Why Large Corporates do not Buy Startups

Unlocking M&A Success in an Era of Uncertainty

A few weeks ago I was invited to speak  in London at the Mergermarket Corporate Development Forum Europe 2023.

The topic (front and center) was M&A. One of the main issues reported during the day was forecasting the results of the target companies under the current circumstances of crisis and volatility of the markets.

This popped up to my mind the categorization introduced by the former US Secretary of State Donald Rumsfeld between “known unknowns” and “unknown unknowns”.

In M&A there are always known unknown

When you buy an established company, you are exposed to some know unknows. Notwithstanding the target company has a track record of trailing results (both revenue and margins) and the “forward” figures are supposed to show a certain continuity with past results. Then metrics and multiples are applicable, though – in condition of  uncertainty – it might be difficult to properly “size” them.

Startups are a totally different game. They play in the “unknown unknowns” league.

When you buy a startup, you are not buying an “add-on” to what your company is doing. You are buying an extension of who you are. Then inherently difficult to assess.

You are buying your potential future. And the future – most of the time – has still to materialize. What you are buying is still ahead of the curve.

Then trailing numbers are not relevant. Forward numbers do matter. But forward numbers are difficult to predict, since they have no continuity with the past results.

Traditional valuation criteria and multiples do not apply to startups.

It might sound quite obvious but – in practice – it is not at all.

When it comes to acquiring startups, many companies struggle to validate acquisition deals involving emerging companies with a negative EBITDA. Because they cannot justify the price adopting traditional evaluation metrics.

Let me give you an example.

We have been asked by a large bank to run an analysis about multiples on startup acquisitions. The outcome (by analyzing thousands of M&A transactions with disclosed amounts involving startups) is that the variance is enormous, ranging from close to nil multiples to two-digit values. What has been the purpose of such an analysis? To provide the bank with a third party analysis able to back up the price paid to buy a startup that they weren’t able to justify adopting standard criteria.

The higher the price, the lower the risk

Another thing companies struggle to accept is the substantial increase of valuation startups might have in a short period of time. I remember a large energy company blaming their own CVC fund for having “contributed to inflate” the valuation of a startup they were interested to buy. I had hard times to explain that the increase in the valuation reflected the reduction of risk of the target company and the CVC actually contributed to de-risk their investment (and reduce the time to market).

Many established companies lack of the perception of time, i.e. the awareness that they are not supposed to stay in the game for so long.

There is a sword swinging over everyone’s head called “disruption”. And this sword is gonna fall down, sooner rather than later.

The sense of urgency is the piece of the corporate puzzle that nowadays is – most of the times – missing.

You shouldn’t waste time negotiating the price of therapies that might save your life.