Start-Ups Acquisition – Good for Innovation?

Managers of publicly traded firms are under constant pressure to find growth, or face dwindling share prices. Managers can either invest in a portfolio of internal innovation projects or look to acquire innovation externally. However, the difficulty of internal innovation is that such experiments will involve a lot of uncertainty, and if they fail, there will be an immediate signal from the market –  your stock price will likely fall. Acquisitions allow entrepreneurs to run innovation experiments with their time, capital, and energy – then once a winning idea is discovered managers can buy them and minimize the risk of failure and the negative market response.

Nonetheless, data suggests that between 70 – 90 % of all acquisitions fail to create value (HBR). This high failure rate has given rise to arguments across both sides of the political divide. On the one hand, pundits claim that when big tech firms acquire start-ups, some of them get killed deliberately for competitive reasons. Others argue that if there is reduced M&A due to legal uncertainty, there is a reduced incentive for angels and VCs to fund those startups in the first place. If acquisitions as an exit strategy for investors in start-ups is closed, then there is a good chance that investing in start-ups may be unattractive, which may raise the barriers to entry for innovation – as it becomes less attractive for investors to put their money into the next round of innovative new companies. A steady flow of tech acquisitions can drive a virtuous cycle of innovation by increasing the incentive to start new companies. 

As a start-up entrepreneur caught in the midst of these arguments, the first question worth answering is to know when you should look to be acquired versus when you should continue growing till an Initial Public Offering (IPO). Going public makes the most sense when your start-up has gained significant traction in key business metrics that affect the bottom line. If your start-up still has a large element of risk, getting acquired is better as it has the effect of shifting innovation risk from you and your investors to large companies, who are better able to handle it in an era of risk-averse markets. If your business model is risky, getting acquired may be a better hypothesis to explore. To test your hypothesis for getting acquired, there are a few more considerations to keep in mind. First, ensure that your product meets a gaping need within the product ecosystem of the acquiring firm. Second, ensure that your product will be used in a fundamentally different way than is currently being used to create true value. 

Getting acquired has its risks. Whereas in a private transaction the value of the firm is capped at the offer price, in a public transaction, speculation can increase the market value of the firm over and above the book value. Second, there is significantly less control of the business and there is a big chance that the acquired firm may be shutdown. Consider that Dropbox shutdown Mailbox, Microsoft shutdown Sunrise and Twitter shutdown Vine. 

Nonetheless, a few acquisitions have been successful. Walmart acquired Jet a few years ago to jumpstart its e-commerce operations. Walmart’s acquisition of Jet allowed them to focus on young, affluent millennials. Getting acquired by Walmart was a good deal because Walmart was going to use Jet in a fundamentally different way, pushing its broad product assortment and leveraging on its solid logistics system. This acquisition paid off: in 2016 Walmart’s e-commerce sales grew by 37%. Although Walmart has wound down the Jet brand, its founder – Marc Lore, leads Walmart’s e-commerce business in the US.

Another successful acquisition move was Amazon’s acquisition of Wholefoods. Overnight, Amazon acquired a national physical presence and a network of distribution centers for fresh foods. Amazon can use Wholefoods in a fundamentally different way e.g. it can stock its regular products in Wholefoods distribution centers located in major cities and place products closer to consumers. Wholefoods founders certainly received more value from getting acquired that from going public.

Another successful move was DocuSign’s acquisition of Spring CM a few years ago. While DocuSign offers digital signature services, Spring CM offered electronic contract management services. Acquiring Spring CM allowed DocuSign to expand from offered just e-signature services to providing businesses with a single, unified, end-to-end document/contract management workflow. Also, in 2018 food delivery company Grubhub acquired LevelUp, a small Boston based startup for $390M. LevelUp offered payments and loyalty management services to restaurants. Purchasing LevelUp allowed GrubHub integrate directly with restaurants Point-of-Sale systems. In addition, GrubHub was able to leverage LevelUps existing relationships with restaurants to grow food service partners. GrubHub has been able to use the fundamental tech of LevelUp and scale it across the US. GrubHub was also able to enter the restaurant ordering segment on the back of this acquisition. 

Overall, there is a delicate trade-off between going public and getting acquired that start-up founders must master. Acquisitions are a great option when the present value of potential loss from a risky business model outweighs the present value of the potential speculative net gains that an IPO can create.  

Poatek is a leading technology firm that provides technology solutions to leading public and private firms alike. We understand the role that a properly implemented technology stack plays to reduce the inherent risk of a technology venture. Poatek hires only the best engineers to ensure that your product is best–in–class and built to outperform competing options in the market. 

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