- Tech is in a historic downturn, with companies of all sizes conducting hiring freezes or layoffs.
- M&A dealmakers are shopping, looking for startups to buy.
- But conditions this time around are unusual, eight investors and bankers told Insider.
Like a pounding headache after a raging party, conversations in the boardrooms of many tech startups have gotten grim, said eight venture investors and bankers whom Insider spoke with.
Yet, there’s one group of investors licking their chops: M&A dealmakers. This is a market ripe for bargain hunting.
“M&A is going to go way up in startupland. The question is, who are the buyers, and at what stage?” said Matt Murphy, a partner at the VC firm Menlo Ventures.
Dealmakers are scouting in overdrive. In the past week, two M&A investment bankers who represent large public tech companies contacted a Silicon Valley growth VC asking for possible startups to acquire.
“People are going shopping and building out a shortlist,” the VC said.
That’s because there is — or soon may be — a glut of overvalued startups low on cash looking for a buyer to save them, bankers and VCs told Insider, with some VCs requesting anonymity because they weren’t authorized to speak about potential deals. Their identities are known to Insider.
“On three boards I’m on, we’re starting to look for homes for these startups,” another early- to mid-stage venture investor told Insider. “We know our last-round prices were high, and we may not have the story to justify the next round being at a higher price. So we are preparing now.”
“We are starting to have a number of acquisition conversations for startups in the portfolio,” said another Silicon Valley VC who invests in early- to mid-stage startups. “Buyers are also putting feelers out offensively because there’s blood in the water. The conversations are up by a magnitude.”
Still, this period of M&A activity is different from any in recent history because the usual buyers — the biggest, wealthiest public internet companies — are being cautious under the scrutiny of regulators. And smaller public companies are being hamstrung by their slashed share prices as part of the overall “market exodus.”
Zombie startups on a challenging road
Any startup running low on cash right now could be in the kind of bind not seen for years.
While fresh funding hasn’t completely dried up, VCs are showing much more caution, which translates into lower valuations than the unicorn mania of 2021. Venture investments totaled $47 billion in April 2022 — the lowest in the past 12 months, Crunchbase said.
Investments from some of the biggest and most prolific investors, such as SoftBank to Tiger Global, have slowed way down, sources said.
“I would say compared to last year, the amount of new investment could be half or could be as small as a quarter,” Masayoshi Son, the chair and CEO of SoftBank, told analysts on a conference call last week.
Tiger, which reports say lost $17 billion during the recent tech sell-off, has also sharply cut back on late-stage investing, multiple sources told Insider.
Another mid-stage investor predicted that many early-stage startups wouldn’t be able to raise Series B or C rounds, nor would many later-stage, newly crowned unicorns — startups valued at over $1 billion — find investors willing to pay higher valuations.
“70% of the growth equity deals that got done over the last 12 to 18 months are going to be underwater,” said Hussein Kanji, a partner at the early-stage venture Hoxton Ventures. “Those companies, they’re basically the walking dead from that perspective. Some of those might turn into M&A, because that’s one way to recover some capital.”
But finding buyers is another matter.
“The pain I foresee is that there are a lot of companies that will be in a state of desperation for funding or an acquisition, but their last valuation is well north of $100 million, which is not an easy range to buy,” one of the mid-stage venture investors said.
There’s already been a number of unicorns, such as Cameo or the
Noom, that resorted to layoffs to cut their cash burn rates.startup
“Most of these companies are not going to exit as unicorns,” the growth investor said.
VCs are preparing to lose money on deals, but employees, who often take a chunk of their pay in equity, may also lose.
“If a startup raised at a high valuation in the past two years, there’s a good chance the company will have to make concessions,” a mid-stage venture investor said. “More of these acquisitions will take place, and no one will be happy, especially the employees who joined in the past two years.”
Public companies are not buying big, yet
In late 2020, Twilio bought the customer-data startup Segment in an all-stock deal valued at $3.2 billion. Ditto for the workplace-security company Okta, which did an all-stock deal valued at $6.5 billion to buy Auth0 in the spring of 2021.
But in the past six months, both Okta’s and Twilio’s share prices have dropped by almost 70%.
Because of the depressed public market, such blockbuster all-stock deals, especially from mid-cap tech companies, are in a holding pattern. “That archetype of M&A has hit a pause,” said one investor who focuses on early- to mid-stage companies.
“The thought is that these types of companies need their share price to stabilize before they can make another big acquisition in the $100 million to $2 billion range,” the mid-stage investor added.
“Every conversation around the $1 to $2 billion range of acquisitions has now been put on ice,” he said.
Mike Wilkins, a partner at the venture firm Shamrock Capital, which manages $3.9 billion in growth and private-equity funds, saw an acquisition deal for a startup die when the public tech company’s share price fell significantly.
“It was a sobering realization,” Wilkins said. “The company didn’t want to put additional pressure on its share price during a challenging time. ”
Meanwhile, buyers with enough cash on their balance sheet to do a blockbuster all-cash deal, such as Google, Facebook, Amazon, and Microsoft, are facing a new, tougher regulatory environment.
“The American companies are boxed in because they’re so heavily scrutinized,” said Hoxton’s Kanji. “I could see them doing smaller acquisitions, but I think the appetite for big ones, at least among the companies that are facing regulations, creates a pretty high bar to doing deals.”
Of particular difficulty would be an acquisition of a company handling personal data. “There’s a new regime with regulators wanting those companies to get broken up, not becoming stronger, and we can’t rely on them to be the saviors,” said Murphy of Menlo Ventures.
The easiest deals for public companies would be smaller, often undisclosed deals that complemented their existing products and services, known as “tuck-in” acquisitions, multiple investors said.
“We will likely see more tuck-in M&A, which is public companies acquiring much smaller startups,” said Asheem Chandna, a partner at Greylock who has backed the enterprise companies Sumo Logic and Palo Alto Networks. Chandna predicted a flurry of M&A in the $50 million to $250 million range.
Such caution among these classic buyers is already playing out. The number of public companies buying US startups fell in the first quarter: 99 acquisitions in Q1 2022 compared to 150 during Q1 2021, Crunchbase data indicated.
Startups to the rescue
It may be other startups, particularly late-stage ones flush with cash from raising giant rounds last year, that will be the most active buyers.
In the first quarter of 2022, more startups bought other startups than in any other first quarter in the past decade, Crunchbase data indicated.
Another mid-stage investor explained, “A company like Carta,
, or Project44 could buy a startup in the $100 million range and give the founder and employees equity at the price of the last round, with the hope that markets and valuations will go up.”
In fact, Project44 — a logistics startup that raised a $420 million round announced in January — confirmed that it’s shopping. A spokesperson said, “Project44 is in a strong position to acquire and accelerate the growth of companies that may have reached the end of their financial runway and want to keep executing on their vision.”
The industries that will be targets
Dealmakers have already been sniffing around cybersecurity and supply-chain startups in one investor’s portfolio, that VC told us.
And all agreed that software-as-a-service companies are ripe targets, especially for public company buyers, because they use a dependable, subscription-based business model.
“Both private equity and strategics have always loved SaaS,” said Cameron Lester, a managing director and cohead of global technology investment banking at Jefferies. “They love the recurring revenue and the predictability.”
There could also be more video-game deals in the aftermath of Microsoft’s $68.7 billion deal to buy Activision Blizzard in January.
“I think we will continue to see significant M&A activity in the space,” said Walter Driver, a cofounder and co-CEO of Scopely, a mobile video-game company. “I anticipate that we’ll see private-equity firms be very active, and that large cap technology and media companies continue to look at ways to play in gaming as Microsoft did with Activision.”
Digital-media and online-shopping startups are ripe for deals, said Robert Jackman, a senior managing director of tech investment banking for SVB Securities, while Jefferies’ Lester sees autonomous-vehicle companies as potential targets.
And given their options, venture investors are standing by to broker the deals.
“I think we’ll see more private-to-private M&A in the next 12 to 18 months,” said Vas Natarajan, a partner at the VC firm Accel who has backed Frame.io and Deepnote. “You often see the investors in the background helping to broker these introductions within the portfolio.”