For every company, there comes a time when lofty goals meet a lack of capital. For many, there also comes a time when the owner(s) are ready to take profits and diversify their holdings by selling part or all of their firm. You have a lot of choices when it comes to selling equity, and owners should consider their company’s current position and future vision when they decide to raise funds or cash out.
This article will focus on the difference and relative strengths of M&A and VC funding, from the perspective of the target firm. As a quick review, let’s go over the differences between M&A (Mergers and Acquisitions) and venture funding.
M&A and Venture Capital
An M&A deal, as the name implies, involves a company either merging with or absorbing another one. Where there were once two entities, there are now one. Naturally, this kind of transaction transforms the target company’s ownership and leadership structures. Sometimes, the acquired company will keep its independence, while on the other extreme it could lose its brand or serve a completely new function. Similarly, the founder and executive team may leave or stay on after an M&A deal.
There are many circumstances that can lead to an M&A deal. Sometimes, two companies will mutually agree to merge as equals, to grow their addressable market or leverage the knowledge and resources of the other company. In the case of acquisitions, the acquiring company is generally much larger, and the smaller company has something it wants. This comparative advantage could be an attractive piece of intellectual property, an innovative work culture, or simply some market share if they are direct competitors.
VC funding is different, especially in terms of how this funding changes the identity of the target firm. A venture capital investor (ideally) does not seek to control the investment. Venture capital takes a sizeable but minority equity interest with the hope that the investment will yield very high returns in the future. This money is paid into the firm to fund its operations, rather than going to the owners as you would see in the case of an acquisition. Generally, the owner and executive team will keep running the company.
Now that we’ve discussed their distinctions, let’s explore the relative strengths of M&A and VC funding, considering some of the major factors that should drive the decision.
If you need to keep full control of your business, from marketing strategy to budgetary decisions, you may find yourself bristling at any type of equity financing. In both VC and M&A fundraising, the investor becomes at least a partial owner of your firm. However, the VC model will often better respect the autonomy of the target firm.
This makes intuitive sense. If someone acquires your company, that means you gave up most or all ownership, and were personally compensated. In the case of a merger, the companies combine as relative equals. In both cases, the company undergoes a fundamental structural change and is no longer a single entity. With VC funding, you sell some serious equity, generally between 25%-50%, but you will usually keep control. The key difference: a VC investor is betting on your company, not buying you out.
Verdict: Venture Capital
When it comes to autonomy, VC funding beats out M&A deals. However, if you need more capital to reach the next level but aren’t interested in taking on an influential partner, neither form of fundraising may work for you. If that describes your team, you might consider a crowdfunded financing approach, or debt financing.
M&A deals live or die by their success or failure in creating synergies. Synergy is the multiplicative effect of combining assets toward a common purpose, causing them to achieve output or efficiency that is greater than their sum as individuals. There are different types of synergy to consider, which we covered in a recent article. When seeking synergistic effects, companies will almost always go the M&A route.
In this case, M&A tends to beat out venture capital, with some key caveats. It’s true that venture capitalists, especially the good ones, will try to improve their target companies’ chance of success. However, funding and knowledge can only go so far, whereas an additional company can unlock powerful timesaving synergies. Think of Google’s acquisition of Youtube, and what that’s done for both platforms. On the other hand, execution risk is high when combining firms based on expected synergies. For such a deal to work out, both firms must do their homework!
Exit and Risk Profile:
Naturally, your exit plan should inform how you sell equity, specifically how much of it you sell and whether you personally get paid. Do you want to be leading this company in the long run? If so, it’s likely not a good idea to get acquired. If you’re not ready to divest yourself and take profits, and if your company is young and growing fast, an acquisition or merger is unlikely to serve your interests.
If you receive VC funding, you must know that your work is just getting started. You didn’t get paid; your company got funded. Now, it’s time to put that money to work and take things to the next level.
Venture capital is less appropriate and less available for more mature, low risk companies, as these have a lower potential yield on the investment. If your company is mature, and you’re ready to diversify your risk or enjoy compensation for what you’ve built, a well-valued M&A deal offers an attractive means to an exit or diversification.
Verdict: It depends!
Are you ready to walk away? Where do you feel your business is in its growth cycle? If your company is young, innovative, and has a long, steep growth trajectory, you may be better served by choosing venture capital. If your company’s growth is slowing, M&A may present an attractive, lucrative way to take profits on what you’ve built.
The Only Right Way to Sell Equity: Through Soul-Searching and Careful Planning
This article would be of little value if it simply recommended one of these paths to all companies in every situation. The answer to the question “M&A or VC?” depends on the unique circumstances and objectives of every boardroom. The success of either deal will also rely upon a careful consideration of shareholders’ vision for the company as well as their personal goals.