Over the past five years, the time it takes to close an M&A deal has increased by more than 30%, according to data from Ideals VDR.
But are early stage investment funds also experiencing the same slow pace when getting deals done? The Financial Times reports that VC funds have more than $300bn in dry powder as investors take a more cautious approach, in large part due to a lack of exit opportunities caused by “an inhospitable IPO market and regulators constraining M&A.”
To find out how this cautious approach is impacting deal times, we spoke to Oliver Finch, who has almost two decades experience in early stage investing, most recently as Founder of early-stage advisory firm Longmont.
Q: What’s the current state of venture capital and early stage investments?
A: The overall landscape continues to normalize after the frenetic activity of the past few years. Many good businesses are still being funded, with attractive round sizes and structures. Clearly there are lots of headline-grabbing deals and bright spots, but the overall landscape appears one of more scrutiny and reversion to longer-term means.
The past few years of “over-funding” have probably meant it takes 6 – 12 months longer for some deficient technology or distribution models to face reality.
There are certainly some great technologies and companies with slightly compromised business models which will struggle, and it will take some difficult conversations and decisions to continue to recalibrate and recapitalize. These businesses might either need to reconfigure to break even with lower growth expectations, explore ways to exit, or package the business differently.
Q: How is this impacting new investments and fundraising activity?
A: Management teams and investors are having to face a tougher reality in some cases. Especially in more nascent markets, bold decisions are needed to determine whether shifts or slowdowns are temporary, or if they necessitate a more fundamental change in direction, business size, or approach – or indeed if they need to wait for the situation to develop.
It takes a huge amount of leadership maturity and discipline for companies that have been overfunded to say, “The tail is wagging the dog here. There isn’t the right-sized market or the broader liquidity for us to effectively deploy what we’ve raised. We can’t yet define a coherent strategy in this new environment.”
There are some fantastic opportunities amidst these challenges for those in the mid-market, lower mid-market, or corporate development sectors.
It’s also become more challenging for many investors to raise new funds. Some large funds like Atomico and Balderton have raised substantial amounts, but this success is not universal. Many smaller and less differentiated funds have struggled. We are hitting some bumps in the road, and it’s difficult to imagine that it doesn’t filter down into company and portfolio-level interactions and advice.
I believe there are some fantastic opportunities amidst these challenges for those in the mid-market, lower mid-market, or corporate development sectors. For companies with the right framework and environment there should be valuable strategic assets at a lower cost, either as standalone businesses or through M&A.
These deals might look similar to restructuring M&As. They would be very fast, small, complex and likely a bit fiddly. But for focussed teams who know what they’re doing, they could be really interesting opportunities with significant asymmetric financial and strategic return.
The other way we’ve seen this theme emerge is via companies that have grown well, been very generously funded, but not met the most outsized expectations. These are now positioned to undertake reverse mergers, acquiring legacy assets and books of business from incumbent firms and applying their novel technology and perhaps more innovative culture to them.
Q: To what extent is the focus on AI influencing investments and due diligence?
A: From an investment perspective, AI has become a significant focus. The handful of fast-tracked “mega-deals” to solve big tech’s existential crisis probably distracts from the more thoughtful approach at most funds.
There is certainly pressure on large corporations to address how AI might disrupt their business, how competitors might use it, and how they can gain a competitive edge.
Generally investors are looking for better linkages to the underlying business problems, even if the technology’s full potential will unfold over months or years rather than immediately.
There is definitely an expectation around technical areas based on a class of techniques that might be now considered outdated or static. We are now back to a healthier market with claims and ambitions better understood in context of the mix of talent, research and technical execution.
At the larger end of the spectrum, there is certainly pressure on large corporations to address how AI might disrupt their business, how competitors might use it, and how they can gain a competitive edge in both narrow ways, and at scale.
Q: Data from the past year shows that M&A deal durations have remained fairly static, decreasing by 5% since last year. Does that reflect your recent experiences?
A: That’s an interesting observation. There does seem to be a slight release in pressure this year compared to the previous one. Last year, there was a more cautious approach, which could be seen as a “risk-off” reaction, manifesting as pauses or deeper dives into certain risk factors not always correlated to core deal rationale and risk. This year seems more normalized within a three to five-year context, which aligns with what I’ve observed.
Working in the syndicated deal space, I’ve also noticed that people are more willing to say no and pass on deals early. Previously, there was a tendency to keep options open longer, with lead investors needing to qualify others out. This mix of factors contributed to a general pressure cooker on more limited deal-doing capacity, which paradoxically might have created a bit of momentum overall.
Q: Do new regulations in areas such as ESG slow down deals, or do they quickly get integrated into standard processes?
A: I think it’s more of the latter. When GDPR was introduced, there was significant concern and urgency to comply, but the actual impact was less dramatic than anticipated. In the early phases of new regulation, more risk-tolerant firms might just say, “We’ll deal with it if it becomes an issue,” whereas the more prudent might over-index initially.
With areas like supply chain circularity and sustainability, early phases looked like a checkbox exercise for many firms. But as these aspects become central to competitive strategy, due diligence in these areas becomes more significant.
This over-preparation often becomes a learning process, allowing deal teams to get faster and more targeted over time, and for firms to either increase deal capability and speed in that area, and be more selective about how and where they invest their time and resources.
With areas like supply chain circularity and sustainability, early phases looked like a checkbox exercise for many firms. But as these aspects become central to competitive strategy, due diligence in these areas becomes more significant. We’ve seen dedicated funds, like Circularity Capital, focusing on companies that reuse or optimize existing resources – on the plausible and increasingly strong evidence base that these firms will be more valuable and more competitive in the next 10-20 years than those that don’t.
This reflects a shift from basic compliance to a more strategic and competitive approach, which might contribute to a slower or more complex deal process as firms and investors develop a deeper understanding of ESG and how it might generate superior long-term returns in specific circumstances.
Q: Sabine Schilg, VP of Customer Success at Ideals, said the cost of money is the main factor slowing deals down. Do you agree?
A: It’s definitely a significant factor, but changes in the cost of money also affect the nature of markets. For instance, it might lead to certain businesses disappearing or changes in market competition. Firms with strong balance sheets might find opportunities to acquire weaker or more questionable assets at a lower cost, which could offer synergistic value.
Cultural legacies and historical experiences with M&A can also influence how firms approach new deals. For example, after a painful M&A experience, some companies may avoid large deals for many years. M&A laggards appear anecdotally to spring to life just as major M&A trends begin to wane. There could also be markets or segments where firms might choose to go on the offensive, taking advantage of lower costs to acquire assets that align well with their strategic goals.
When the weighted average cost of capital for Fortune 500 companies exceeds around 9-10%, the dynamics of M&A can change significantly. Companies might shift their focus from paying a high price for growth to valuing cost-saving M&A far more. This often means that while the volume of deals might remain similar, the nature of those deals changes. Companies might be more willing to pay a premium for cost-saving synergies rather than growth, and undertake different work to diligence their hypothesis.
Even in broadly challenging financial environments, technology remains so attractive. Great technology delivers cost savings and growth with less overall expenditure.
Methodology
The figures referenced in this article are based on anonymized data collected from Ideals Virtual Data Room customers on the sell and buy sides of M&A deals. We calculated the deal duration as the time between the first non-admin invited and the closure of the room. We also measured the number of hours spent working on documents within the room.
