Technology and Internet
M&A for high-growth companies: Navigating rocky territories successfully
10 Jun 2020
World’s largest brick-and-mortar retail player buys India’s biggest Ecommerce platform. An Edtech startup acquires an online learning platform to foray into state competitive exams. A leading online insurance policy aggregator announces its intent to acquire a reinsurance player.
With a median acquisition value of US$ 20M, consolidation in the Indian technology and internet space has truly come of age. In recent years, the acquisition of many new-age companies by established players has demonstrated to a certain extent the value created by the startup space – something that many skeptics had previously doubted. We believe that this trend will accelerate as technology disrupts many more traditionally-run industries and leads to newer ways of doing business. 
M&A in high-growth companies is driven by a host of factors including augmenting the product portfolio, reshaping consumer experience, gaining a foothold in a particular market or upgrading key capabilities, and the texture of these is very different from traditional industries. At Praxis, we have identified seven key trends which stand out with respect to M&A activity in high-growth companies:
  1. M&A in high-growth companies is at the core of further accelerating their pace of growth. A strategy first pioneered by the FAANG companies has been rapidly adopted by high-growth enterprises across tech-driven business models in the last decade. This, of course, is quite different from traditional industries where M&A was a strategy to be deployed if faced with organic growth challenges.
  2. In 2019, almost US$ 10B was deployed in venture capital in India-based tech and internet companies. At these high stakes, one clear trend is the growing role and influence of financial investors (i.e. other than founders) in directing the strategic roadmap of a company (operating independently vs merging with another player). Notice, for instance, how investors/Limited Partners have placed bets in multiple players in the same industry - the Indian Foodtech landscape is a prime example of this. 
  3. The widely held view of most tech-enabled disruptors is that they operate in an industry structure where ‘winner takes all’. While the jury is out on this question, we are increasingly seeing companies being ‘built for acquisition’. Entrepreneurial ingenuity and intensity are being devoted to building agile, nimble businesses that almost have a ‘target acquirer’ in mind from Day 1, especially in industries such as digital media, HealthTech, Logistics Tech, etc.
  4. Monetization for initial cohorts of employees (across levels) through ESOP sales to the acquirer has become a distinguishing characteristic of recent acquisitions in the tech and internet landscape. This was extremely rare a decade ago, and will only become more prevalent in the years ahead.
  5. In general, there are less ‘physical’ and more ‘knowledge’ or intangible assets including platforms, brands, networks, teams, customer loyalty, etc. involved in transactions between high-growth companies. This has led to a redefinition of the term ‘synergy’. Far from looking at what can be optimized, the question is mostly ‘how much faster can we grow’. “What we can achieve together” rather than “what we have today” is the driving mantra in most merger discussions. For instance, a leading Edtech player acquired a vernacular language platform for competitive exams and successfully cracked a market which it wasn’t able to foray into initially even after multiple attempts.
  6. As of date, we have nearly 30 India-based high-growth ‘unicorns’ which have created US$ 100B+  in value. We believe that startup India has been noticed on the global stage, and global companies headquartered outside India want to be a part of this action. This will spur significant cross-border (inbound) M&A in the high-growth companies. 
  7. Traditionally, M&A decisions have been based on time-tested P&L metrics such as revenues, EBIDTA and cash flow. However, these metrics are difficult to apply in high growth tech-enabled businesses which not only have short operating histories, multiple-year losses and the lack of precedents but also are based on a ‘winner takes all’ view of the industry structure. Obviously outside-in metrics such as total market size, customer acquisition track record, etc. become important determinants. We believe that as ‘burn-to-scale’ or ‘growth at all costs’ loses sheen, investors will start to look at metrics such as net income and EBIDTA in addition to GMV or volume growth, as they think through their M&A strategy. 
In the fast-moving world of tech-driven high growth businesses, the form and texture of M&A activity are also changing rapidly. Based on our extensive work with new economy businesses, their founders and investors, we have identified four imperatives for a successful M&A strategy for high-growth companies:
  1. It’s important to ask as early as possible ‘how exactly’ the day-to-day business operations will run in the post-merger scenario. This becomes quite critical in the case of new-age companies because both companies could be powerful brands by themselves, or could be serving distinct customer needs. One of the key decisions in such cases, therefore, is whether to integrate the two entities into a single entity or run them independently (often the preferred option so as to ensure that there is no slowing of the growth agenda).
  2. As financial investors deploy a ‘string of pearls’ strategy and drive M&A activity in their portfolio companies, it becomes increasingly important for them to think through the sequence of and gap between multiple acquisitions.  
  3. Traditional companies that are buying into young tech-driven businesses need to watch out for the risk of alienating and stifling their acquisitions by trying to impose their systems and processes on the high-growth companies. They need to learn to live with some degree of chaos around them to allow their newly acquired intangibles to blossom and realize the intended value.
  4. Startups, financial investors, or other strategic investors have to accept the fact that it takes just an idea to topple them from their leadership position. It is very important, therefore, to treat the founders and key employees of the businesses they acquire with objectivity, fairness and respect. Those who do not display the required degree of empathy and professionalism are likely to turn off potential targets, who may choose to fight it out or combine with other suitors instead. 
M&A activity in high growth companies is here to stay, and in fact, accelerate as traditional and global companies start throwing their hats in the ring. Meanwhile, financial investors are also actively using M&A as a strategic tool within their portfolio companies to fuel growth and attain industry leadership. While growth remains the all-important goal, we do see some reversion to metrics such as revenues and EBITDA as indicators of a sustainable business model. Making high growth companies’ acquisitions a different ballgame altogether. Acquirers need to demonstrate empathy and objectivity with the founders and key employees of the target companies and often let them retain their culture while driving synergies to drive growth.

Authored by (at the time of writing): 
Shishir Mankad, Leader, Financial Services Practice 
Sushman Das, Member, Technology and Internet Practice 
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