Three M&A Alternatives For Accelerating Your Digital Transformation

By Russ Banham

Chief Executive

Apprehensive over inferior mobile and online platforms, inefficient processes and frightful visions of becoming irrelevant, both tech and non-tech organizations are looking to leapfrog the innovation curve by acquiring proficiency in A.I., robotics, predictive analytics, machine learning, blockchain, natural language processing, image recognition software and the Internet of Things (IoT).

“You can look across literally every industry out there today and see both old-guard companies and new age businesses acquiring tech startups, from auto companies buying autonomous vehicle software providers to retailers buying e-commerce portals,” says Jason Flegel, partner and leader of Deloitte’s technology, media and telecom M&A practice. “Unequivocally, this is a major M&A trend with real lasting power.”

A recent survey conducted by Chief Executive with Tata Consultancy Services found 72 percent of CEO respondents considering either a merger, acquisition or divestiture in the next three years. Top drivers include new products or services, new markets and new business models. Since 2010, more than 21,800 tech startup exits—or points at which investors like VCs sell their stakes in a firm—have been tracked worldwide, representing a total deal value of about $1.2 trillion.

“Large technology companies have acquired smaller tech companies for years, but what is really eye-opening is the extraordinary number of non-tech companies closing deals,” says Marc Suidan, leader of PwC’s technology, media and telecom deals practice.

The result? Sky-high valuations, of course. Elvir Causevic, managing director and co-head of global investment bank Houlihan Lokey’s Tech+IPadvisory practice, says some of the leading tech startups that come to the firm to represent their sale “are seeing very high valuations in the market relative to historical multiples and expect the same for their own deals, especially if they have the best-in-class technology.”

He’s not kidding. 3-D printer maker Desktop Metal, for instance, took 1.79 years from founding to reach $1 billion, whereas autonomous driving startup Zoox took two and one-half years. Electronic scooter maker Bird jumped from a $400 million valuation to $1.2 billion in under three months.

Further clouding the picture is the tightening debt market. Cheap debt and ample private equity fueled the run in M&A. With rates rising and recent instability in the equity markets, the window for funding is narrowing and not every midsize buyer will be able to buy what it wants.

Luckily, there are other ways to round out your transformations. “Assuming the board and senior management identify what they need and why, they can generally get it in a joint venture or partnership, a licensing deal, or by poaching technology skill sets,” says Robert Hartwig, a professor of finance at the University of South Carolina’s Darla Moore School of Business. “M&A is not the only path toward digital and data transformation.”

Here are three examples of such alternatives, which serve as a prudent counterbalance to risky M&A transactions.

A License to License

Like many midsized companies, W.L. Gore & Associates must compete against larger business entities to acquire innovative startups. The 60-year-old global materials science company is circumventing this obstacle by licensing the patent for a groundbreaking technology.

Gore is primarily known for its GORE-TEX waterproof, breathable fabric membrane, but it also creates medical devices and products for the aerospace, pharmaceutical and mobile electronics industries. While it pursues traditional acquisitions, joint ventures and venture capital investments as part of its external growth strategy, the company also engages in novel patent licensing deals.

“Startups in the medical device space are very high-priced right now relative to historical multiples,” says Paul Fischer, who leads Gore’s corporate development organization. “We’re challenged in acquiring these organizations by larger publicly traded companies that can use their equity to purchase these companies. We need to deploy other creative strategies.”

By licensing an inventor’s patent on a breakthrough technology, Gore avoids the typical pitfalls of an acquisition, chief among them the cultural integration issues. The license also can be exploited to serve different needs. “We can use it to make things, but we can also use it to prevent others from making things,” Fischer says.

With regard to this defensive use, he explains that by owning the patent for a period of time, Gore can block a competitor from moving forward with a new product using the particular technology in its market space, or thwart the aims of a potential market entrant planning to do the same thing. “Patent licensing has become a large piece of our overall growth strategy,” says Fischer.

The drawbacks are relatively minor. While most patents can be licensed on a 20-year basis, some may require specific use restrictions. “Most times you can license it for whatever you want to use it for, but not always,” says Fischer. Another issue is whether the license provides exclusive use or non-exclusive use of the patent. In the latter case, other companies can also license the patent, limiting its effectiveness as a market barrier. “Universities that develop technologies that accept government research funding can’t provide exclusive licenses,” Fischer notes.

Still, there is more for CEOs to gain than lose from considering patent licensing as a means toward digital and data transformation. While a patent creates an effective market barrier, no company should license a patent it doesn’t expect to actually use.

“Thomas Jefferson opined that inventors of a patent should be incentivized for the betterment of society,” Fischer says. “If you keep it in the drawer, you’re squandering its value.”

Invest, Learn and Buy (Maybe)

Long disparaged as technology laggards, insurance companies are transforming operations from top to bottom using a variety of innovative digital and data technologies. In cases where these tools are not built in-house, they’re obtained from the more than 1,500 insurance technology startups that have sprouted like mushrooms over the past 10 years.

These nimble InsurTech startups seek to either compete against traditional insurers, sell to them, or be acquired by them. For insurers that opt to buy a startup, one way to lessen the risk of a failed deal is to invest in the company first, by way of forging a close partnership. This is the strategy of American Family Insurance (AmFam), a large, 90-year-old mutual insurance company providing property, casualty, health and life insurance products.

In 2014, AmFam launched a separate venture capital fund called American Family Ventures to scout promising investments in early-stage startups. Armed initially with a $50 million war chest, the fund eyeballs InsurTech startups from the seed capital phase through the Series B round, the point where investors take bigger stakes right before the company starts to scale.

“Our approach is to invest in these companies to build a strong relationship, give them some work and, if the time is right, at some point to consider an acquisition,” says Dan Reed, managing director of American Family Ventures. “If we get to this stage, it’s just a much easier conversation to have since we already know them well, and vice versa.”

While most of the fund’s investments don’t culminate in an acquisition, they nonetheless serve the purpose of providing access to innovative technologies that can be used in underwriting, claims management or other parts of the insurance value chain. A case in point is the fund’s investment in Hover, a startup with a machine learning application that homeowners use to assess damage to their property.

Once a homeowner clicks on the Hover app, they’re asked to take pictures of the damage. The tool then stitches together these images into a highly accurate 3-D model that includes accurate measurements for claims purposes. “We invested $4 million in the company, giving us a headstart for our own needs and theirs,” says Reed.

In scrutinizing startups, the fund looks for insurance innovators in product distribution, predictive analytics and the Internet of Things (such as developers of home automation and autonomous vehicle systems). Most investments result in the fund receiving 5 percent to 10 percent of equity in the startup.

Some investments turn into acquisitions. In 2013, the fund invested $5 million in Networked Insights, a startup that ingested social media posts on a massive scale. Using Natural Language Processing, a form of machine learning, the tool provides unique insights into customer experiences for marketing purposes.

“After we made the investment, we became one of their largest customers; I spent time on their board and helped them raise more money,” says Reed. “As they continued to build out their capabilities, they became a more meaningful partner to us.”

AmFam acquired the company last year, which is now part of its new digital transformation division.

Investments have been made in 54 startups since the fund’s launch. “Ten of these companies have been sold to the likes of Google, Amazon and Apple, providing good returns,” says Reed.

As for the remainder of its investments, the returns are measured in enhanced efficiencies and customer-focused innovations. Says Reed, “The ideas we’re getting from these companies are worth more than what we’ve invested.”

Locking Up a Joint Venture

Accuform, a developer and distributor of workplace safety signs, tags and labels, has acquired companies in the past, but when CEO Wayne Johnson wanted to develop a high-tech new product, he opted to take a different path. Accuform already offered lockout/tagout systems that ensure dangerous machines are properly shut off before employees service and maintain the equipment. Johnson’s idea was to create a digital locking system that would provide maintenance teams with real-time data over the Internet about the status of equipment repairs. “Electronic locks have been around for some time now, but nobody had designed one specifically for the safety applications of lockout/tagout,” he says.

He learned this fact by scouring the Internet for evidence of a small startup tech company actually making such locks, thinking of a possible acquisition. None surfaced. Lacking the tech resources to design the product in-house, he spoke with a friend who had recently sold his startup technology business and was looking for another venture to stick his teeth into. “I told him my idea and he was intrigued,” Johnson says. “He understood both safety and technology and happened to know a design group in Taiwan that could develop the Internet-enabled software inside the lock.”

The two men met with representatives of the Taiwanese company. This past summer the three parties inked a joint venture to make the novel electronic lockout-tagout system, which Accuform would brand and market. The Taiwan-based company is a silent partner in the deal. “We put together an MOU (Memo of Understanding) where we’d share in the design and development costs and split the eventual revenues,” explains Johnson.

The partners established a one-year deadline to bring the product to market in summer 2019. The Taiwan-based technology provider is in charge of design and development and will manufacture the product in Taiwan and ship it to Accuform in Brooksville, Florida. The other two partners are in charge of sales and marketing in North America and globally.

The design is now completed, and a prototype is ready for testing. Once the tests conclude, Accuform will reach out to the Occupational Safety and Health Administration (OSHA) for regulatory approval, since the agency’s current standards don’t address an electronic lockout-tagout. “The system is designed for user access via an electronic key as opposed to a traditional metal key that goes into a padlock,” Johnson explains. “It works just fine, and we have no qualms. We just need OSHA’s buyoff, which may involve some additional tinkering.”

From Johnson’s perspective, the arrangement is far more palatable than buying a company outright and attempting the messy business of integration. “From a risk standpoint, [acquisitions] are a much bigger bet than simply partnering up,” says Johnson. “A JV is much simpler and less risky.”

Russ Banham is a Pulitzer-nominated financial journalist and best-selling author.