By Philani Mzila
Over the past year, Africa has witnessed a substantial decline in venture capital [VC] funding. Between July 2022 and June 2023, the total funding raised dropped by nearly 40% compared to the same period from 2021 to 2022. This decline is particularly pronounced in the “Big Four” markets of Nigeria, Egypt, South Africa, and Kenya, where funding has shrunk by as much as 77%.
As a consequence of these challenging market conditions, many startups find themselves approaching the end of their financial resources and struggling to secure further investments.
In such circumstances, founders typically face three potential paths:
Survival Strategy: This involves making significant cost reductions and slowing down growth. However, this approach is viable for only some startups.
Shutting Down: This means winding up operations and returning any remaining funds to investors.
M&A Route: Opting for a merger or acquisition.
In this context, mergers and acquisitions [M&A] hold the potential for growth and stability among African venture-backed startups. As companies grapple with reduced funding, M&A offers well-funded startups an avenue to improve their offerings, expand their reach, and achieve greater scale.
Key Drivers of M&A Activity in VC
Several strategic and financial factors drive M&A within the startup ecosystem:
Technological or Product Enhancements: Businesses often acquire startups to bolster their technical capabilities or enrich their product portfolios. This acquisition of innovative technologies or unique products not only accelerates time-to-market but also provides a competitive advantage through access to protected intellectual property.
Talent Acquisition: Mature startups can acquire companies primarily for their skilled teams. This immediate integration of experienced talent can significantly reduce project timelines and provide valuable insights.
Expanding Market Share: M&A allows startups to absorb competitors, enhancing their market presence. Regional expansion through M&A can open doors to new customers, local insights, and distribution channels. Vertical integration can streamline operations by gaining control over the supply chain.
Opportunistic or Distressed Asset Acquisitions: These acquisitions offer valuable assets at reduced costs, providing strategic advantages, particularly for asset-heavy models.
Navigating the M&A Landscape
Before embarking on the M&A process, founders should conduct a comprehensive market analysis to identify potential targets that align with their strategic or financial objectives. This involves evaluating the competitive landscape, understanding the target’s value proposition, and assessing growth potential.
Factors to consider during market analysis include:
Strategic Fit and Growth Potential: Ensure that the acquisition enhances the overall business and creates synergies. Assess the target’s growth trajectory and scalability.
Market Positioning: A startup with a unique selling proposition and strong market presence can offer a significant advantage to the acquiring company.
The Art of Due Diligence
Conducting due diligence [DD] is crucial in any M&A deal. This involves a thorough review of the target company to identify potential risks and opportunities associated with the transaction.
Key areas of due diligence include:
Commercial DD: Evaluate the target’s market position, customer base, and competitive advantage. Understand the target’s revenue streams and market challenges.
Product DD: Assess the target’s products or services, uniqueness, and fit within the acquirer’s portfolio. Review growth metrics, customer acquisition strategies, and potential for future growth.
Legal and Financial DD: Review contracts, licenses, intellectual property rights, and legal issues. Examine the target’s financial statements, cash flow, profitability, and financial health.
The deal structure plays a pivotal role in M&A transactions. Founders should carefully consider how the deal is structured to ensure a successful outcome for both parties.
Structuring the Deal
Common deal structures in the VC space include:
Cash and/or Shares: Consideration can be in the form of cash, equity, or a combination. The choice between cash and shares impacts long-term alignment.
Upfront or Earn-Out: Payments can be made upfront or based on achieving milestones (earn-out), particularly when the target’s future performance is uncertain.
Management Incentives Post-Deal: To facilitate integration, incentives may be offered to the acquired company’s management team to ensure continuity and growth.
Bridging Cultures and Valuing Teams
After closing the deal, the integration phase involves merging two entities and aligning processes, teams, and cultures. Attention to cultural alignment, talent retention, communication, and synergy realization is vital for success.
M&A offers a fresh perspective in the African venture capital landscape, particularly as startups contend with limited resources and financial uncertainty. Whether the motivation is talent acquisition, technological enhancement, or market expansion, these deals can rejuvenate companies and fortify their competitive positions. However, success in M&A hinges on strategy, diligence, and a clear understanding of mutual value.
Philani Mzila is an Investment Manager at Founders Factory Africa, an early-stage investor that has invested in over 55 startups across the African continent.