Since 2015, more than one-third of acquisitions in the African tech space have involved South African companies. Does the hypothesis that some of the exit deals are premature legitimate?
South Africa is and has, for a while now, been the undisputed king of mergers and acquisitions in the African tech startup ecosystem. According to Disrupt Africa’s 2022 South Africa Startup Ecosystem Report, the country’s startup ecosystem leads the way in exit mergers and acquisitions (M&As).
Refinitiv Data says that in the first half of 2021 M&A deals involving tech companies increased by $160 million, an almost 2,000% increase compared to the same period in 2020.
Several reasons have been attributed to South Africa’s impressive M&A dominance. These include active capital markets and banking systems, mature companies that can snatch up startups, and others. However, together with the appreciation of exit opportunities in the ecosystem, there are some concerns, albeit not that constantly had, that South African startups might be exiting too early, giving perhaps a warped picture of the country’s M&A space.
TechCabal talked to some experts in the country to try to see if the hypothesis holds any weight.
Why do SA startups exit?
M&As are typically valuable exit avenues for all involved. Acquirees get a very nice payday for founders, employees, and investors and access to a broader pool of markets, resources, and capital. Acquirers benefit from product diversification, talent acquisition, and market expansion.
According to Chris Loker, managing partner of the corporate advisory firm Moksha, the main motivators for tech startup acquisition deals are exits for international growth, procuring capital required to scale, or access to a wider client base. But these deals come particularly when the concept is proven.
“Banks have even set up incubators to test new innovations, knowing that a corporate is often where innovation goes to die and their new product lead times can be many years. The travesty is that we don’t often get repeat entrepreneurs as failure is viewed with disdain or exits are rich enough – in the latter case, the trend of successful entrepreneurs becoming angel investors will hopefully grow,” Loker explained.
For more established companies—and some startups too—the main reason is product diversification. Acquiring a startup that already has a product and traction makes more business sense instead of building the said product from scratch.
A South African investment banker who has overseen numerous acquisitions and wishes to remain anonymous for employment reasons explained:
“I’ll give an example of when many retailers were caught off guard when the [COVID-19] pandemic hit. A lot of their online stores were not well established to service their customers when the lockdown happened. This drove many of them to either evaluate whether they could develop or improve their online mediums quickly enough. The quickest route out of this predicament would be to make an acquisition, and an example is MassMart acquiring OneCart to assist them with their online service offering.”
A number of acquisitions that have happened in the South African tech space do seem to be majorly driven by product diversification. Weaver Fintech acquired PayJustNow to expand into buy-now-pay-later. TymeBank acquired Retail Capital to expand into offering online banking services for SMEs. inq. acquired Syrex to diversify its product offering into hyper-converged cloud technology. Imperial Logistics acquired ParcelNinja to expand into e-commerce and last-mile distribution and Vodacom acquired iot.nxt to expand into Internet of Things (IoT).
Market expansion and talent acquisition are two other significant reasons for acquisitions in South Africa.
A market-expansion-driven acquisition example is Africa Fashion International acquiring online art marketplace Wezart with the intention of using the platform to expand its product offering globally and provide a stronger user base for artists.
Talent acquisition deals are also getting more popular because as the ecosystem grows, competition for tech talent is getting tougher in the continent. For startups with capital, acquiring a smaller startup to integrate its talent often saves time and money instead of poaching it. This is known as an acqui-hire.
For example, after raising an $83 million Series C round in July 2021, fintech startup Yoco acquired web3 software development agency Nona Digital in March 2022 to accelerate its roadmap by bringing a team of highly-specialised fintech product and technology professionals into the Yoco team.
Are the concerns about early exits warranted?
According to Keet van Zyl, co-founder and partner at venture capital firm Knife Capital, there is some legitimacy to the hypotheses. Van Zyl states that in some instances, there is a disconnection between the growth capital needed by startups and what is available, so it makes sense to sell instead of trying to embark on more fundraising. On average, according to van Zyl, South African startups exit after three to four rounds of funding.
“Despite the increasing availability of deal-flow, there remains a significant follow-on financing gap for high-growth local startups with proven traction. Regarding South African entrepreneurs, we have a large mismatch between the size of the opportunities and the amount of capital required to access them. Compared to peer economies, the venture capital and growth equity investment market in SA is drastically under-serviced with available investment capital. Therefore sometimes when startups try to raise growth capital, they turn to strategic investors who seize the opportunity and make a full acquisition offer,” van Zyl tells TechCabal.
However, according to van Zyl, this trend is not necessarily bad as it allows for an increased number of smaller exits – which then recycles capital into the ecosystem – instead of a long road to unicorn building and a lack of liquidity for investors.
Clive Butkow, CEO of Johannesburg-based venture capital firm Kalon Ventures, shares the same sentiments with van Zyl regarding why startups exit too early. According to Butkow, if a startup is not clocking around 200% to 300% growth and an offer presents itself, it should be very well considered by the founding team and investors. “Late-stage venture capital has always been hard to come by in South Africa. For most founders, if you are unable to raise, it might be better to sell before you run out of runway. You get to create some wealth for founders and investors, plus you get to keep the company alive,” he tells TechCabal.
The art of selling
With the venture capital industry currently experiencing a downturn, the M&A market is pretty much in the hands of buyers, but this should not mean that founders should be forced to settle for any deal that comes their way.
“It is [a buyer’s market], and buyers know this and sometimes take advantage of that situation by dragging out due diligence. It helps optics to have VCs on your cap table as the Startup can always make the case to potential buyers that if they don’t acquire – the VC will continue funding the Startup into the next round. This creates a sense of urgency. Preferably get ahead of the game by working with an M&A advisor that will instil discipline in the process and generate interest from multiple potential acquirers,” van Zyl says.
Apart from holding their fort, van Zyl advises startups to seek out opportunities for late-stage funding instead of taking whatever is given to them because of desperation.
“There are a few follow-on and later stage funds that have raised or are being finalised like the $50m Knife Capital Fund III, the SA SME Fund, new VC Fund-of-Funds and local institutional investors are finally waking up to the opportunity, so there is positive momentum,” he added.
Tshepo Magagane, an investment banker, advises startups to be realistic and approach deal-making without emotions. Additionally, Magagane advises the engagement of an expert who has done both sell and buy-side deal-making.
“Have open and honest discussions [with the expert] about the landscape. Go through all the valuation techniques, e.g. how much money have you put in? What is the replacement cost of the assets? What IP have you created? What revenue lines do you currently have? What is the profitability? What cash flows are you generating? How much more capital do you need to put in to get to the next stage? What does the company look like stand-alone?,” Magagane tells TechCabal.
As economic conditions show no signs of simmering down, for most founders with a decent product but unable to raise further capital for growth, a merger or acquisition is often the next plan of action.
Being able to command a fair valuation, as Magagane puts it, is more of an art than a science. For founders, therefore, it is imperative to strike a balance between not only being able to exit but doing so for a price which will appease all those concerned.