The Opportunity for Startups in India & ASEAN to Write a New M&A Playbook
2020 will be a tipping point for M&A in India and Southeast Asia’s startup ecosystem. Piyush Gupta unpacks what’s held founders back from M&A in our region – and provide a framework founders can use to ensure better outcomes.
Published June 25, 2020
Even before COVID, public and private investors assessing late-stage startups were looking much more closely at their path to significant scale and sustained profitability. That focus is here to stay, and many companies will need to expand their toolkit.
Against this backdrop, M&A will become an increasingly important tool for startups that want to scale, enter adjacent businesses and enhance their financial profile. This will require a change in mindset among founders in India and ASEAN.
M&A has been drastically under-utilized as a growth tool by startups in this region. That’s partly because many founders on both sides of the fence feel a natural sense of anxiety about , loss of control and the impact on culture, customers and employees. It’s also because M&A, as a tool, has a bad reputation. Numerous global studies put the failure rate of M&A somewhere between 70% and 90% which makes it look like a poor bet, even for natural risk takers.
This data is typically based on studies of larger corporations managed by boards and run by career chief executives. We believe it doesn’t apply as much to startup founders, who have a different level of ownership – in every sense of the word. Done right, there are significant benefits for both the acquired and acquiring companies. And when startups acquire other startups, there are several interesting ways to structure these deals to drive alignment and ensure better outcomes.
The Founder Factor
Mergers and acquisitions fail for a lot of reasons: ego, culture clashes, business strategy misalignment or poor integration can all take a toll. What’s more, a McKinsey study titled “Where Mergers Go Wrong” shows that when companies merge, most of the shareholder value created ends up going to the seller – partly because buyers are often wowed by vanity metrics and overvalue the synergies they’ll get out of the deal. As a result, buyers often overpay.
But there’s some differences that doesn’t show up in the data. Startup founders are a different breed to the big-cap company CEO who drives the mergers typically tracked by these studies.
A CEO with limited tenure tends to focus on the immediate impact. The pay-out for achieving such acquisitions or consolidations could be near term whereas any fallout is often felt years down the road, possibly after they are gone. There’s thus a misalignment of incentives and outcomes.
Founders, on the other hand, are driven by a mission and vision, and are deeply invested, on multiple levels. When a founder with a strong purpose, skin in the game and a high level of accountability to themselves and their teams, undertakes a merger or acquisition, they’re likely to have better outcomes.
Facebook’s acquisition of WhatsApp and Instagram are classic examples to this narrative. They were both big and gutsy moves by Mark Zuckerberg, not justified on financial excel as much as in the strategic opportunity they represented to the social network’s ambitious founder. WhatsApp was acquired for $16 billion in 2014 and is estimated by research analysts to be worth $80 billion today. Instagram was acquired for $ 1billion in 2012 and is estimated to be worth $160 billion today for Facebook.
Google’s early acquisition of YouTube in 2006 for $1.65 billion was another plucky move. The Google board may have had their reservations about the massive price tag for only a one-year old company, but Larry Page, Sergey Brin and Susan Wojcicki saw the promise of online videos and managed to drive it through. Today it generates $15 billion in annual revenue and is estimated to be worth over $100 billion.
Meituan and Dianping founders agreed to join forces in a $15 billion merger in 2015 creating a significantly stronger company, worth more than $100 billion on public markets in 2020.
An M&A Framework for Startups
The first step in building a winning M&A strategy is to put it on the table. Make this an active consideration in your strategy planning sessions. Continually ask yourself what companies you could merge with or buy to acquire new products or new technology, to enter adjacent business areas, to enter a new geography or to consolidate market share. Build good relationships with other founders in your industry and its adjacencies. The soft factors are important for getting the hard business done.
Startups we’ve worked with on M&A have been able to achieve their objectives by structuring their deals with these principles in mind:
Create an ownership mindset with stock-weighted acquisitions.
Founders are the heart and soul of a startup, so when one startup acquires another it’s critical to think about how to keep the founder of the acquired company engaged and motivated for the long term. Structuring the deal with stock helps foster an ownership mindset and create long-term alignment between the acquiring and acquired founding teams.
Change your organizational structure to make a home for the acquired team
All too often, acquiring founders bristle at the idea of another founder in their company. Set egos aside and recognize you want to harness, not avoid, that lightning. While there’s no one size fits all approach, ideally, you’re not just acquiring a product or market – you’re acquiring the missionary zeal those founders bring. Empower them to grow even bigger than they ever could on their own, by ensuring they have enough voice and autonomy.
Add on incentive for successful integration and performance
Where possible, give the target startup founder additional stock linked to longer term performance in the new set up. This is beyond the consideration you would have given them for value created in their own start up until the point of acquisition.
Bring some cash to the acquisition if you can
If you can include an element of cash in your acquisition to give partial liquidity to employees and full exit to early financial investors, this supercharges seller motivation to get the deal done and prevents an excessively large shareholder list.
Simplify cap table liquidation preferences
If the acquisition is material, use this opportunity to simplify the liquidation preference stocks. Alternatively, you can allocate the stock purchase consideration in ratio of your existing liquidation preference stack. There are other ways to do this, but it gets more complicated and simplified cap tables are founder friendly in the long run.
SCI Portfolio Examples of Driving Momentum Through M&A
Startups in Sequoia India’s portfolio that have approached M&A with these principles in mind have seen clear upside.
Pine Labs’ acquisition of Qwikcilver in early 2019 allowed the company to extend its business leadership from processing point-of-sale digital payments to the prepaid payment segment as well. The acquisition unlocked regional and customer synergies, added to its revenue scale and profitability and brought on board a dynamic Qwikcilver team that added energy in the room.
When BYJU’S acquired Osmo, it was all about new product and adjacencies. Osmo’s innovative tech, which combines paper and electronic device learning for a ‘phygital’ experience, was novel but not a big business. Byju saw it as an important enhancement to the company’s core student learning offering. Osmo’s leadership stayed on board at BYJU’S, fuelled by the dream of playing on a bigger canvas. Since the M&A, Osmo’s standalone business has grown manifold, benefitting from its integration into Disney BYJU’S Early Learn app for children in LKG to Class 3 and the new online tutoring product.
Carousell in quick succession acquired OLX’s Philippines business and then Telenor’s 701Search, which owns online marketplaces across the region, including Mudah in Malaysia, Cho Tot in Vietnam and OneKyat in Myanmar. Those deals put Carousell in the leadership position in Asia, and strengthened its capital position, as both Naspers and Telenor invested new capital into Carousell. These acquisitions also brought into Carousell dynamic and talented management teams.
The M&A strategy at Gojek, which has acquired 12 companies in four years, has helped the company acquire technology, talent, adjacent business and grow its market share. GoPay, its payments unit, provide a great case study. The acquisition of Midtrans for its online payment gateway business in Indonesia, Kartuku for its offline merchant payment processing business, and MokaPOS for its small merchant commerce solutions helped make GoPay the leading payments platform that it is today. Most of the talent from the acquired companies stayed on, bringing with them their missionary zeal.
We think 2020 will be a tipping point for M&A in India and Southeast Asia’s startup ecosystems. Conversations with founders have moved beyond the ‘why’ to the ‘how. Over the next few months we’ll start to see a secular, upward trend in the number of deals, marking a new milestone in the evolution of the region’s startup ecosystem.