A few weeks ago a startup that we [Black Sheep Capital] invested in called Grocery Butler announced that it was joining forces with Rocket Internet-backed Shopwings to create a new entity to take on the Australian market.
As an active investor who’s backed over 20 startups over the past three years, including the likes of Airtasker, I can understand why there are different schools of thought when it comes to mergers and acquisitions among early stage businesses.
In the US for example, many founders refuse to even consider the idea of joining forces with a competitor. Likewise, investors can be wary of the erosion in shareholder value and the risk that a startup that has already gained traction can lose momentum and be bogged down by integrating another business.
Closer to home, we have only seen a handful of high-profile startup mergers to date. Posse and Beat the Q became Hey You, while fitness gym app Kfit merged with two similar startups, Classhopper and SweatPass.
However, there are structural reasons why mergers may be good business in Australia. We are a relatively small consumer market, and we’ve seen a proliferation of startups in certain niches, such as the “Airbnb for Pets” market, home services such as cleaning and handymen, and in influencer marketing plays.
Rather than compete for a small base of early adopters, there is an argument to be made for two startups with middling traction teaming up. With the additional resources, they can focus on accelerating their market uptake and achieve real growth.
There are certain things that as an investor you need to look for if one of your portfolio companies is looking to join forces with a competitor.
Is it a marriage of equals? And if not, who is holding the upper hand?
Sometimes you need to look beyond the headline and delve into how exactly the merger is occurring. Is it a 50/50 split, and how does that effect the valuation of the two entities?
Often there will be winners and losers, and you need to know which camp your team is falling into.
How will the management team evolve?
There’s going to need to be one CEO who manages both the integration process and the business going forward. Startup investing is a people business, so you need to be comfortable with whoever will be running the show.
New life, new term sheets?
Of course, you can expect some dilution in your shareholding. But be aware of the other changes that may come with a new entity. Do you hold the same voting rights? Are other investors getting prioritised in the transaction?
Do you think it can actually work?
Some people believe it’s actually harder for startups to merge than established corporations. Based on the information you have on the founder and management team of the company you’re backing, and the team leading their potential partner, do you think they can work well together?
It is important not to be too swept up in the nitty gritty of the contractual details that you forget the most important point – what is the big picture outcome? We all know it is better to have a small stake in a successful and growing venture than a big stake in a startup being decimated by the competition and rapidly approaching the end of its runway.
In some cases, such as the Grocery Butler-Shopwings merger, it makes perfect sense for an investor to see them merge.
I expect more Australian startup investors will be grappling with similar questions over the coming months and years.
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