Buy-up nation: Acqui-hires - the next growth tier for Israel's startup ecosystem

"Facebook has not once bought a company for the company itself. We buy companies to get excellent people." - Mark Zuckerberg

There is fierce competition for talent in the startup ecosystem, highlighting the increasingly grave shortage of qualified applicants in the market. Acqui-hires are a popular choice for filling the talent gap, with the buyer integrating the skills and expertise of the smaller company’s staff. This is a smart, albeit nuanced, recruitment strategy: you get a team with a proven track record of working together and building innovative products, preferably in areas where your team is lacking, thus enabling quick time to market – less recruitment, no training costs, and lots of expertise.

Timor Arbel-Sadras (left) & Nimrod Vromen

Typically, acqui-hires are done by large companies, who have deep pockets and seasoned M&A teams. They have the know-how and experience needed to identify the right companies, structure the deals, and successfully integrate new teams.

Historically, startups haven’t been tapping into this talent pool - it’s just not an avenue they explore. According to recent Startup Snapshot data, only 6% of startups have considered an acqui-hire, and only 2% have done one.

Now is the time

The current market is ripe for startups to embrace acqui-hires – it isn’t just for large corporates or public companies anymore. There will be an abundant supply of potential acquisition targets, as startups that are unable to raise additional funding will consider acquisition as an option. On the other hand, there is clear demand, as many ventures are going into this downturn heavily capitalized and with the resources to take advantage of market opportunities. Now that there will be more smaller startups shopping around for a new home, acquiring companies can capitalize on these declining valuations and enjoy reasonable pricing. Every private startup that has raised $10-20 million should start thinking about acquiring small teams as a way to access top talent.

Acqui-hires is the next growth tier for the Israeli startup ecosystem. In the past, the Startup Nation took on two massive challenges as the need arose: scaling and penetrating overseas markets. Now it’s time to hone the skills and develop the tools necessary to jump to the next maturity level. The next phase will be full blown acquisitions of companies.

3 steps to ensuring acqui-hire success

When it comes to acqui-hires, startups have a lot at stake. They have to raise additional equity rounds from VCs, which will require in-depth due diligence – they can’t afford to have a failed deal on their hands.

The main challenges of succeeding in an acqui-hire, are first, to mitigate the risks of this unique type of transaction that are inherent risks to an acquiring startup; second, to create a strong playbook for the deal and execute on it with the right consultants who have the requisite experience in buying other companies; and third, to deploy as many efforts as possible into post-merger-integration (which is the bit where most acquisitions fail).

1. Mitigating the risks

There are many tips on how to mitigate the risks to a buying startup, but the main one is to keep the transaction structure as an "asset deal.” In this deal, the buyer buys the assets of the target company (the assets being mostly workforce being fired and re-hired by the buyer). This deal structure is inefficient from a tax perspective for the seller, compared with a deal in which the buyer acquires the shares of the selling company, however one must remember that in the context of an acqui-hire, the seller is normally at wits end and wants to sell, even if only to cover amounts invested, debt and a secure a future for its employees or some legacy for its product. They should be able to compromise on this point, as painful as it may be.

Second, build a compensation structure that incentivizes the acquired team to stay with the acquirer. Offer them less than what they wanted when the deal closes, but generously give them an avenue to make more than what they wanted if they end up staying. This can be achieved through equity incentives and earn-out payments.

2. Cover all your bases

When you acquire a company, you must go through all the motions of an acquisition. Give yourself at least 4-6 months for the end-to-end process. Conduct due diligence on business and HR aspects of the target company in advance of signing a letter of intent that will lock them into exclusivity or "no shop" with you. Then, after the LOI, engage experts in finance (to review financial statements, the quality of the target's revenues if you're absorbing them, and that all expenses were properly budgeted for, like employee benefits for example), legal (review all assigned and transferred contracts of the target company and make sure that they properly approved the transaction), and HR (background check the people, interview them and make sure there will be a fit to your team, whom you should interview as well in the context of the transaction). Manage the deal timeline, and also the groups of people who know about it, and when they know about it, religiously.

3. Post-merger integration

Startups need to tread carefully here – this stage is critical. This is where the secret sauce comes in. Post-merger-integration is a standalone continuous process that begins just before the acquisition is completed and can continue for years. It requires seasoned experts who are not necessarily employed by the acquirer at the time. Have a representative of your experienced investors involved and get real help on this one, for it to succeed.

Nimrod Vromen is a partner at the Yigal Arnon & Co. law offices and founder & CEO of the consulting firm Consiglieri. Timor Arbel-Sadras is CEO of LeumiTech.