Unlocking Growth: M&A Opportunities In VC Space

The Great Tech Reset (a recalibration of growth versus spending as investors and consumers grow more cautious while the economy recovers), is still ongoing with many upsets happening across the African tech landscape. This has birthed a difficult environment for investment across the continent’s major tech markets. Despite this, mergers and acquisitions (M&A) are forecasted to enjoy an upturn despite the current market.

The past 12 months have seen a significant decline in venture capital (VC) funding in the continent. The total amount raised declined by almost 40 per cent between July 2022 and June 2023 compared to the same period between 2021 and 2022. This sharp decline is particularly evident in the Big Four markets of Nigeria, Egypt, South Africa, and Kenya, with funding contracting by as much as 77 per cent in some. Due to these challenging market conditions, numerous start-ups are nearing the end of their financial runway and are struggling to secure further investment.

Founders in this situation usually face three paths:

Survival strategy: This entails major cutbacks and slower growth. This is only feasible for some start-ups.
Shutting down: This involves ending operations and returning any remaining funds to investors.
M&A route: Opting for a merger or acquisition.

Against this backdrop, M&A may present a growing opportunity for African venture-backed start-ups. As many companies face a contraction in funding, M&A can offer well-provisioned start-ups a way to enhance their offering, expand their reach, and achieve greater scale.

Key Drivers Of M&A Activity In VC

Several strategic and financial considerations power M&A within the startup ecosystem:

Technological or product enhancements: Businesses often use acquisitions to boost their technical prowess or enrich their product catalogue. By acquiring start-ups with innovative technologies or unique products, businesses enrich their product catalogue and elevate their technological capability. Strategically, this move provides companies with a twofold advantage. First, it accelerates the time-to-market for technology, sidestepping the lengthy and expensive in-house development process. Second, the acquisition grants companies a competitive edge by hopefully giving them rights to protected intellectual property. In essence, acquisitions serve as a strategic shortcut for businesses to improve their technological standing and product offerings, ensuring they remain ahead of the curve.
Talent acquisition: By acquiring a company primarily for its talent, more mature start-ups can access proven capability and teams that are experienced at building a startup. This immediate integration of a proficient team with pertinent skills ensures they can seamlessly transition into projects, potentially cutting down product or business launch timelines by months. Strategically, this not only grants the acquiring company access to scarce technical expertise but also provides insight into the invaluable knowledge held by these operators.
Expanding market share (locally and regionally): Horizontal integration allows start-ups to absorb competitors, amplifying the firm’s market presence and reach. Moreover, regional expansion through M&A allows start-ups to access new consumers, tap into local insights and leverage pre-existing distribution channels. On the other hand, through vertical integration, a start-up can streamline its operations by acquiring control over its supply chain, including suppliers or distributors. Strategically, this crafts a holistic ecosystem of offerings with potential synergies and propels immediate growth in sales revenue and customer base, facilitating accelerated market penetration.
Opportunistic or distressed asset acquisitions: These acquisitions offer valuable assets at lower costs, equipping the acquiring company with strategic leverage. This is particularly beneficial with more asset-heavy type models.

Navigating The M&A Landscape

Before diving into the M&A process, founders need to conduct a thorough market mapping exercise to identify potential targets that align with their strategic or financial objectives. This involves assessing the competitive landscape, understanding the target’s value proposition, and evaluating growth potential.

Founders should consider the following factors during market mapping:

Strategic fit and growth potential: A strong strategic fit ensures that the acquisition enhances the overall business and creates synergies. The growth trajectory and scalability of the target’s offering are also critical as they can enhance current growth by the acquirer.
Market positioning: A start-up with a unique selling proposition and a strong market presence may provide a significant advantage to the acquiring company.

The Art Of Due Diligence

Performing due diligence (DD) is critical to any M&A deal. This comprehensive review of the target company helps the acquiring company identify potential risks and opportunities linked to the transaction.

Some of the key due diligence areas are:

Commercial due diligence: Founders should evaluate the target’s market position, customer base, and competitive advantage. Understand the target’s revenue streams and potential challenges in the market.
Product due diligence (including growth strategies): Founders should assess the target’s products or services, their uniqueness, and how they fit into the acquirer’s product portfolio. In addition, it is important to assess the target’s growth metrics, customer acquisition strategies, and potential for future growth. Ultimately the point is to understand the factors driving or impeding growth.
Legal and financial due diligence: Founders should review contracts, licences, intellectual property rights, and any legal issues that could impact the deal. In addition, it is critical to thoroughly examine the target’s financial statements, cash flow, profitability, and financial health, as well as identify any potential financial risks.

Structuring The Deal

The deal structure plays a crucial role in M&A transactions. Founders should carefully consider how the deal is structured to ensure a successful outcome for both parties.

Common deal structures in the VC space include:

Cash and/or shares: The consideration for the acquisition can be in the form of cash, equity, or a combination of both. An all-cash acquisition may result in a misalignment of long-term interests between the parties, whereas an all-share offer may be a challenge to get over the line.
Upfront or earn-out: The payment can be made entirely upfront or partially upfront with deferred payments based on achieving certain milestones (earn-out). Earn-outs are particularly common when the target’s future performance is uncertain.
Management incentives post-deal: To ensure a smooth integration, management teams of the acquired company may be offered incentives to stay and continue driving growth.

Bridging Cultures, Valuing Teams

Following the deal’s closure, the integration phase involves merging two entities and aligning processes, teams, and cultures. Careful attention to cultural alignment, talent retention, communication, and synergy realisation is paramount for the success of this endeavour.

M&A Can Breathe Fresh Life Into Start-up Ecosystem

The shifting landscape of African venture capital, marked by a decline in funding, necessitates a fresh look at the role of M&A. As more startups grapple with limited resources and financial uncertainty, M&A emerges as a viable path for growth, expansion, and innovation. Whether the motivation is talent acquisition, technological enhancement, or market expansion, these deals can breathe new life into companies and fortify their position in a competitive market.

However, the path to a successful merger or acquisition is intricate and multifaceted. It’s not just about the numbers or assets — it’s about people, cultures, visions and. For Big Four and beyond start-ups, embracing M&A could be the transformative move that paves the way for more sustainable businesses. But as with any significant venture, the key lies in strategy, diligence, and a clear understanding of the mutual value on offer.

You can learn more about Founders Factory Africa and how it supports Africa’s early-stage start-ups here.

This article was written by Philani Mzila, Investment Manager at Founders Factory Africa, an early-stage investor who has invested in over 55 start-ups across the African continent.