Tech M&A in 2023 with Jonathan Simnett, Director at Hampleton Partners

With IPO markets cooling on tech, there’s an increased focus on M&A as the exit strategy of choice in 2023. To learn more, we interviewed Jonathan Simnett, the UK director at the sell-side tech M&A advisory firm Hampleton Partners.

How do you see 2023 looking for tech valuations in the UK compared to 2021 and 2022 in terms of raising and also exits?

Record amounts are being committed currently to tech venture funds. Such funds raised $151 billion in the first three quarters of this year, exceeding any prior full year. 

But given the current macroeconomic outlook, venture investors are broadly using existing funds to consolidate the existing wave of technologies and looking with new money as to where to place their bets for the next upturn. To that extent, we are in a period of “slack water” before confidence returns and the massive amount of “dry powder” gets deployed.

Consequently, the current investment market is very tight indeed with companies fighting very hard for every investment dollar, pound or euro, with a resulting downward pressure on exit valuations. 

With IPO markets cooling on tech companies, M&A would seemingly become more vital as an exit route. What are the main challenges facing tech M&A? How are acquirers’ behaviours changing?

As I mentioned, with the ending of a tech growth cycle, the focus of M&A has moved from primarily one of expansion to mostly one of consolidation. As the economy slows, and companies run out of financial runway, they are coming under pressure to find new strategic and PE investors. 

But acquisitors are less bargain hunting than looking for value in well-run companies with teams that have created clear potential to flourish further or attain category leadership under new ownership. But that doesn’t mean they won’t be looking for discounts on the valuations that have been achieved in recent years and be wanting their money to work harder. 

What has become ever clearer in recent months from investment to exit is that profitability in the current generation of startups and scaleups is everything. Unless you have some unique technology that an acquisitor can’t do without, don’t even consider going to market if you can’t show a track record of generating recurring revenues and repeatable margin.    

Which are the hottest tech areas for M&A?

As downturns bite then the focus for acquirers turns to technologies that increase efficiencies in existing infrastructures or business models and not furious economic “land grabs” based on new technology platforms.

Top of the list in this respect is enterprise software, and particularly machine learning and AI, which has the potential to increase efficiencies right across the economy from ecommerce to manufacturing and from finance to pharma. Recent Hampleton reports have also highlighted demand for tech consultancies and systems integrators with expertise in supply chain modernisation, cybersecurity integration, and ESG data consulting.

In tech M&A deals, what should founders expect in terms of differences in their sale terms vs say investors? (e.g. cash out at completion vs. deferred consideration (e.g. EOs, rolling equity)

The biggest difference in the current environment is in the change in appetite for risk in acquirers. That means more shouldering of risk by the acquired in terms of factors from delivering projected turnover and margin to ensuring effective integration and market expansion. That can be reflected in deal structures that bind the seller to the acquiring company over an extended period, payments deferred into earnouts, equity participation in the acquirer in lieu of cash, more onerous warranties and so on.    

What advice would you give founders currently at the start of an M&A process?

Even in the best of times, an M&A process will put tech boards under pressure as they try to balance the requirements of seamlessly running a fast-moving business and managing an exit. In turbulent times, that pressure is going to be even greater as firms struggle to deliver quarter by quarter numbers, optimise their operations and fight the fires that inevitably arise. So, make sure you have enough people available to manage the internal processes effectively and supplement them with experienced external resources to drive the M&A process.

Be certain too that you have achieved clarity and alignment amongst shareholders about what it is that you each need to achieve both strategically and financially in the M&A process. Ensure early on that any acquisitor will be able to deliver these. Walk away early if you have any doubt that the fit is right as the opportunity cost of your time will be very high, especially in current conditions where you need to ensure you are running a very tight ship.   

What advice would you give founders considering an M&A exit in the near future?

Think of M&A as potentially the next stage in your company’s development, an opportunity that will give it access not just to finance, but more resources, markets, expertise and so on. Remember potential acquisitors love predictability and abhor surprises. So, act now to make any adjustments you need in terms of areas such as headcount, product development roadmap, and marketing spend so that you can demonstrate predictable and consistent growth and margin numbers from your business going forward and, crucially, throughout the M&A process. 

If your numbers have not been stable for, at least, the last 12 months then delay any M&A activity until they have, and you are confident they can be sustained during the process. Also, start to assemble your data room ensuring that there is complete and auditable trail on all materials in preparation for future due diligence.

By this I mean documents such as contracts, corporate records, capitalisation tables, IP rights, and data privacy records as well as the ability to provide multiple years of audited accounts. This is not only a good exercise in terms of readiness but allows you to backfill any information holes and ensures that your contracting, reporting and archiving processes are bulletproof. You also need to decide on whether you need a set of different advisors than those you have been working with as you have built the company to get the best out of an M&A process. Financial advisors to tax accountants and corporate lawyers, for instance. And, of course, good M&A advisors.

Lastly, if an exit isn’t an immediate requirement, you should look carefully at your company’s strategy and whether it will bring sufficient value to an acquirer.  Are you merely better than your competitors or are you different enough to attract the right acquisitor at the right price when you decide to go to market?

If you’d like to find out more about how Hampleton Partners can help you with your M&A strategy, email jonathan@hampletonpartners.com