment, whereas others seem less enthusiastic (if not completely against) these smaller exits.
HW: We make 8-10 investments a year and each one needs to have the potential to be meaningful to our fund. The way we define that is, “in a success scenario for them, could we return minimally 1x the fund with our investment?” What makes this work?
First a realistic scenario of what “success” looks like – for many companies that’s a $300-$500 million exit. We don’t want to force ourselves into a corner where we look to multibillion dollar exits as the only definition of success for every type of company.
The second part of the equation is our ownership. We look to invest to the level where we can get that impactful stake at a fair price. On average this ends up being around 10-11% but we’ve gone up to 20% and higher in certain circumstances.
So we sit somewhere between Dave’s strategy for 500 Startups and the large funds that *must* own 20% or it’s not worth their time. For us it’s the right place given what we think seed companies need from a lead investor.
Q: How active do you get in terms of the M&A process with your companies? Or do you prefer VCs stay out of it?
HW: To me, M&A is like any other funding activity – the investors can play an important supporting role but ultimately it’s about the founders and the acquiring company. I’ve definitely seen M&A deals get messed up when the investors or other intermediaries play too large a role.
That said, to date we’ve gotten very involved in these sorts of discussions, always in concert of trying to help both parties find mutual ground. We can give founders a perspective of the market, what a M&A process typically looks like, and other information which comes from our position.
We can use reputation and goodwill to help connect with potential acquirers or gain endorsements from other stakeholders within a company. We can help a startup extend their runway to let M&A discussions play out organically versus their back being against the wall. There are plenty of things a good lead seed VC can do.