Amid a venture funding decline and dearth of IPO activity, startups have found a new way to occupy their time: buying other startups.
The notion of startups acquiring other VC-backed companies is nothing new. Meta bought venture-backed Instagram a month before Facebook’s May 2012 IPO; food delivery company GrubHub merged with Seamless in 2013 when they were both still operating off venture funding. But up until the last few years, these transactions were mainly large and infrequent. Now, they are getting smaller and more frequent.
In 2021, 1,283 transactions involving startups on both sides of the table took place, according to data from Crunchbase. That compares to 689 in 2020 and 599 in 2019. So far this year, 663 startups have been acquired by other VC-backed companies, with more than half of 2022 left to go.
Why is this happening now, during a downturn? The venture funding bull market of the last decade has created a barbell of startups. Last year simultaneously saw a record number of startups crossing the billion-dollar valuation threshold while seed-stage funding broke its own record. Now that the funding fever has come to a screeching halt, the market is filled with late-stage companies with oodles of cash on hand — and no real exit opportunities — and a plethora of early-stage startups.
This has created a perfect storm for an increase in startups acquiring other VC-backed companies, Kyle Stanford, a senior analyst at PitchBook, said.
“There are over 7,000 venture-backed companies and a record number of seed deals,” Stanford said. “There will be a lot of companies that will struggle to raise this year that will be easy targets for companies looking to acquire.”
For some startups, getting acquired by another venture-backed company will be their only option forward. A record number of seed-stage startups doesn’t change the fact that the majority of them won’t go on to raise a Series A, and many of them are fighting to solve the same problems.
“There are generally two or three big leaders of a market, and maybe a couple others that are successful,” Stanford said. “Nowadays, we see 10 to 20 startups in very similar categories or sectors raising seed rounds. Obviously, they are not all going to be able to continue on the same path.”
For many early-stage companies, getting acquired will be their only option. In contrast, later-stage startups may pursue tuck-in acquisitions to make them more competitive by quickly adding features for greater product-market fit or grow into a lofty valuation from a prior funding round by expanding their revenue base.
Maëlle Gavet, the CEO of startup accelerator Techstars, said companies might turn to acquisitions to build out their product offerings, too. If a startup has the cash to spend, sometimes it makes a lot more sense to buy a company for a particular function rather than building the same capability itself.
“There is a lot of boardroom conversation around how you have so much cash and this high valuation,” she said. “Growing your business through acquisition will be a lot faster than building it organically.”
Jonathan Lehr, a co-founder and general partner at software-focused VC Work-Bench, said that this will be true especially on the enterprise side, as many young software startups would really fit better into a larger company than on their own.
“Some companies are just features that shouldn’t have been a full-fledged company,” Lehr said. “Some actually have cool tech but couldn’t wedge into the market on their own.”
Some of these transactions will be less about a startup’s product and more about its headcount. Many companies will turn to this strategy as a way to better secure talent, which — up until the recent wave of startup layoffs — was easily one of the largest challenges facing startups.
“There was a big push around, ‘Hey, with all this cash, instead of spending it on marketing, go spend it on acquisitions,’” Gavet said. “Acquisitions help them achieve what a lot of other startups suffer from: talent gaps. The war for talent was brutal, and [acqui-hiring] was a great way to solve some of this immediately — at least on paper.”
Stanford said that these acqui-hires not only give companies access to executive and engineering talent but also sales personnel who already understand the industry and what potential customers are looking for.
Unless the public markets change overnight, this trend looks likely to continue throughout at least this year, Stanford said. Gavet and Stanford agreed that the third and fourth quarters of 2022 will likely be busier than what we’ve seen thus far.
“This trend of the increase of venture-backed company acquisitions is not going to go down,” Stanford said. “It will either be the same as 2021 or higher. There are a lot of reasons to look at this data and market conditions and to expect that this trend will stay high.”
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