Tech M&A – poised to take off?

One of the benefits I gained from my early-career experience as an Industry Analyst was an ability to look at the big picture. When I look around at what’s going on in the tech market right now – and the global economy in general – the tea leaves are telling a pretty clear story.

While the general economy has been doing reasonably well since the recovery from COVID – with the big exception of high interest rates and inflation – these past few years have been very tough for both early- and later-stage technology companies.

They have had different but related issues. For early-stage companies, fundraising has been extremely challenging. Venture capital swung wildly from too loose in the post-covid “ZIRP” (Zero Interest Rate Policy) period of late ‘20-early ’22, and then tightened dramatically as interest rates rose and buyers cut back during these most recent 2+ years. As a result – and as I detailed a few months back – the market now finds itself with an oversupply of startups, and an undersupply of both investors to fund them and paying customers to keep them going.

Even startups in hot markets – such as AI – are struggling to grow into their valuations and moderate their burn rates – recent estimates have suggested a $500 billion+ revenue shortfall for AI startups simply to cover the investments they have made in infrastructure in the past year. That is an industry burn rate that is clearly unsustainable and will force even the hottest & fastest-growing AI companies to soon decide whether to attempt to raise additional new funds in a crowded, challenging market – or find a buyer. Expect many to choose the latter.

In the meantime, larger, more established tech companies have been struggling at least for growth, if not for survival. Because the influx of Private Equity into many of these companies has levered up their debt and made them significantly more sensitive to the higher interest rate environment we’ve been in these past 2+ years, they have been less active on the M&A buy-side. While the bigger firms tend to have the capital to “ride out” this tougher environment – and have benefitted from buyers seeing them as safe(r) choices than startups – they have at best been stagnant.

In other words, M&A has been dormant, but pressure has been building on both the buy-side and sell-side – and as the economic and political environments shift, that pressure is likely to rapidly released via an explosion in deal activity.

First of all, interest rates appear poised to decline in the US, and in some parts of the globe that dynamic has already started. This will almost certainly cause Private Equity to come off the sidelines – a massive amount that S&P estimates at more than $2.5 trillion USD. Much of that capital will go into technology – and those slumbering PE-backed companies are already tuning up their Corporate Development teams to capitalize.

And of course, the political winds are shifting. As with interest rates, while the US gets much of the attention, this is a global phenomena. Right-wing politicians have been gaining share and both winning and influencing politics in Europe, Asia and other areas of the globe, and of course it’s been interesting to watch a large swath of Silicon Valley investors and operating executives suddenly line up behind the GOP – including a significant number who had previously supported Democratic candidates.

Why? Because it can be argued that the past few years have also seen tech overregulated. Regardless of one’s personal political preferences, it is clear that there is an appetite for more business-friendly, less restrictive policies – including (but not limited to) loosening restrictions on tech M&A.

Even if we don’t see a regime change in DC, there is a good chance that the new administration will be more tech- and investor-friendly, especially with Kamala Harris’ strong ties to Silicon Valley.

While this fall’s US elections remain up in the air, the trend and the built-up pressures are already clearly pointing to a lowering of interest rates, a loosening up of regulatory restrictions, and as a result a likely explosion of tech M&A.

What does it mean for tech buyers?

Expect that your vendors will be impacted and involved in significant M&A for at least the next 12-24 months, if not much longer. One question to ask yourself – and watch for evidence of – is whether they are a potential consolidator – or consolidatee. In other words, will they acquire – or get acquired.

Acquirers generally tend to have much more control over their development roadmap – and key employees. In a time of consolidation, they are generally perceived as safer choices. However, a well-run acquiree will generally come through an acquisition mostly if not entirely intact – and in many cases, in a much stronger financial position.

There is little that a tech buyer can do at this point aside from staying tuned and staying close to your most critical vendors. This is an excellent time to sit down with your key sponsoring executives at those vendors – look them in the eye, ask the hard questions and see how they answer.

Don’t be rash but watch this space. The remainder of 2024 is going to be very active, and very interesting.