The Shifting Landscape of Early Stage M&A in 2023: More Acquisitions of Early-Stage Companies

The year 2023 saw a shift in the mergers and acquisitions (M&A) landscape for venture-backed companies. According to the latest PitchBook-NVCA Venture Monitor, 2023 was the worst year in a decade for acquisitions of VC-backed companies, with corporate acquirers showing a strong preference for younger startups, particularly those at the seed stage. This trend is a byproduct of a market that now entices founders to consider selling early, given the challenges in raising new capital and the disappearance of secondary share sales at the Series A stage.

As startups navigate this new reality, it is crucial for founders and their advisors to understand the factors driving this shift and to develop strategies that align with their goals and the current market dynamics. By staying informed and adaptable, startups can make well-informed decisions and position themselves for success in this evolving landscape.

2023 M&A Market Analysis

Corporate acquirers scooped up 151 seed-stage startups in the US last year, the lowest count since 2017. However, the impact on more mature companies was even more pronounced, with acquisitions of Series A and later-stage companies falling to a 10-year low.

Several factors are driving the trend towards early stage startup acquisitions in the current market. One of the primary drivers is the financial incentive for founders. There are compelling reasons for founders to consider an early exit, especially in a challenging fundraising environment (outside of certain sectors, such as artificial intelligence). At the seed stage, founders typically still own a large percentage of the company, having not yet suffered the dilution from multiple future rounds of financing, which means that an acquisition can result in a significant financial outcome. For example, if a startup is acquired for $50 million, the founders could potentially receive $10 million to $20 million, depending on their ownership stake. There are compelling reasons for founders to consider an early exit, especially in a challenging fundraising environment (outside of certain sectors, such as artificial intelligence).

One might argue that it makes sense to wait to sell a startup until after the company has grown much larger, even it means owning less of that company when the time comes. However, the changing market dynamics have also played a significant role in influencing early stage acquisitions. The downturn in fundraising IS making it more difficult for startups to raise new capital, and, even if capital can be raised it has become harder to create founder liquidity through secondary share sales at the Series A stage. Thus, founders are increasingly looking for alternative paths to liquidity, like a sale of the company.

While a quick sale may be attractive to founders, investors are not always thrilled about these early exits. While a sale can provide a return on their investment, the absolute dollar returns usually don’t move the needle for the underlying funds, compared to a later stage exit. 

Strategies for Startups Navigating the Current M&A Landscape

Given the current market dynamics and the factors influencing early stage acquisitions, startups must adopt a strategic approach when navigating the M&A landscape. Founders must carefully evaluate the benefits and drawbacks of early acquisition offers, including possible earnout provisions, employment obligations post-closing, and non-compete tails. While an early exit can provide founders with a significant financial outcome and mitigate the challenges of raising new capital, it’s essential to consider the long-term potential of the business and whether an acquisition aligns with the company’s mission and vision.

Effective communication with investors is also important. Founders should be transparent about their goals and, to the extent legally permissible, any potential acquisition offers, seeking input and guidance from their investors. Additionally, founders should prioritize having upfront conversations about the current fundraising market and the alternatives for all parties to achieve their goals. This open dialogue can help ensure that everyone is on the same page and that any decisions made are in the best interest of the company and its stakeholders.

At the same time, startups must maintain a focus on building a sustainable and scalable business. While the allure of an early exit may be tempting, founders should not deprioritize creating value for their customers and developing a strong market position. By continuing to innovate, iterate, and execute on their vision, startups can increase their appeal to potential acquirers while also positioning themselves for long-term success.

Whenever a startup begins to think about an exit strategy, it’s critical to seek guidance from experienced legal counsel specializing in the corporate and transactional issues that affect startups. An experienced attorney can help startups evaluate the complex legal landscape of M&A transactions, identify potential issues and risks (such as the requirements of organizational documents, investor rights agreement and tax implications), and ensure that the startup’s interests are protected throughout the process. 

Conclusion

While the early stage M&A market in 2023 presented unique challenges, it also offered opportunities for startups to achieve significant financial outcomes and form strategic partnerships. By staying informed, adaptable, and seeking the right guidance, startups can successfully navigate the complexities of the current M&A landscape and make decisions that align with their long-term goals and vision. As the market continues to evolve, it will be essential for startups and their advisors to remain vigilant, proactive, and open to new possibilities in the world of M&A.