Early Charm Ventures Executive Director Ken Malone's inbox has been getting flooded lately with requests from private equity firms and others trying to buy one of his portfolio companies, a reflection of the increased interest in mergers and acquisition deals even amid a down market for the tech industry.
“In prior years at this time I was getting maybe two requests a month from somebody wanting to buy one of our businesses,” Malone said. “That's up to about two a week now.”
Despite the increase in interest, Malone hasn’t sold a single Early Charm company this year. Malone doesn't face the same pressure to sell as others because his company is not backed by venture capital and low valuations mean a deal is even less tempting. Malone's situation is one faced by many tech companies in Baltimore and across the country as they grapple with how to deal with lower valuations for their companies. Those lower valuations may give the impression that it’s a great market for buyers, but many startups are not willing to sell for bargain prices. Companies in the market to acquire another business are also facing their own financial problems as high interest rates have increased the cost of capital for many would-be buyers.
Even with these struggles some experts believe a boost in deals could be on the horizon as startups stuck between a tough venture capital market and a declining balance sheet are forced to make a sale even at a lower valuation.
"[Buyers] believe they can find somebody that has some decent cash flow that just can't raise that next big round and wants to sell because they're tired and ready to get out," Malone said.
Many of the lower valuations are because buyers have changed how they evaluate companies. Private equity firms and other groups focus more on current revenue, compared to three years ago when most buyers took into account the potential for the future growth of a company, Malone said.The decline in valuations is even starker because many companies saw a huge growth in their valuations in 2021 due to federal stimulus money and low interest rates.
ZeroFox CEO James Foster believes that most companies that are looking to sell are too attached to past evaluations and are unwilling to see that the current economic downturn is more than just a temporary decline. The Baltimore cybersecurity firm is active in the M&A space and has made four acquisitions in the past four years, not including the merger it did in order to go public through a Special Purpose Acquisition Company (SPAC) deal.
“Greed kills most deals,” Foster said. “There's still a lot of folks out there that haven't come to recognize that this may be more than just a small dip in valuations.”
Many possible buyers are also not in the best position to make huge moves in the market. The increase in federal interest rates makes the cost of getting a loan much higher, so many companies use their own cash reserves or equity to acquire companies, Foster added.
There is potential on the horizon for a boom in tech M&A. The federal reserve choosing to cut interest rates would ignite much of the capital markets and lead to an increase in deals. The federal reserve simply choosing to keep interest rates stable instead of making further interests could also lead to banks being more comfortable underwriting acquisitions for the rest of 2023 and force some companies to rethink their valuations, said Garrett Hinds, a senior analyst with industry database PitchBook.
"It's been over a year since the Fed started hiking [interest rates]," Hinds said. "People are eventually going to start seeing that they're going to need to reset their valuation expectations."
Companies more dependent on venture capital investment will likely try to find an exit in the coming months as their cash reserves run out. Startups that are backed by venture capital generally have to liquidate their shares through an acquisition or a public offering to give a return to their initial investors. The difficult initial public offering market makes it harder for startups to exit by going public, creating opportunities to buy promising startups at a discount when they have few other choices, according to PitchBook's Q3 venture monitor report.
The desperation of companies caught in the middle of a lackluster venture capital market and declining balance sheet have led to an increase in “distressed M&A” where a company sells because they have no other options since they are about to run out of money or need to exit to satisfy an investor, Foster said.
“We've gotten calls from companies saying, ‘We'd love to talk to you about an acquisition. We’ve run out of cash in a quarter, so we're going to move fast,' " Foster said.
Click here to read the rest of the BBJ's "What's the deal?" series.
