The Startup Acquisition Wave Is Coming. How Will You Thrive?

The Future of Innovation Is Global. We Discuss It Here.

Photo by Silas Baisch on Unsplash

Adapted from a piece originally posted on my Forbes column here.

In startup boardrooms around the world, acquisitions are becoming a key topic of discussion. Those with capital and thriving businesses are looking for ways to grow, expand product lines or build footholds in new markets. Conversely, those facing challenges may seek the security of an acquisition to weather the storm. In fintech particularly, as predicted for the year, we will likely see a rise of strategic acquisitions (i.e. by other companies rather than financial investments).

In this piece we will explore the key rationales for acquisitions, as well as crucial strategies to make them successful.

There are five rationales for startup acquisitions. Let’s dive in there first.

Rationale 1: Revenue Growth

Acquisitions can drive topline revenue growth. This can manifest in multiple separate and often overlapping ways.

For one, they allow companies to expand their reach to new customer segments.

For example, UBS acquired Wealthfront for $1.4b. The rationale was about acquiring a millennial and Gen-Z customer base that was largely different than UBS’ traditional wealth management division. “With more than 130 million investors in the US alone, millennials and the Gen Z population together comprise a high growth segment that will own an increasing share of the world’s wealth…Wealthfront’s capabilities will become the foundation of its new digital offering which will also include access to remote human advice.”

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

Some companies enjoy distribution advantages that can make them valuable targets. For example, H&R block benefits from Wave’s free accounting system that brought in strong organic growth. Similarly, Credit Karma brought one of the largest fintech customer bases in the US to Intuit, and an opportunity to cross-sell to other products like Mint or Turbo Tax.

Perhaps the ultimate acquisition strategies are those that drive fabled network effects. The combined entity is not just worth 1+1=2 (or 3 with synergies) but instead 1+1=5. Most fintech products are not the most natural network effect use cases (e.g. lending, insurance), but some startups have demonstrated its potential. In some ways, that is the long-term promise of the buy-now-pay-later offer: by onboarding merchants BNPL providers acquire customers cheaply. If a network on the other side of it 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 of the BNPL acquisitions recently, notably Paidy by Paypal and Afterpay by Square.

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

Rationale 2: Building Blocks & Efficiencies

Acquisitions can also have transformative effects on a business through vertical building blocks. For example, Lending Club’s $185m purchase of Radius Bank transformed it from a purely peer to peer lender to a much broader financial institution with more varied revenue streams. The acquisition allowed multiple benefits. “One is financial. We knocked out very, very significant costs. [including a warehouse facility swapped for deposits] The other big expense that we've eliminated [involved] issuing banks… We also added a whole new revenue stream, interest income. We used to sell all of the loans that we manufacture. Now we hold about 15% to 25% of the loans we originate and holding those loans generates an interest income stream, which is new and independent of origination.”

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

Acquisitions offer the opportunity to purchase key building blocks that provide greater strategic optionality. For example, when SOFI acquired Galileo they reasoned, “Galileo’s digital payments platform enables critical checking and savings account-like functionality via its powerful open APIs, providing companies with an easy way to create sophisticated consumer and B2B financial services.” Similarly, American Express purchased Kabbage for $850m to expand its small business offering.

Rationale 3: Defensive

Sometimes the best defense is a strong offense. Certain assets are too valuable to risk them being purchased by someone else, and thus must be purchased. Arguably, the attempted Visa acquisition of Plaid and similarly Mastercard’s Finicity transactions fit this mold. Plaid for instance is a horizontal tooling for the fintech industry to allow interoperability between many players, something many customers are looking for and consider table stakes. Their technology has become core infrastructure for many fintech offerings.

Defensiveness can also be in the form of neutralizing competition. Peter Thiel once wrote “Competition is for losers”. In many ways this was the rationale of the original Paypal & X merger back in the day. The two companies were competing head to head, but combined created one dominant market leader.

Rationale 4: Talent

One of the classic reasons to complete acquisitions is to bring in the talent required for a new strategy. This of course can overlap with building blocks in adjacent products. For example, ZenBusiness (a portfolio company) purchased Joust to build the foundation of its fintech offering for small businesses and expand beyond formations. Importantly, it also acquired fintech talent that it did not have internally to scale.

While often these are smaller acquisitions they need not be. Large scale talent infusions are possible.

Rationale 5: International expansion

One final important driver for acquisitions can be to gain international footholds. The approach often also overlaps with some of the other objectives noted above, including revenue growth, building blocks, competitive defensiveness and talent. For example, Paypal’s purchase of Paidy extended their foothold in Japan. Equally possible is purchasing key building blocks or talent as a foundation for future growth.

So You’ve Decided To Merge: Considerations

First the bad news: while the above rationales are all quite compelling, most acquisitions fail. Therefore, before going on a buying spree, make sure to reflect on a number of key considerations:

1. What is the reason you are acquiring the business? It is easy to point to multiple reasons an acquisition will be beneficial. Rarely are all of them possible. Therefore be honest about the rationales for the deal, and the KPIs by which you will measure success. Then make a plan to optimize around those KPIs.

2. Be conservative: Acquisitions of startups are not easy to undertake. The DNA of small teams and cultures can often be quite different. Few acquisitions are transformative. When you build projections, be conservative about what can be achievable in a reasonable time frame.

3. Consider management capacity: Acquisitions have one underrated opportunity cost: management time. Integrating a new team and building a growth strategy will take mind share, at the cost of other initiatives. Consider the trade-offs and make sure you’re comfortable.

4. Build the muscle over time: The most successful acquirers don’t do it one off. They hone a culture, process and organization to acquire and integrate companies. If you haven’t done it before, start with something small rather than transformative. Then build out this capability over time.

5. Consider other tools to meet your objectives: Acquisitions offer many benefits, but are not the only way to achieve them. For example, partnering with others can bring the requisite talent. Management time could also be focused on recruiting talent and building internally. Sometimes these options can be cheaper financially and easier to integrate.

Good luck!