Startups begin to acquire peers as valuations fall

WELL-FUNDED startups in South-east Asia have been quietly seeking out chances to acquire other startups, seizing a window of opportunity as red-hot valuations are tempered by macroeconomic headwinds.

Growing cautiousness by investors over the past six months has battered the market for fundraising. Startups rushed to cut headcount as capital got more scarce, while scaling back on expansion in a bid to extend cash runways.

But for companies with a stronger balance sheet, the softening market has presented a chance to snap up industry peers at a good price. It has led some to seriously consider inorganic growth for the first time.

“I’ve done this for the last eight years and I’ve never seen a market like that,” said Karl Mak, whose startup Hepmil Media Group recently made its first acquisition, which has yet to be disclosed. Hepmil, the company behind meme site SGAG, is aiming to expand in Indonesia.

“People are willing to talk, there are (founders) who are tired, and there are people who are looking for exits,” he said.

It has inspired startups to raise money for acquisitions, with target companies explicitly identified in the term sheets of investment agreements. Share swaps are often a feature of the M&A (mergers and acquisitions) transactions, said dealmakers, given the need to preserve liquid cash reserves in a weakening environment.

With companies hunkering down for a “winter”, some startups see such conditions as a good time to grow market share and outplay competitors.

It is pushing up M&A activity. The number of publicly disclosed deals involving at least one startup hit a high of 75 last year, from 41 the year before and 60 in 2019, the previous peak, according to Tech in Asia research.

“As transaction lawyers, we’re seeing the investments part of our practice (slowing down). The size and nature of the deals are becoming very different today than they were 12 months ago,” said Joel Shen, head of Withers Tech Asia at law firm Withersworldwide.

“On the other hand, we are seeing M&A go through the roof. A spike in M&A activity has balanced out the decline in investments,” he said.

These deals are, however, not the blockbuster exits that venture capitalists crave. Most deals value startups in the more modest region of US$10 million to US$50 million, said Shen.

Haulio, which connects first-mile container hauliers with businesses and shippers, acquired Jakarta-based Logol last year. This was Haulio’s first overseas acquisition. The deal followed Haulio’s US$7 million Series A funding round led by Temasek’s Heliconia Capital.

“We strongly believe acquiring Logol will fast-track our growth by increasing our regional fleet coverage by another 2,000 first-mile vehicles,” said Haulio co-founder Alvin Ea last month.

Last year also saw the acquisitions of crypto platform Tokocrypto by Binance, cross-border payments provider Wallex by M-Daq, and private securities platform Hg Exchange by Alta (formerly Fundnel).

This comes amid a larger flurry of M&A deals involving more traditional players. Healthcare startup Doctor Anywhere in December succeeded in its bid for a S$109 million buyout of Asian Healthcare Specialists, a medical services group listed on the Singapore Exchange.

A global study by EY found that 72 per cent of tech chief executive officer respondents plan to pursue M&As in the next 12 months, compared with 59 per cent of CEO respondents across all industries.

“In recent years, we are also seeing more unicorns making steady investments to boost their capabilities or offerings and expand their footprint, as well as venture capital-backed companies that adopt an M&A approach to grow their existing product portfolio,” said EY Asean technology, media and entertainment, and telecommunications leader Joongshik Wang.

But with the cost of capital rising, startups are approaching potential deals with more caution than before.

Influencer platform Partipost recently began exploring acquisitions for the first time. The startup has been conscious of how any deal affects its cash runway and company culture, and if it has the backing of existing investors.

“Do the numbers make sense? Will the acquisition actually help us achieve our goals? And the other part is the actual day-to-day culture and the quality of the company’s founders and senior leadership. That’s really important,” said Jonathan Eg, co-founder of Partipost.

“Then there’s pricing and valuation. Everything’s good, but maybe they are just asking too high of a price right now. All of that has to align.”

With more companies having fallen on hard times, the industry could see more rescue-type deals with further ripple effects.

M&As have been a key feature of a maturing tech ecosystem, ensuring value creation continues when assets change hands. But in the event of a distressed sale, or if certain investors have overwhelmingly favourable rights, employees who had a stake in the acquired company could end up with nothing.

Last year, employees of co-living startup Hmlet were told their employee share option programme (Esop) will be terminated, and any options granted will be cancelled. Hmlet was sold to European operator Habyt, and deal terms meant that any ordinary shares in Hmlet now had zero value.

Venture capital deals typically involve preference shares and a provision called the liquidation preference. It gives investors priority in recovering their initial capital during a trade sale or liquidation, before the rest of the proceeds are distributed among shareholders.

If a startup is sold below a certain valuation, investors could lay claim to all sales proceeds and leave nothing for company employees.

Withersworldwide’s Shen said such situations have been rare and normally occur in cases of a total business failure, where only assets are valuable.

Though employees rely entirely on founders to champion their cause, it is in the buyers’ interest to keep employees happy and motivated to stay, he said.

Employees could have their Esop subsumed into the parent company’s programme, or the startup and acquirer could work out a way for employees to still have direct ownership in the startup.

Shen said: “We are working on a few deals where the founder does, in fact, say, ‘If I’m expected to continue operating the business post-completion, then I will need to be able to incentivise my own employees. So, I want to retain the Esop at the company level.’”