Tech Index 2022: Acquiring external businesses

Tech transactions dominated record-breaking global M&A activity in 2021 and continue to be a dominant theme in 2022, even though the market has cooled in the face of growing economic and political uncertainty.

Despite the current turbulence, companies continue to see important potential to create value and achieve growth through acquisitions.

We’re seeing a sharp increase in “roll-up” transactions led by private equity investors and their portfolio companies, for example. Often this will involve making a series of bolt-on acquisitions where the acquired businesses can achieve an immediate boost in valuation if bought by a larger business trading at a much higher multiple.

Increasingly, tech companies are seeing this as an interesting route to take as they plot their M&A strategy.

Our survey provides clear evidence that the main motivation for acquiring external businesses continues to be access to new technology. Strangely, a differentiation is made in the data between accessing technology and IP, which comes much lower down the list of perceived benefits. In legal terms they are one and the same thing.

The war for talent intensifies

Speedy acquisition of market share and access to much needed talent are now seen to be of growing importance, with the latter moving from 22% in 2020 to 25%. It’s worth noting that, when asked about the key technological challenges of acquiring an external company, respondents put mitigating gaps in skills and resources at the top of the list of their concerns.

The war for tech talent is intense and as a result we are seeing acquirors increasingly paying generous retention bonuses over several years to keep key technical staff on board.

But it’s not all about money. Increasingly employees are concerned about corporate purpose and look to work for organizations that reflect their personal values on social and environmental issues.

Some sectors, notably fossil fuel companies, feel this most acutely as public pressure to tackle the climate crisis grows.

But employees are asking tech companies similar questions about their ESG and sustainability agendas. Employee activism is on the rise, with staff coming together and speaking with one voice when a business is perceived to have made a misstep on issues such as diversity or data use.

Defensive strategies?

One surprise in the findings is how highly respondents continue to rank making an acquisition for defensive purposes, up one point to 45% in 2022. As tech companies continue to expand their capabilities, defensive M&A has been used to safeguard markets and maintain competitive advantage. Potential defensive strategies include:

• M&A targeted at operational synergies to improve efficiency and unit cost reduction; and
• opportunistic deals which seek to protect the core business.

In some cases, large corporates may buy up several early-stage businesses, which can mitigate the risk of a credible competitor eventually emerging. With antitrust authorities increasingly alert to the risk that promising businesses being acquired larger players may dampen potential future competition, defensive M&A can give rise to particularly acute regulatory challenges.

Whilst boards may be more enthusiastic about M&A with a more obvious growth focus it is clear that defensive M&A will be an ongoing feature in the sector and corporate development teams need to be able to articulate the pros and cons of such activity.

Elsewhere we continue to see acquisitions being made to gain access to a key technology which would otherwise have to be developed in house. And, in an environment where achieving organic growth is difficult, transactions can be the fastest way to gain market share and boost revenues.

Cultural integration, leadership and smaller deals are big challenges

The market shift towards smaller more frequent acquisitions has brought a unique set of challenges which tech companies will now need to navigate, or risk a reduction in their competitive edge. In overcoming these challenges, the odds of deal success improve when an acquirer is proactive with its integration strategy.

Nearly all the drawbacks to acquiring an external business identified in our survey relate, in one way or another, to the complexities of integration.

Integrating incompatible systems, achieving promised cost savings, diversion of funds from other projects and integrating working practices and culture all rank highest in the list of drawbacks.

Tech companies internal teams are under time pressure to assess the benefits of numerous targets and strategies and then complete multiple acquisitions within a short time span. With limited time available for due diligence and necessary planning for the successful integration of capabilities this in-turn can cause issues realizing synergies.

Acquirers are increasingly seeking external expertise to aid with thorough pre-deal, integration and post-deal due diligence. In our experience, acquirers who have:

• a clear strategic plan and adopt a relatively rigid deal thesis and costed integration plan are most likely to ensure optimal use of finances and other resources; and
• a detailed M&A review system can help with identifying areas for improvement for transaction planning and integration as the acquirer evolves.

Culture clashes between large, well-established and sometimes slow-moving companies and the nimble young companies they are buying are often a major hurdle to successful integration.

Key staff may well leave the merged business as these differences in culture manifest themselves, and even those offered incentives to stay will often be counting the days until their contractual obligation to remain expires.

That’s not always the case, of course. Many young businesses see rewards from being part of a larger business and relish the opportunity to continue developing in a new and better resourced environment.

There are leadership challenges on both the buy and sell sides of a deal. For small companies being sold, a deal will inevitably be a major distraction. If successful, that distraction can be easily justified. But if the deal falls through, important sales targets can be missed at a critical point in the company’s development, simply because management have taken their eye off the ball to focus on the transaction.

From the buy side it’s important that the integration process continues to be led by the executive who initially sponsored the deal. If a CEO who had the initial vision subsequently leaves the business, the integration can easily go off-course and even fail if the new leader is focused on other priorities.

Often difficult integration issues only become evident when the deal has been completed, especially in the context of carve out deals. In such deals, carefully constructed transitional services agreements (TSAs) can really help to surface such issues ahead of time.

Sitting alongside the sale and purchase agreement, the TSA can assist with the integration process by providing a schedule of tasks that need to be done, particularly around some of the key technological challenges identified in our survey, such as managing data and integrating working practices or cybersecurity protocols.

National security controls

Although respondents to our survey express increased confidence in the overall regulatory environment, this belies the growing regulatory complexity dealmakers are facing around foreign direct investment on national security grounds.

Across the globe controls are being tightened dramatically, including in the US, Australia, the UK and in most EU Member States. Dealmakers are having to interpret the different approaches being taken at a national level to make sure they comply with often stringent, but sometimes conflicting, FDI controls.

Technology companies are often in the firing line of these ever-stricter regimes, since their products and services are easily categorized as vital infrastructure or as highly sensitive from a national security perspective. Navigating these complexities is far from impossible – deals still go through having passed national security checks. But the task has certainly become a great deal more difficult.