It often goes unsaid, but anyone who takes investment from a VC firm has also agreed to work towards an exit. Whether an IPO, an acquisition or any other means of returning capital, this gives investors the chance to sell their stake and, hopefully, realise a sizeable return. Exits are not just about the investors, however. While it might not be their primary motivation for building a business, many founders dream of creating a life-changing amount of wealth, too.
That’s what brings us here, to part three of this series.
Part one: The five questions investors need to ask deeptech startups
Part two: How to scale a deeptech company
We’ll talk about deeptech exits, the best way of getting there and, just as importantly, how to achieve a good outcome. Given everything we’ve said in the first two parts, it won’t be a surprise to learn that deep tech exits work a bit differently.
Let’s start with a home truth: companies are bought, not sold.
When we say ‘exit’, we will mainly mean a trade sale of the company to a corporate buyer. This is partly because it's the most common exit route for deep tech start-ups, but also because even those companies that target an IPO will have to turn down acquisition offers along the way!
How to create value
Let’s start with a home truth: companies are bought, not sold. “Build it and they will come”, as the saying goes. The “it”, in this case, is value. But where does the value lie in a deep tech company? Conveniently this can be broken down into three Ts (thanks to the team at Menalto Advisors for introducing us to the concept). The three Ts generally occur in this order, and with each one you add you’ll get an order of magnitude jump in value:
- Team: Deeptech companies have one rare advantage over their regular tech counterparts: deep tech teams are hard, ideally impossible, to replicate. Their specific knowledge and talents are therefore, like all rare materials, very valuable. For example, it has been reported that Apple buys teams at $3m per engineer. That might seem a lot, and it is, but sometimes the cost to find and retain these type of people (especially a concentrated group of them) is much, much higher.
- Technology: One of the defining characteristics of deep tech is the hard-to-replicate technology. Whether it's because there are patents to work around, or because of the time and unique skills that go into its making, there is value in technology. But an idea alone isn’t enough. What data or demos do you have to prove that your technology works? How much risk is left in its development? How far are you along the path from turning the technology into a product? The more of these questions you can answer, the further along the road to having a valuable technology you will be.
- Traction: This is the game-changer for deep tech companies. If you can combine market leading, defensible technology and a world class team with an established and growing customer base, your value starts to climb into the multiple hundreds of millions, if not billions.
Stealth or spotlight?
Even the most “valuable” company won’t realise that value if nobody's heard of you. No one in a corporate development department wakes up one day thinking, “I’ve got a billion dollars to spend on an interesting technology company, I should go and see what’s out there.” Companies buy companies they know! This is especially true when team and technology are such a big factor in the acquisition decision. So getting known, for the right reasons, is an important part of your journey to exit.
Companies buy companies they know. Active promotion will be necessary.
Deeptech is a small world, and the niche you're working in is smaller still, so you may already have a good network of relationships in your field. The team behind WaveOptics (AR display company bought by Snap for $500m in May) for example, came from backgrounds at the epicentre of augmented reality (BAE Systems and 1066 Labs), which meant they were automatically plugged into everyone there was to know. This close-knit nature of deep tech may therefore mean you already have a contact at a potential acquirer, who could in time become your “champion”, instigating and driving interest in your company.
Ideally, you should also try and get permission to use their logos and reference those customers in your marketing materials — even if they don’t end up acquiring you, they help build your reputation.
Active promotion will still be necessary to get your reputation to the level and shape it needs to be. Thought leadership — writing articles and speaking about your technology — can be an answer, but can also alert competitors to what you’re doing . You’ll need to navigate that constant trade off between staying stealth and creating marketing buzz. But ultimately, some buzz is needed.
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We’ve established that people buy deep tech companies they know and deem to be invaluable. But where might these offers come from?
Customers turned acquirers
Many customers may be acquirers or investors-in-waiting, so of course, they need to be nurtured. WaveOptics was a supplier to Snap Inc before its acquisition, while CQC recently merged with Honeywell, with Honeywell having previously been a ‘collaborator’ and investor in CQC. Customers become acquirers because they get to know your team and your technology.
They could then make an offer for your business for a number of reasons: because they fear that they’ll lose access to a technology and capability (or because it might go to one of their competitors!); because your technology was on their roadmap anyway and it lets them get there quicker; or because the team you’ve assembled would be hard to put together themselves.
Keep hold of your IP — nothing gets potential acquirers more worried than thinking your technology may not be available to them at some point.
Customers as potential future acquirers can, therefore, hold sway over you in the present, but it’s important not to allow them to tie you into knots with exclusivity, rights of first refusal to acquire the company and so on. For example, a clean approach to ensuring you keep your IP, and any IP created out of the relationship, is crucial. Nothing gets potential acquirers more worried than thinking your technology may not be available to them at some point if you are taken out of the market by someone else.
As above, customers can also become investors. Similarly, when this happens, it’s vital that the two relationships are kept separate. Investors often get proprietary information about a company that you wouldn’t want a potential acquirer to have, so flows of information and who’s included and excluded in different circumstances need to be carefully thought through.
Often the investment and commercial sides of big corporates are separate, and the natural lack of streamlining will help maintain the Chinese walls. But it’s also a good idea to insist that any potential acquirers are an observer on the board, or removed entirely. This reduces their entitlement to key materials and means they just receive high-level reporting.
The reality is that during a due diligence process, a prospective buyer will learn all the key metrics about business performance. However, by this point you already want the buyer to be ‘in love’ with the idea of acquiring you, rather than an investor who is looking at forecasted revenues as a means of anchoring price negotiations.
Specialisation and saying no
Deep tech companies often have technology that can be applied to all sorts of problems. However, startups are necessarily cash and headcount constrained. This makes it critical to zone in on a specific market segment and identify those customers with the biggest need for your product. When going through this process, it is worth considering if customers in that segment might also be acquirers.
One portfolio company chose to double down on smartphones because this is where the future acquirer is most likely to be found.
One portfolio company of ours, whose tech could be applied across a vast array of consumer technology, has chosen to double down on smartphones. Not only is this where the biggest commercial opportunities lie, but also where the future acquirer is most likely to be found. This kind of focus can require tenacity and courage, as it will often mean saying no to some customers — and maybe even letting old relationships go. Having said that, you don't want to become exit-obsessed too early, by bending the company out of shape to fit some idea of an acquirer’s vision.
When is the right time to sell?
You’ve taken all the right steps and suddenly you’ve got a life-changing offer on the table. But is it too early? This is one of the hardest questions and something that we think about a lot. Our duty as investors is to try to achieve the best possible return for our own investors, yet it’s not always as simple as just holding out for a better offer.
It’s not always as simple as just holding out for a better offer.
You might only get one chance at a big exit via acquisition. If you say no, your potential acquirer may look elsewhere and buy a rival, or their strategic priorities might change meaning your technology is no longer critical. Given the speed of technological progress, your tech could also end up being seen as Gen 1 where a Gen 2 is emerging. On the flipside, if your tech stays ahead, the acquirer could come back two years later when the business has scaled up and gained more traction, with a much better offer.
For these reasons, some useful questions to ask yourself include:
- Are there many possible acquirers or is this offer likely to be your ultimate buyer anyway?
- Are you likely to get a better offer in two years (when you may have had to take more capital)?
- Will you be able to drive a competitive process from one offer, or could that potentially derail the initial offer — and even your customer relationship?
- Will the management team be happy in the new company and do they agree on their ultimate vision?
For founder-led businesses, the final decision on whether to sell is often theirs and if they have an offer on the table for a life-changing sum, it can be hard to say no, especially if they’re not financially secure yet. For this reason, supporting secondary sales, or allowing key management to “take money off the table" along the way, can be important to de-risk their position and keep them motivated on the journey. Serial founders with a previous exit under their belt are in a stronger position here. They will be much less motivated to sell early and can build towards much larger outcomes.
The funding gap
It's also easier to say no to an acquisition offer if you have an alternative, such as an offer from investors to fund the business on to the next stage. Later stage capital at Series C and D has been much harder to access for deep tech companies, particularly in Europe. This is changing, and the UK government’s recent launch of ‘Future Fund: Breakthrough’, a £375m fund for British tech scaleups, indicates the growing intention to plug this gap.
If you can make it through the funding gap and start growing revenues, your options open up.
According to its founding investor, Humayun Sheikh, DeepMind might not have survived back in 2014 had it not been acquired by Google. Its $600m price was based on a great team and the “promise value” of its technology, but the company had not yet reached commercialisation, and could have found it difficult to keep fundraising.
If you can make it through this funding gap and start growing revenues, your options really start to open up, and that multi-billion-dollar exit appears on the horizon. Darktrace did this very successfully and recently listed on the London Stock Exchange for £1.7 billion. Graphcore looks to be on a similar trajectory, but they are currently the exceptions rather than the norm.
What about an IPO?
IPOs tend to be less common in deeptech, partly because the most common acquirers are some of the biggest companies in the world, with very large cash reserves.
We’ve seen a lack of market understanding (and therefore interest) in Europe. This is partly because few deeptech businesses suit the traditional public market profile — namely profitable business, with a specific growth trajectory, a differentiated offering, and strong revenues with visible upside opportunities on the horizon. That said, public investors are starting to take an active interest in industry-changing technologies. The success of Darktrace and Graphcore on this side of the Atlantic, as well as SPAC (Special Purpose Acquisition Companies) activity leading to the likes of Babylon, and quantum technology encryption startup, Arqit, going public, could mean European deeptech exits start to look more like their American cousins.
When should you bring in advisors?
Our view is that it’s never too early to start the conversation about exits. Your investors should always be there to chat if you need them, but should you start talking to advisors as well? You might assume that it’s too early to be taking on formal relationships, but the fortunate reality is that some are happy to work with you at any stage, initially on an informal basis.
Some advisors are happy to work with you at any stage, on an informal basis.
The right ones will give you invaluable input and there are a number of specialist deeptech advisors. They’ll know the landscape inside out — not only who the potential acquirers are — but they’ll know their roadmaps and how you might fit in to them. For example, they could credibly say “we know that the Facebook team are looking for a computer vision team to set up Facebook Reality Labs in the UK,” as we were told before Facebook acquired Scape Technologies. The other reason for initiating these relationships sooner rather than later is that when the time comes to formalise things, you’ll know exactly who to call.
Despite some notable successes, deeptech startups in Europe have still found it more difficult to make it through the pre-revenue desert to reach commercialisation and successful exit. Yet the tide is turning, with governments and investors waking up to the fact that deep tech could be a gold mine. Our own experience with Magic Pony, SwiftKey, Zynstra and now WaveOptics, is a strong indicator that we are on the right path, with much bigger exits ahead.
Simon King, Partner and deep tech investor at Octopus Ventures – led the investment in WaveOptics, which recently sold to Snap Inc, and sat on its Board.
Zoe Chambers, Principal and deep tech investor at Octopus Ventures – spent 8 years as an M&A lawyer before joining Octopus.