Having been involved in quite a few capital raises and trade sales where big gorillas invest in or buy start-ups, I thought there would be some value in communicating some of my key learnings.
A common pathway for a start-up trade sale to a large mature business (the gorilla) is as follows:
The gorilla is introduced to the start-up
The gorilla monitors the progress of the start-up
The gorilla participates in an investment round
The start-up continues to demonstrate traction / progress
The gorilla buys the start-up with an inflated valuation
There are two main reasons startups get a high valuation when purchased by a gorilla; the gorilla’s ability to scale distribution easily and the capability the start-up brings to the gorillas overall business.
The gorilla has a significant customer base and a large well-oiled sales and marketing machine, which it can sell the new products in to (assuming the product is complimentary and relevant to its current customer base). Let’s call this scaled distribution advantage.
So even if the gorilla is paying well over the odds for the startup it can justify the high price, as it has a ready-made customer base and existing sales and marketing infrastructure to seed its new product /service into. Examples of scaled distribution plays are Apple purchasing Beats by Dre, Atlassian’s purchase of Trello or Microsofts purchase of Skype.
Let’s work through an example, a software startup had annual recurring revenue (ARR) of $10M, 1,000 customers @ a $10K annual contract value per customer. A gorilla valued them at 6x ARR a premium on the market which is 4 -5x multiple on revenue typically, they get a $60M purchase price.
The gorilla then slots the product into its sales and marketing machine targeting its existing customers and its database of prospects, 100K of contacts. Say it converts 1.5% or 1.5K of new customers. It has just added a further $15M of ARR to the business. Now the business has $25M of ARR (including the existing customer base), even applying a conservative multiple say 4x ARR. It is now worth $100M. The gorilla hasn’t had to invest a huge amount in incremental customer acquisition costs or sales people as the resources / infrastructure already existed. It can now offer its existing portfolio of products to these customers, for even greater upside. They leveraged their scaled distribution, driving growth and enterprise value.
The ongoing digitisation of the economy and proliferation of new technology means gorillas are having their traditional business models cannibalised by start-ups whose products or services provide better customer experiences or solutions to their problems than the incumbents. They are also missing out on opportunities in emerging fields: drones, the sharing economy, block chain, sustainable energy, big data, nano tech and many other fields.
Big companies have often failed to transform through internal efforts – think the “digital transformation” project or internal incubators most big corporates implement and pay the likes of Accenture and McKinsey to implement with a huge failure rate. The reason they fail is that there are often too many competing interests at play that put barriers in place to making changes (ahem big executive bonuses), or the underlying culture doesn’t support innovation or entrepreneurial behaviours.
The quickest way to gain the capability required to maintain their position or capitalise on a growth opportunity is to purchase a business with the skillset or product extension that they can sell into their existing client base to increase revenues.
Think IBMs acquisition of red hat a big data / analytics consultancy or the numerous acquisitions of digital agencies specialising in big data, social, B2B CRM by the likes of Saatchi and Saatchi and Universal McCann. The latter’s strategy is to acquire the small agency at todays valuation and then roll out their specific capability to their broader base of customers. In this scenario they can convert the start-ups existing base over to broader advertising agency services, PR, creative etc and also sell their start-ups new services to their existing base.
They often pay a premium to acquire the business, which means the founders and shareholders are cheering, but the upside is significant for the gorilla too!
If you are operating in an emerging technology field – either product or service and the plan is to sell or exit at some point, think about how you can either add capability or be a complimentary product to the gorillas of your industry. Don’t hesitate to start a dialogue with the big players, its good to get on their radar early on. If you can get an interested party looking to make a strategic acquisition, the chances are you can command a significant premium on your valuation, if you play your cards right!