M&A Opportunities in the African Venture Capital Space || Business Post Nigeria

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By Philani Mzila

The last 12 months have seen a significant decline in venture capital (VC) funding in Africa. The total amount raised decreases by almost 40% between July 2022 and June 2023 compared to the same period between 2021 and 2022. This sharp decline is particularly evident in the “big four” markets of Nigeria, Egypt, South Africa and of Kenya, with a contraction of funding of up to 77% in some.

Due to these challenging market conditions, many startups are nearing the end of their financial journey and struggling to secure new investment.

Founders in this situation typically face three paths:

  • Survival strategy: This involves significant reductions and slower growth. This is only feasible for certain startups.

  • Termination: This involves ending operations and returning remaining funds to investors.

  • M&A path: Opting for a merger or acquisition.

In this context, mergers and acquisitions (M&A) may present a growing opportunity for venture capital-backed African startups. While many companies face a contraction in funding, mergers and acquisitions can offer well-funded startups a way to improve their offering, expand their reach, and achieve greater scale.

Key Drivers of M&A Activity in the Venture Capital Industry

Several strategic and financial considerations fuel mergers and acquisitions within the startup ecosystem:

  • Technological or product improvements: Companies often use acquisitions to boost their technical prowess or enrich their product catalog. By acquiring startups with innovative technologies or unique products, companies enrich their product catalog and elevate their technological capacity. Strategically, this approach offers companies a double advantage. First, it accelerates the technology’s time to market, avoiding the lengthy and costly internal development process. Second, the acquisition gives the companies a competitive advantage by hopefully granting them protected intellectual property rights. Essentially, acquisitions provide a strategic shortcut for companies to improve their technological position and product offering, ensuring they stay ahead of the curve.

  • Talent Acquisition: By acquiring a company primarily for its talent, more mature startups can gain access to proven capabilities and teams experienced in building a startup. This immediate onboarding of a competent team with relevant skills ensures they can seamlessly transition into projects, potentially reducing product or business launch times by months. Strategically, this not only allows the acquiring company access to rare technical expertise, but also provides insight into the invaluable knowledge held by these operators.

  • Market share expansion (locally and regionally): Horizontal integration allows startups to absorb competitors, thereby amplifying the company’s presence and reach in the market. Additionally, regional expansion through mergers and acquisitions allows startups to access new consumers, leverage local knowledge, and leverage pre-existing distribution channels. On the other hand, through vertical integration, a startup can streamline its operations by gaining control of its supply chain, including its suppliers or distributors. Strategically, this creates a holistic ecosystem of offerings with potential synergies and propels immediate revenue and customer growth, thereby facilitating accelerated market penetration.

  • Opportunistic or Distressed Asset Acquisitions: These acquisitions offer valuable assets at a lower cost, providing the acquiring company with strategic leverage. This is particularly advantageous with more active type models.

Navigating the M&A Landscape

Before diving into the Merger and acquisition process, founders should conduct a thorough market mapping exercise to identify potential targets that align with their strategic or financial goals. This involves assessing the competitive landscape, understanding the target’s value proposition, and assessing growth potential.

Founders should consider the following factors when mapping the market:

  • Strategic fit and growth potential: A strong strategic fit ensures that the acquisition improves the overall business and creates synergies. The growth trajectory and scalability of the target’s offering are also critical as they can enhance the acquirer’s current growth.

  • Market positioning: A startup with a unique selling proposition and a strong market presence can provide a significant advantage to the acquiring company.

The Art of Due Diligence

Efficient due diligence (DD) is essential to any M&A transaction. This comprehensive review of the target company helps the acquiring company identify potential risks and opportunities associated with the transaction.

Some of the main areas of due diligence are:

  • Commercial DD: founders must assess the target’s position in the market, its customer base and its competitive advantage. Understand the target’s revenue sources and potential market challenges.

  • Product DD (including growth strategies): Founders should evaluate the target’s products or services, their uniqueness, and how they fit into the acquirer’s product portfolio. Additionally, it is important to evaluate the target’s growth indicators, customer acquisition strategies and future growth potential. Ultimately, it’s about understanding the factors that drive or hinder growth.

  • Legal and financial DD: Founders should review contracts, licenses, intellectual property rights and any legal issues that may impact the transaction. Additionally, it is essential to carefully review the target’s financial statements, cash flow, profitability and financial health, as well as identify any potential financial risks.

Structuring the deal

Deal structure plays a crucial role in M&A transactions. Founders should carefully consider how the deal is structured to ensure a positive outcome for both parties.

Common deal structures in the VC space include:

  • Cash and/or Stock: Acquisition consideration may be in the form of cash, equity, or a combination of both. An all-cash acquisition may result in a misalignment of long-term interests between the parties, while an all-stock offering may be a challenge to navigate.

  • Initially or additional price: payment can be made entirely in advance or partially in advance with deferred payments depending on the achievement of certain milestones (earn-out). Earn-outs are particularly common when the future performance of the target is uncertain.

  • Post-transaction management incentives: To ensure a smooth integration, management teams of the acquired company may be offered incentives to stay and continue to drive growth.

Bringing cultures together, enhancing teams

After the deal closes, the integration phase involves merging two entities and aligning processes, teams and cultures. Close attention to cultural alignment, talent retention, communication and achieving synergies is paramount to the success of this business.

Mergers and acquisitions can breathe new life into the startup ecosystem

The changing landscape of African venture capital, marked by a decline in funding, requires a new look at the role of mergers and acquisitions. As more startups struggle with limited resources and financial uncertainty, mergers and acquisitions are emerging as a viable path for growth, expansion and innovation. Whether the motivation is talent acquisition, technological improvement or market expansion, these transactions can breathe new life into companies and strengthen their position in a competitive market.

However, the path to a successful merger or acquisition is complex and multifaceted. It’s not just about numbers or assets, but also about people, cultures, visions and other things. For startups from Africa’s Big Four and beyond, embarking on M&A could be a transformative move paving the way for more sustainable businesses. But as with any large undertaking, the key lies in strategy, diligence and a clear understanding of the mutual value offered.

Philani Mzila is the Investment Director at Founders Factory Africa

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