Facebook recently acquired LittleEye Labs, an Indian startup that helps developers identify and fix performance issues in their mobile apps. According to Sateesh Andra, Managing Partner of VentureEast Tenet Fund, which invested in LittleEye’s less than a year ago “This is a transformative event for the Indian Product Startup Ecosystem. Also validates our Fund’s belief in Product Startups, with Global Focus and Local (India) Execution.”
And a transformative event indeed it is. Facebook has made several acquisitions so far. But this is its first acquisition in India. early-stage mergers or acquisitions have been rare in India. As a result, early investors in Indian startups could make money only if the startup did fundamentally well on its business case and traction. Exits for angel investors and early investors in Indian startups were largely from follow-on rounds of investments. The acquisition of LittleEye by Facebook is transformative, because it could be the harbinger of the opening up of an important exit option for investors. This, in our view, could lead to a lot more people becoming angel investors and certainly will lead to a lot more angel investors taking bets on companies where value unlocking could be through acquisitions by large Indian or overseas platforms.
It will transformative, also because, increase in M&A activity at early-stages will hopefully make raising capital easier for startups.
The LittleEye – Facebook deal is an early and strong indicator that more M&A will happen in India in the early-stage space. Since M&A should be, and now increasingly it will be, an important exit vehicle for investors, there is a need for founders to be familiar with concepts, terms and technicalities that guide M&A deals. One question that often gets asked is why there aren’t many more acquisition targets in India for Facebook, Google, Intel, Cisco and others. Our view is that though there are a number of companies that could be meaningful for these global brands to acquire, there is neither a platform for discovering these startups, nor do the founders in India do anything actively to position themselves as potential targets. At Aurum, we recognize this gap in the market and are working towards creating an online marketplace for startups and early-stage companies that could be potential acquisition targets for relevant global brands.
What do large companies acquire startups and early-stage companies for?
Large companies acquire early-stage companies for either of the following reasons
To acquire the talent – either a crack founding team and a great talent pool in the venture
To acquire the product – usually to get the IP for a product that may be a strategic fit in the acquiring company’s business. In early-stage acquisitions, the products may not be completely ready or even market-ready. However, if there is a demonstrable good concept and IP to protect the gold, product companies could be good acquisition targets. Google’s acquisition of YouTube and Android are strategic acquisitions, as was Microsoft’s acquisition of PowerPoint many years back, which they integrated into their Office Product Suite.
To acquire a brand – this is rare in early-stage acquisitions as brand equity takes time to build
To acquire innovation that could assist their business or can open up new possibilities – Innovation costs a lot in large companies and companies certainly cannot hire all the innovators. Hence, if they think something can make a difference to their business, they can consider acquiring it. Large companies acquire companies also to acquire innovation that can threaten their business.
Large companies may also buy smaller players to build scale – but again, because the early-stage companies are unlikely to have meaningful scale, a stand-alone acquisition does not necessarily make sense to an acquirer. There have however been instances of multiple acquisitions where the acquirer consolidated the position in the marketplace through acquisitions.
To acquire a customer base – Large companies could acquire an early-stage company if the company has customers that could be valuable for the acquiring company, or if the acquisition can give them a head start in the market.
To acquire competencies that they may currently not have – like a digital ad agency being acquired by WPP, or a online education company being acquired by a healthcare major.
When founders think of their exit strategy, they should assess what exactly they are likely to be acquired for, and then if acquisition is indeed an exit option to consider, they should strengthen their foundation on that front. E.g. if you are likely to be acquired for a great initial team and founders, then the hiring strategy should be in line with building a crack team of high-quality people.
They also need to think of how their pitch decks and presentations should be structured to give a potential acquirer a good view of exactly what they are looking for. Hence, pitch decks used for investor pitches may NOT be most useful when pitching to potential acquirers. All acquisition discussions need not be explicit. Hence if you are presenting to a potential customer who could be a potential acquirer too, it will be wise to pepper your pitch deck with pointers which also reinforce to the company the value of what you can bring to them.
Founders should be aware that large companies do not usually buy companies just because the target company has started developing the product and that they will save a few months by acquiring rather than building the product ground up. But they may – only in circumstances where the time to market is crucial (e.g. to beat a launch announced by a competitor).
Which sectors are likely to see exits?
Well, not all sectors are acquisition conducive. Typically technology driven sectors where the product or the team is likely to be of strategic value to the acquirer are naturally much better positioned for being acquired.
You will therefore see a lot more M&A activity in e-commerce (which is typically to build mass), mobile, media, analytics, e-payments, etc.
Some points to note
Just as an Investment Term Sheet and Share Holder Agreement, it is not just the valuation, but the specific terms and conditions that make the deal sweet or not-so-sweet for the target company.
Some key terms
Cash or equity swap: Simply put, do the founders get the money or do they get shares of the acquiring company to the extent of the valuation on which the deal was done. Share swap too is not a bad deal, depending on the terms and timelines on which the team can liquidate their share holding.
Cash-out of earn-out (also called Single-shot and multiple-shot or milestone linked): i.e. do they get the money upfront or do they get it in tranches over a period of time. And if over a period of time, then there are usually conditions and deliverables on the founders to live up to, before they can see the money.
Non-compete clause: Does the deal ask the founders to not be in a similar business again. If so, for how long?
How important are financials in an exit?
Well, it depends on what the team is going to get acquired for. Typically in earlystage acquisitions, their financials are unlikely to be attractive to the acquirer. Even if the numbers (users or revenues) look solid, they are likely to be the size of a rounding off error in the acquirer’s books. That said, healthy financials give you a good cushion and strength to bargain on. With weak financials the valuations are likely to be lower, even if the financials do not mean anything to the acquirer.
In summary
M&A activity in early-stage ventures in India will increase.
Large global players who are experts at acquiring strategic assets are likely to get active in India.
M&A is the new game that founders will need to learn to play. And quickly.
There are several reasons why your company could make sense for an acquirer.
Be aware of what that value will be – build on it and reinforce it.
Share your vision and expected preference in case of an acquisition to your cofounders and investors.
[About the author: Sanjay Bansal is the Founder of Aurum Equity Partners, an investment banking firm. You can reach him on sanjaybansal@aurumequity.com.]
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