2023 startup M&A: the wave is (still) cooking

The anticipated surge of M&A deals for venture-backed startups in 2023, driven by drying funding sources and cash-strapped companies seeking an exit, has failed to materialize year to date.

Contrary to predictions, startup M&A activity has continued to decline.

In Q1 2023, the number of disclosed M&A deals for venture-backed startups globally decreased by 31% compared to the previous year, totaling 491 deals (although there was a slight increase from Q4 2022).

This downward trend is evident even in heavily funded sectors such as cybersecurity and fintech.

Despite notable deals, including Hewlett Packard Enterprise's acquisition of Axis Security for $500 million, M&A deals for venture-backed startups in the cybersecurity sector dropped by 58% in Q1 compared to the previous year, with only 13 deals recorded. Throughout 2022, Crunchbase recorded 82 such deals, down from 126 in 2021.

Similarly, in the fintech sector, the number of M&A deals decreased from 319 in 2021 to 289 in 2022. In Q1 2023, there was a further decline of 37% year over year, with only 51 deals recorded. Although there were noteworthy fintech acquisitions, such as Marqeta's purchase of Power for $275 million (Marqeta's first acquisition), the overall trend indicates a decline in deal-making.

The decline in M&A deals also extends to venture-backed startups acquiring other startups across various industries. In Q1 2023, the number of U.S.-funded startups being acquired by their peers dropped to 82, down from 137 in the previous year.

Several factors contribute to this slump in M&A activity. The reduced startup valuations have led to lower sale premiums, dissuading sellers from cashing out at lower prices. Prospective buyers also face higher capital costs due to rising interest rates, making even bargain purchases more expensive. Furthermore, the growing list of unsuccessful startup acquisitions adds to the hesitation surrounding M&A deals.

However, there is optimism that the situation may change as the year progresses and startups become more desperate for alternatives to scarce funding. Not only has total venture spending declined significantly in 2023, but deal sizes are also decreasing.

One encouraging aspect is that the price expectations between buyers and sellers have aligned more closely compared to 2022. This development indicates that the gap in price negotiations has diminished. Dealmakers are also displaying greater flexibility by considering alternative deal terms, such as earnouts and seller notes, to navigate the uncertain landscape. Earnouts involve a portion of the price being contingent on achieving specific milestones in the future, while seller notes guarantee a payout to the seller at a later date. These innovative terms contribute to making acquisitions more appealing in the current environment.

Throughout Q2 2023, venture capitalists mentioned an increase in inbound calls from potential buyers, indicating a growing interest in M&A opportunities. Although this uptick may not be reflected in the first-quarter numbers, they anticipate a more active M&A environment as the year progresses. The overall sentiment suggests a positive outlook for increased deal-making activity in the coming months.