• Wed. Nov 16th, 2022

How to Thrive in the Next Wave of Startup Acquisitions

ByElla E. Kidwell

Jul 10, 2022

On startup boards around the world, acquisitions are becoming a key talking point. Those with capital and successful businesses are looking for ways to grow, expand their product lines or expand into new markets. Conversely, those facing challenges may seek the security of an acquisition to weather the storm. In fintech in particular, as expected for the year, we will likely see an increase in strategic acquisitions (i.e. by other companies rather than financial investments).

In this article, we’ll explore the main rationales for acquisitions, as well as the crucial strategies for making them successful. There are five reasons for startup acquisitions. Let’s dive into it first.

ADVERTISING

Rationale 1: Revenue Growth

Acquisitions can drive revenue growth. This can manifest in several distinct and often overlapping ways.

On the one hand, they allow companies to extend their reach to new customer segments.

For example, UBS acquired Wealthfront for $1.4 billion. The goal was to acquire a millennial and Gen Z client base that was vastly different from UBS’s traditional wealth management division. “With more than 130 million investors in the United States alone, Millennials and the Gen Z population together constitute a high-growth segment that will hold an increasing share of global wealth…Wealthfront Capabilities will become the foundation of its new digital offering which will also include access to remote human advice.

ADVERTISING

Acquisitions allow cross-selling opportunities. For example, Bill.com acquired Divvy for $2.5 billion. The rationale was that “[t]The combination will expand market opportunities for both companies. Bill.com can offer expense management and budgeting software combined with corporate smart cards to its customer base of more than 115,000 and its network of 2.5 million members. Divvy will be able to offer automated payment, receivables and workflow capabilities to the more than 7,500 monthly active SMBs it serves.

Some companies enjoy distribution advantages that can make them prime targets. For example, the H&R block benefits from Wave’s free accounting system which has driven strong organic growth. Similarly, Credit Karma has brought one of the largest fintech client bases in the United States to Intuit.
INTU
and a cross-sell opportunity with other products like Mint or Turbo Tax.

Perhaps the ultimate acquisition strategies are those that generate legendary network effects. The combined entity is not only worth 1+1=2 (or 3 with synergies) but rather 1+1=5. Most fintech products are not the most natural network effect use cases (e.g. loans, insurance), but some startups have demonstrated their potential. In a way, this is the long-term promise of the buy-now-pay-later offer: by integrating merchants, BNPL suppliers acquire customers at a lower cost. If a network on the other side can be created, allowing customers to access brands offering BNPL, or other financial products, an ecosystem can be produced. This is part of the rationale for many recent BNPL acquisitions, including Paidy by Paypal and Afterpay by Square.

ADVERTISING

Payments offer perhaps the most direct network effect application. It’s definitely Block
SQ
The strategy of (Square) with cashapp. Venmo is therefore the quintessential example of an acquisition for network effects: the value of the P2P payments platform increases as more and more people send each other capital (and pizza emojis). It was partly for this reason that it was acquired (twice) by Braintree and later by Paypal.

Rationale 2: Constituents and Effectiveness

Acquisitions can also have transformative effects on a business through vertical building blocks. For example, Lending Club’s purchase of Radius Bank for $185 million transformed it from a purely peer-to-peer lender into a much larger financial institution with more varied revenue streams. The acquisition has brought multiple benefits. “One is financial. We have eliminated very, very significant costs. [including a warehouse facility swapped for deposits] The other big expense we eliminated [involved] issuing banks… We have also added a whole new source of income, interest income. We used to sell all the loans we made. Now we own about 15% to 25% of the loans we make, and holding those loans generates a stream of interest income, which is new and independent of origin. »

ADVERTISING

In some cases, companies can execute a deployment strategy to benefit from both rationales 1 and 2 through economies of scale through customer acquisition and synergies in operations.

Acquisitions provide the opportunity to buy key building blocks that provide greater strategic option. For example, when SOFI acquired Galileo, they felt that “Galileo’s digital payment platform enables critical checking and savings account-like functionality through its powerful open APIs, giving businesses an easy way to create sophisticated financial services for consumers and B2B”. Likewise, American Express
AXP
bought Kabbage for $850 million to expand its small business offering.

Rationale 3: Defensive

ADVERTISING

Sometimes the best defense is a powerful attack. Some assets are too valuable to risk being purchased by someone else and therefore must be purchased. Undoubtedly, Visa’s attempt
V
acquisition of Plaid and Mastercard’s
MY
Finite transactions fit into this mould. Plaid, for example, is a horizontal tool for the fintech industry enabling interoperability between many players, which many customers are looking for and consider table stakes. Their technology has become a backbone infrastructure for many fintech offerings.

Defensiveness can also take the form of neutralizing competition. Peter Thiel once wrote “Competition is for losers”. In many ways, this was the reason for the original merger of Paypal and X at the time. The two companies were in direct competition, but combined created a dominant market leader.

Rationale 4: Talents

ADVERTISING

One of the classic reasons for making acquisitions is to bring in the talent needed for a new strategy. This can of course overlap with building blocks in adjacent products. For example, ZenBusiness (a holding company) bought Joust to lay the foundation for its small business fintech offering and expand beyond training. Crucially, he also picked up fintech talent that he didn’t have internally at scale.

While these are often small acquisitions, they don’t have to be. Large-scale talent injections are possible.

Rationale 5: international expansion

A final important factor for acquisitions may be to establish themselves internationally. The approach also often overlaps with some of the other goals mentioned above, including revenue growth, building blocks, competitive defense, and talent. For example, the purchase of Paidy by Paypal extended their presence in Japan. It is also possible to purchase core items or key talents as a basis for future growth.

ADVERTISING

So you’ve decided to merge: considerations

First, the bad news: while the rationales above are all pretty compelling, most acquisitions fail. So before you go on a buying spree, be sure to think through a number of key considerations:

ADVERTISING

  1. Why are you buying the business? It is easy to state several reasons why an acquisition will be beneficial. They are rarely all possible. Therefore, be honest about the reasons for the deal and the KPIs by which you will measure success. Then, make a plan to optimize around those KPIs.
  2. Be conservative: Startup acquisitions are not easy to undertake. The DNA of small teams and cultures can often be very different. Few acquisitions are transformative. When making projections, be careful about what can be achieved in a reasonable time frame.
  3. Consider management capacity: Acquisitions have an underestimated opportunity cost: management time. Onboarding a new team and building a growth strategy will take time, to the detriment of other initiatives. Consider trade-offs and make sure you’re comfortable.
  4. Build muscle over time: The most successful acquirers don’t do it just once. They refine a culture, a process and an organization to acquire and integrate companies. If you haven’t already, start small rather than transformative. Then build that ability over time.
  5. Consider other tools to achieve your goals: Acquisitions offer many benefits, but are not the only way to achieve this. For example, a partnership with others can bring in the required talent. Management time could also be spent recruiting talent and building in-house. Sometimes these options can be cheaper financially and easier to integrate.

Good luck!