As hopes of an impending tech rebound fade, fears of a spate of "fire sale" mergers and acquisitions among startups are rising.
Investors and others close to the action expect such M&A activity will accelerate in the months ahead. The deal-making follows tough conversations that began last summer between venture capitalists and their portfolio companies.
“A lot of last year was a depressed environment in the tech ecosystem and that’s continuing this year,” said Immad Akhund, co-founder and CEO of San Francisco-based Mercury, which provides banking services to startups. “I do see more blood on the streets before things actually improve.
“These relatively hot private companies having bad exits or failures will be part of that," Akhund added.
He anticipates 20% of today’s unicorns — tech startups that reached a $1 billion valuation — will find themselves being acquired.
“They don’t have great unit economics. They have massive valuations. They probably can’t raise money anytime soon,” Akhund said. “I think there will be buyers out there. But to some extent, it’s going to be more like a fire sale.”
The Bay Area is no stranger to downturns, most recently the dot-com bust at the turn of the century and the 2008 financial crisis. That’s created a playbook for how to handle times like these, which often involves turning to M&A as an exit. In those cases, the terms are often unfavorable to founders and early investors, but the alternative can be worse.
“When going into a downturn, venture capitalists have to decide which of their portfolio companies to back and continue to channel capital to them. As a result, some of their portfolio companies are confronted with running out of capital,” said Matthew Le Merle, managing partner and CEO of Blockchain Co-investors, which has invested in 45 blockchain funds and about 500 blockchain companies. “The positive cash-flow companies are mostly going to batten down the hatches, reduce costs, be patient and wait until the market for acquisitions or going public are open again.”
But the clock is ticking for companies with negative cash flow. They face more limited options as they burn through their cash, and they may have to sell at lower valuations than they once received.
“If you look at the typical venture capital firm, over the course of a fund, about 60% of the portfolio companies will go under. In downturns, that gets accelerated,” Le Merle said.
Deals involving early-stages startups are expected to see a rapid increase this year. Often referred to as “acqui-hires,” these are acquisitions designed largely to pick up talented teams and useful technology.
While details of buyout talks remain private, two startups founded in 2021 announced in recent days that they were acquired in deals involving companies with Bay Area ties. Nav purchased the assets of Toronto-based Nuula for an undisclosed sum after Nuula was unsuccessful in raising a Series A round.
“I’ve been impressed by the caliber of talent and excited to integrate our team,” Nav CEO Greg Ott said in unveiling the transaction. Ott, who is based in Northern California, oversees Nav's fully distributed workforce. Nav also has "event spaces" in San Mateo, Salt Lake City and Philadelphia.
Nav plans to leverage Nuula’s technology to advance its services that help small businesses get financing.
Another young startup was acquired when Oakland-based Marqeta said it was buying Power Finance for $223 million in cash. Power Finance’s credit card program management platform will round out Marqeta’s menu of services.
“We thoroughly examined possible acquisitions to more quickly establish Marqeta’s leadership in the modern credit space. It became clear to us that Power would strengthen Marqeta’s platform,” said incoming Marqeta CEO Simon Khalaf.
In addition to outright sales of entire companies, some expect a pick up in selling off underperforming operations.
“There are particular flavors of divestitures, and we’re going to see more in 2023, particularly around corporate parents divesting unproductive units or nonessential business units,” said Paul Lennick, senior vice president of M&A services at ContinuServe.
The former operating director at private equity firm Apollo Global Management now works with private equity firms buying middle market companies that are seeking to quickly streamline their operations and cut costs through outsourcing and other measures. Lennick’s firm has worked with private-equity-backed cosmetics company Orveon in its purchase of Laura Mercier, BareMinerals and Buxom from Japanese cosmetics giant Shiseido. The maker of BareMinerals once called San Francisco home.
Typically, there are 600 to 700 so-called carve outs from larger companies every year. Lennick expects this year that number will rise at least 50% if not more, given the recession and softening demand.
The factors fueling that increase will not come as a surprise to those following the massive layoff announcements. Companies are taking a sharper pencil to their operations and the growth projections that no longer seem realistic.
“There was just an over-extension of spending that went through 2021 and an anticipation that things would continue into 2022,” Lennick said. Now those companies are turning to M&A to divest operations that are a drag on profitability, often turning to private equity firms that have plenty of dry powder to make acquisitions at the right price.
In addition to seeing more private equity deals, these investors will likely hold their portfolio companies longer, so rather than a typical three- to five-year holding period, they may hold on to an investment for a year or two longer.
The slowing economy has also pressured how quickly private equity firms seek to turn around the fortunes of a newly acquired company. Popular moves include streamlining operations, outsourcing, cutting staff and, as Lennick puts it, “firing unprofitable customers.”
“There’s a sense of urgency that really kicked in this year,” Lennick said in discussing private equity firms pushing newly acquired portfolio companies to take steps to improve operations so they can weather the downturn.
Silicon Valley’s tech companies may feel the brunt of the downturn because times have been so good for so long.
“Technology companies that have always had growth and good times, and had more and more extra money pouring into them, are learning a lesson," Lennick said.
Correction: An earlier version of this story misstated the headquarters city for Nuula, which is based in Toronto.
