M&A for start-ups

Lately, I’ve been having a number of conversations with well-funded start-ups about their first deal.

In most cases, the executive management team and founders have limited transactional experience.  To me, that makes complete sense and is as it should be, they’ve naturally dedicated countless years toward building a successful product or service offering. Their other major focus has been on raising capital and they’ve clearly kicked some huge goals in both fields otherwise the thought of M&A wouldn’t be on their radar.

While every situation is different, I thought to consolidate some general principles which I think are good practice and should have broad application for start-ups considering M&A:

1.     Be wary of starting with an opportunistic deal

Be extra cautious if the first deal opportunity arises out of the blue and isn’t driven by an orderly and intentional process (see 2 below). The challenge of starting with an opportunistic deal is that you’re more likely to be skipping an important step of writing down and analysing the full spectrum of options across your business value chain. As a result, you’ll find that it’ll be harder to articulate “why this deal and not some other deal?” and your answers to related questions like “how did you determine the right price?” and “what’s your integration plan?” might be a little ambiguous.

2.     Start with a roadmap

The best place to start the M&A journey is by establishing a crystal clear rationale for what you want out of a deal. I like to start with a one-pager that visually shows the full value chain in your industry and where your business sits. I then overlay this with other businesses and where they sit in each part of that value chain. I also like to look outside of my immediate geography. This map helps paint the picture of your role in the value chain and often presents some obvious acquisition targets.

The next step is to do a simple sensitivity analysis on your P&L and a SWOT analysis. I know what you’re thinking, SWOT is boring. True. That’s why I’ve thrown in P&L sensitivity analysis! Knowing which levers actually matter and which are short term distractions is underrated and can become a bit addictive.

Once you know exactly what you’re doing well and what you’re missing, it’s a lot easier to find it, value it and integrate it (or intentionally leave it un-integrated).

For example, you may have a terrific widget business. You decide that you don’t need vertical integration right now because your P&L sensitivity paints an obvious picture – you’re just desperately in need of more scale in the form of customers. You don’t need more equipment and you don’t need more headcount. I would then turn to my trusty one-pager and find a few small competitors with underwhelming equipment and mediocre headcount. I would have previously dismissed them as being small and irrelevant but now I see them differently – I want their customers. I also know what I don’t want, their systems, processes, equipment and headcount. I’m now clear in my vision, I can articulate why I want to do the deal and what success looks like, I know how to value them (because my P&L sensitivity analysis told me that dropping more customers in has a clear incremental profit outcome) and I can speak comfortably to my integration plan.

3.     Take your stakeholders on the journey

Once you’re armed with the information from step 2, you need to start building your high level M&A plan into your strategy conversations. More specifically, I mean mentioning the possibility of M&A to the broader business (not just the exec and founder group) and having robust discussions with the board. Keep in mind that M&A can be a daunting topic, so it’s a dish best served in small bites over time.

In my experience, the process which you’ve completed in step 2 will create some very solid guardrails for curating and assessing opportunities and will give your board a lot of comfort that you’re being strategic and diligent in your approach. I find that it also makes the decision making process much smoother when there’s an already-agreed ‘wish list’ of what you need in your business and a clear target-by-target rationale for why each fits your wish list. Knowing what you want and why will make it much easier to value, structure and execute.

There’s nothing more stressful for a board than to hear about an M&A opportunity for the first time when the opportunity arises out of the blue and before any meaningful discussion of how M&A fits into the broader strategy.