2018 was a banner year for tech mergers and acquisitions, including IBM’s $34 billion purchase of Red Hat (the largest software acquisition ever), Broadcom’s $18.9 billion buyout of CA Technologies, and Microsoft’s $7.5 billion deal for GitHub.
Despite geopolitical and economic uncertainty, most observers are optimistic about continued robust prospects for M&A activity in 2019. “There is near unanimity that the deal environment will improve or remain stable over the next 12 months,” according to a report by Ernst & Young. Nearly two-thirds of respondents to law firm Dykema’s annual survey said they expect the M&A market to strengthen in the next year.
A healthy M&A environment is good news for the tech startup ecosystem, but it also adds urgency to an age-old question that founders and CEOs must ask at various inflection points in a company’s life: when to keep building the company from the inside and when to grow through acquisition.
The “build or buy” dilemma is similar to the choice a Major League Baseball team faces when deciding whether to improve through talent developed in its own Minor League system or by signing free agents. Each approach has its pros and cons, and there are no easy answers or sure bets.
For every successful acquisition like Apple’s 2010 buyout of Siri to add voice command capabilities to its devices, there is a disastrous one such as Google’s $3.2 billion acquisition of Nest in 2014 – considered such a failure that Google’s parent company tried to sell the business two years later.
Here are arguments on both sides that companies of all sizes should consider when deciding whether to grow from the inside or the out.
Path of least resistance: It’s simply faster to improve offerings or create new ones by acquiring capabilities rather than developing them internally. Plus, an acquisition doesn’t just bring you technology but also customers, intellectual property, and revenue. And it sidesteps the organizational weight inherent in the organic approach – the process of making a case for new products with senior management and devoting resources to developing and marketing them from scratch. Icing on the cake: Established offerings from the acquired company are likely to have much more of a track record on which to build revenue and growth projections compared with freshly developed in-house offerings.
Technical debt forgiveness: Technical debt is a catchall term for code flaws and poor design choices in software systems – usually made in haste to meet deadlines – that will need additional work to fix at a later time (usually at the most inopportune moment). This deferred work is a common problem in technology companies. Capabilities brought in through acquisition can be a way to eradicate this debt.
Feature debt elimination: Similar to technical debt, feature debt occurs when a company’s offerings have become stale due to poor product management habits. By acquiring, a company can inject a shot of freshness and innovation into its portfolio.
New market opportunities: As tech companies grow, their product lines inevitably will bump up against adjacent markets. Acquisition is an opportunity to move laterally, as long as the acquired tech and team talent is complementary and doesn’t contort the organization. Companies need to be careful, though: There are many examples of these types of acquisitions that made sense on paper and in spreadsheets but that failed miserably – such as Verizon’s purchase of legacy media brands like AOL and Yahoo to create now worthless Oath.
Talent acquisition: Acquiring talent and skills more quickly than they could be developed in house is so appealing that there’s a term for it: acquihire. The phrase has entered the startup lexicon to describe when a team has been acquired for its talent and potential future contribution, not necessarily for what it has already created.
Minuses to acquiring
The “new kid in town” effect: Internal teams may feel slighted by a “cool” acquisition, since the acquired people will get to work on the new technologies while they’re stuck on existing projects. This is especially magnified when the acquisition is to get out of technical or feature debt.
Integration problems: Post-acquisition integration is a multi-step process fraught with challenges. IT alone is “often identified as a root cause of failed M&A and divestiture efforts due to poor IT platform and organization integration, inefficient due diligence, and failure of IT to enable business synergies,” according to a Bain & Company report. Companies also can’t overlook the human factors of post-acquisition integration, such as stress among existing employees. Having a realistic timeline can go a long way to making it all easier, though this requires better due diligence and not falling into the trap of inflating the net contribution the acquisition will make to the buying firm.
Employee turnover: Personnel departures are common after an acquisition. This can be avoided with creative business deal structures and employee incentives, but it’s natural to see employees reevaluate their career options after an M&A transaction. Before taking the acquisition route, companies must weigh the risks and rewards in this area.
The bottom line
Any company considering the acquisition approach would be wise to ask itself exactly why it has to buy vs. build. Are there systemic issues that an acquisition will mask for a while but that will resurface again? Companies should always be challenging themselves to innovate internally to the greatest extent possible so that when they do decide to acquire, they can be confident it’s for the right reasons.
Greg Arnette is technology evangelist at Barracuda, a Thoma Bravo company, and a serial entrepreneur. He has founded and served as CTO of three enterprise software companies – Sonian (acquired by Barracuda), IntelliReach (acquired by Infocrossing), and AlertWare (acquired by Netpro). He has been a messaging, collaboration, Internet, and networking expert for more than 20 years, and has consulted leading corporations on the management and administration of email systems.