How Companies Can Win With M&A
By Grant Hosford - General Manager, HOMER & codeSpark
EdTech is on a roll. Before COVID-19 turbo-charged the global EdTech sector, overall investment was modest, exits were rare and M&A deals were generally small. Then since 2019, global investment in the sector tripled from $7B to $21B. In addition, liquidity events accelerated, increasing both confidence and competition. Five IPOs and prodigious amounts of fund raising in the last twelve months helped the red-hot sector produce 17 new unicorns. These newly minted unicorns, flush with cash, felt immense pressure to maintain rapid growth, so the race was on to snap up the most promising early and mid-stage companies.
At the same time, companies that had been focused on raising their next round of capital were surprised by suitors who wanted to acquire them outright. According to investment bank BerkeryNoyes, these unprecedented market dynamics led to $30.2 billion in 2021 transaction volume, up 40 percent from $21.4 billion in 2020.
This burst in activity forced EdTech CEOs to carefully evaluate whether M&A should be part of their growth playbook. Potential buyers needed to make sure they had the teams and processes in place to effectively evaluate potential deals and then integrate any purchases they initiated. Potential sellers had to shift gears from preparing for their next fund raise to thinking about how becoming part of a bigger organization might be the most effective growth path available. EdTech can be a particularly hard sector to grow in because you often need to acquire both the parent (payer) and the child (user).
Regardless of whether you are a buyer or a seller, when is M&A right for your business? The answer is, of course, it depends!
Here’s what potential buyers must consider:
- Market share growth: When acquiring, buyers should understand if the company they are buying has a sustainable high rate of growth. How and where is the company acquiring new customers and are the unit economics for each new customer positive? There should be a clear and believable path to profitability if the target isn’t profitable already.
- Geographic diversification: One goal of acquiring a new company is to attract new groups of customers, and that includes customers in other regions or countries. Diversifying your portfolio across different geographical regions can lower acquisition costs and grow revenue faster.
- Product portfolio diversification: If the company you’re seeking to buy is already in your portfolio, you should consider looking at others. Diversification allows for more variety and options for products and services. Additionally, it opens the door to bring in new customers that may not have been interested in your product before.
Successful buyers focus heavily on exactly how new products or services will fit inside their portfolio of offerings. They are experts at considering the benefits of building their own capabilities vs acquiring someone else’s. Often, they have built meaningful relationships with a list of potential acquisitions through partnerships, supplier relationships and networking. Experienced buyers understand that when acquisitions fail, it’s generally due to problems with culture, systems, or both. This means successful due diligence covers much more than just financial and legal information. Buyers must understand the core elements of a target company’s culture as well as their processes for getting work done.
A successful M&A strategy includes the creation and curation of a target list. This list should ideally focus on companies that share the same mission and vision as the buyer - that way discussions start from a shared perspective on what success looks like. Leadership alignment is another critical factor for successful deals. It’s critical to be very clear about how reporting and decision making will work once the deal is complete. Post-deal, team communication often centers around how the new team will work with the existing team. The nitty gritty details of meeting cadence, goal setting, prioritization and reporting are all areas that can quickly become problems if not addressed proactively and flexibly.
Here is what potential sellers should consider:
- Capital for rapid hiring and product investment: Once you’ve raised capital and need more people to hire within the company, you should develop a clear roadmap that details what employees you’re looking for and if they have the same values as your brand. On the other hand, for product investment, you should make sure you have cash, loans or assets to fund the company's operations.
- Improved systems and people support: Merging two companies can be hard on the employees as it will bring a new culture to the workplace. Employers should support their employees through mergers by helping them adapt to new structures and processes and making the transition phase as seamless as possible.
- Access to new markets/customers: When selling your company, you should be prepared to get responses from different customers and look to emerging markets for new growth opportunities.
A chance to build a highly valuable company more quickly: Businesses in the same sector, such as EdTech, can combine resources to reduce costs, eliminate facilities, or departments and increase revenue. This can help both parties grow faster without spending as much money to reach that goal.
Seller teams need to have a deep understanding of the buyer’s mission, vision, goals, culture, systems, and organizational structure. It’s important for seller management to have a realistic expectation around influence and decision making. At a minimum, making decisions in the new company will require some collaboration with buyer management. Sellers must be prepared for aggressive negotiation of deal terms, including key elements like how the deal will be paid off. From a seller’s perspective cash is generally the best option since making earnouts and other similar structures work can be both difficult and hard to measure accurately. Often some portion of the deal proceeds will be locked up in escrow for a year or more which has to be put into considerations when thinking how this might affect the biggest shareholders/investors in the company.
What will be the post-deal obligations of the founders and/or the seller’s management?
If the deal proceeds, 5%-15% of funds will often be tied up in escrow for a year or more to account for unknown liabilities or other issues. The size of the escrow holdback is important to the buyer as the seller wants insurance that this number is as small as possible to reduce payment risk.
In a world where paid marketing, forecasting and risk management are increasingly difficult, a solid M&A strategy can provide huge dividends for buyers and sellers alike. Just make sure you know what outcome will be a win before you do anything on the checklists above.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.