The landscape is changing rapidly in tech M&A. Investments in the tech sector are decreasing, valuations are lower, but tech M&A deal volume will increase albeit with stricter deal terms.
The path from unicorn to unicorpse is hasty — and rather steep
The valuation for unicorns are decreasing:
- Square lowered its initial public offering price to $9 from its original range of $11 to $13 per share in November 2015.
- Foursquare recently raised $45 million, which reduced its original valuation by half.
- Gilt Groupe, which valued itself at $1 billion three years ago, was sold recently to Hudson’s Bay Co. for $250 million.
Major mutual funds decrease investments in the tech sector
Major mutual funds like Fidelity, T. Rowe Price and Putnam have been channeling cash into unicorns. Fidelity’s Contrafund alone has poured roughly $2 billion into pre-IPO tech firms like Pinterest, Blue Apron and Twilio. This investment activity will decrease in 2016.
Funding for venture capital-backed startups decreases
Funding for venture capital-backed startups fell sharply in the fourth quarter of 2015. Total VC investment in North America dropped to $14.1 billion in the fourth quarter, down from $20.8 billion in the previous quarter, according to KPMG.
The effect on the M&A market: more deal volume, lower valuations
My prediction is that the tech M&A market will see more deal volume at lower valuations. The increase in deal volume will be spurred by:
- The reset in valuations will encourage more acquirers to buy companies.
- Large public tech companies still have considerable cash reserves at $1.5 trillion.
- Acquirers can finance at relatively low interest rates, further incentivising buying.
- The pace of innovation in cloud, mobile and Big Data will increase, requiring large tech companies to acquire to keep up with the rapid changes in the tech sector.
Expect changes to deal terms
More down rounds will occur. For example, I received a call recently from a CEO of a tech company in Silicon Valley. The last round valued his company at $150M on a post money basis. The company has a burn rate of 1M$ per month and he could not raise another round, since the current VC’s will not invest since the company’s growth rate had slowed to 20%. If the current VC’s do not invest, other outside VC’s will not invest. The company was too small to go public. His only option was to sell. In the M&A market, his company is worth $100M. As a result, upon the completion of a transaction, the founders and employees will not be richly compensated.
I know a company where the founders had a preference where the first $25M in a sale went to the founders. This is unusual, but desirable for the founders.
Expect more distressed deals, where the management and boards of companies wait too long to enter the M&A market, where a transaction takes typically 6 months or more to complete. With a cash runway of 6 months or shorter, the leverage in negotiation of valuation and structure is compromised. If a company is raising the next round, a parallel path, approaching both VC’s and strategic acquirers, is recommended in case the capital raise is unsuccessful.
As discussed above, lower valuations will be the new normal. I do not expect a crash in valuations, just a reset.
Buyers will require more due diligence, stricter representations & warranties and larger indemnification pools.
The M&A market is cyclical, with 7 good years and 7 bad years. It would be wise to consider the rapidly changing M&A landscape as part of a company’s corporate finance strategy for 2016.
M&A in the Technology Sector in the US (The Market Mogul)