Business Management

IPO or M&A? How Venture Capital Shapes a Startup’s Future

By Aniket Warty | 15 March 2023 |10 Min Read

Entrepreneurs have many financial options for their businesses, including funds from venture capital firms. A company can take two main paths in the venture capital world: an initial public offering (IPO) or a merger and acquisition (M&A).

Both approaches have their own unique pros and cons, and it’s essential to know which path is best for your business. Let’s explore the differences between IPO and M&A and how venture capital helps shape a startup’s future.

How does venture capital work?

Venture capital is a type of funding provided to startup companies and small businesses, usually by wealthy investors, that are deemed to have long-term growth potential. Venture capital aims to help the business grow and eventually go public or be acquired by a larger company. Venture capital is often the only way a startup company can get the funding it needs to get off the ground.

When a company needs financing, a venture capitalist (VC) will consider investing in the business. The VC will thoroughly review the company’s business plan and financials, as well as the founders’ backgrounds and qualifications. A deal will be negotiated if the VC believes the company has a good chance of achieving its goals. This deal may involve the VC providing the startup with capital in exchange for equity in the startup or some other form of compensation.

Once the VC has invested in the company, they will work with the founders and management to help it grow and achieve its goals. This may include providing strategic advice, introducing the company to potential partners, and helping to secure additional funding. The VC may also be involved in the company’s day-to-day operations, such as helping to hire key personnel and providing financial guidance.

Once the company has achieved its goals, the VC will receive a return on its investment. This can be in the form of a capital gain if the company goes public or is acquired, or through dividends or other forms of compensation. The return on the VC’s investment will depend on the terms of the agreement between the VC and the company.

What is an IPO?

An IPO marks the first time a private company offers shares of its stock to the public, allowing anyone to buy those shares on the open market. A company going through an IPO must register with the Securities and Exchange Commission (SEC), which means that potential investors will have access to information about its operations, finances, and management team—all of which must meet specific criteria. This makes it easier for investors to determine whether they want to invest in a particular company.

The Steps Involved in Going Public

Going through an IPO requires several steps, which may take some time depending on the size of your company and the complexity of your operations. The process usually begins months before trading begins on a stock exchange, with registration documents filed with the SEC and marketing materials prepared for potential investors. After that comes pricing negotiations between investment banks, who may offer assistance with underwriting (buying) portions of shares from newly issued stocks from companies going public, followed by finally trading those shares on the stock exchange where they are available for purchase by individual investors.

The Benefits of an Initial Public Offering

Going public has advantages, such as increased visibility, access to more capital, and greater liquidity. An IPO will also give existing shareholders an exit opportunity if they choose to cash out their investment. It provides more options for employees who may be able to purchase stock at a discounted rate through an employee stock option plan (ESOP). Plus, it allows the company founders to remain in control of the company while still being able to raise funds from outside investors.

What is an M&A?

Mergers and acquisitions (M&A) involve combining two organizations or businesses. The two companies can merge together to become one entity, or one company can acquire another by buying its assets or stock. In general, M&As occur when a larger company looks to expand into new markets or gain access to further resources.

How Do M&As Work?

The process of an M&A involves many steps a business must take before completion. First, there will be negotiations between the two companies involved to determine the terms of the deal—including price, structure, and other details. Once these negotiations have been finalized, a due diligence process will begin in which all aspects of the deal are thoroughly examined for accuracy and compliance with applicable laws. During this period, contracts will also be drawn up that outline all terms related to the merger or acquisition. Both parties will sign off on the agreement and complete the transaction if everything is satisfactory.

The Benefits of Merger & Acquisition (M&A)

Merging with or getting acquired by another company can be beneficial for startups. Combining with another business gives companies access to new markets and customers they wouldn’t have had before. It also increases efficiency by eliminating redundant processes and departments that help cut costs in the long run.

Another perk is that it gives companies access to new technology or intellectual property rights that can help them gain a competitive advantage in their industry. It also provides founders with an exit strategy if they want to sell their shares after the merger or acquisition is completed.

Thinking long-term

If you just started your business, cash from an investor can make or break your company. In fact, it could be the difference between launching a product or going out of business. However, if you don’t scrutinize investors’ relationships, you may have to relinquish control later down the line. It’s not uncommon for founders to hand over their business to a larger acquirer or be subject to a certain level of profit expectations as a publicly traded company.

In a recent article, Harvard Business Review published the results of a study conducted by researchers at Harvard, Columbia University, and the University of Washington. This study examined about 71,000 funding rounds for approximately 42,000 new ventures and 20,142 investors between 1982 and 2014. It aimed to identify relationships among venture capitalists in a startup’s first round of funding. The research found that about 16% of the startups were acquired. It also found that, on average, venture capitalist firms usually sold their holdings after about 3.4 years.

While these low-profile exits may have some benefits, like recouping backers’ investments, they also come with complications. The company founder may feel pressure to succumb to the plans of an investor group, or even give up control of the startup’s vision. After a larger company takes possession, many founders are forced to step back while a larger company takes over.

Out of the companies in this study, about 2.9% went public through “broadcast successes.” On average, venture capitalists who haven’t worked closely together tend to stay on board longer, about four and a half years, before moving on to a high-profile exit. According to the study, becoming a public company can give a business more attention while retaining the original team. Still, the risk of failure is higher for these types of ventures.

What does this mean for your business?

Simply put, this study found that startups funded by a VC who usually works with the same group of partners typically exit faster by selling the company to a larger business. In contrast, if a startup is funded by a VC syndicate with less familiar co-investors, the VCs are more likely to exit through an IPO, allowing founders to retain more control (although these founders may be under the pressure of high expectations).

The research on the degree of collaboration of a business’s investors offers several pros and cons. On the one hand, a diverse investor group could give founders more control over decision-making. On the other hand, investors working together could potentially pool resources, have more industry connections, or understand how to find the right opportunity for the business. Either way, being informed about each scenario is a must before committing to venture capital funds. While most business owners hardly ever consider the structure of the relationships of investors, the research shows that this is clearly an important factor.

It’s critical to remember that for everyone involved, both founders and funders, the best-case scenario is to make money. Many venture capitalist investments yield no return of any kind.

Although venture capital provides many opportunities and benefits, you should also remember that in this day and age, there are several other ways to raise funds for your venture, especially if the cons of VC aren’t so appealing to your business structure. Different forms of acquiring funds include getting capital from private equity firms, angel investors, or crowdfunding.

Final thoughts

Venture capital is integral to the success of many businesses, but entrepreneurs must carefully determine which path is best for their startup.

Ultimately, each path has its merits, but only you know what’s best for your business! With careful consideration of both options, you can make an educated decision regarding your company’s future success.

By Aniket Warty

I need no sanction for my life, permission for my freedom, or excuse for my wealth: I am the sanction, the warrant and the reason. The creation of wealth is merely an extension of my innate freedom to produce.

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