Abstract
Facing constant pressures to grow, established firms increasingly harness external innovation by collaborating with and eventually acquiring startups. To succeed in their exit through acquisition, startup firms and incumbents have to master three steps (the “3 Cs”) that enhance the co-specialization with the acquirer: establishing the Complementarity of offerings, generating Customer endorsement, and attracting an acquirer executive Champion. Drawing on a multiple-case, inductive study of seven Israeli startup acquisitions completed by two acquirers from the information and communications technology (ICT) industry, this article illustrates the different approaches pursued by the startup firms and their acquirers to succeed in managing pre- and post-acquisition processes.
A growing and increasingly important category of merger and acquisition (M&A) activity is the acquiring of technology startups by technology incumbents that are pursuing new products and technologies. There have been many such acquisitions in high-tech industries over the past two decades, allowing incumbents to obtain technological know-how or product extensions in response to shorter product life cycles. 1 From the startup’s perspective, acquisition by a large incumbent may offer access to complementary and otherwise unavailable resources that are needed to expand its business. 2
Yet, acquisitions in general, and technology acquisitions in particular, pose significant challenges for the acquiring incumbents as well as for the acquired startups. In seeking to alleviate these problems, prior research has identified two main mechanisms, both of which encourage early interaction between the acquirer and the target before the deal is initiated. The first such mechanism is collaboration in the form of a strategic alliance, 3 since an acquisition that is preceded by a target-acquirer alliance will probably encounter “reduced organizational, human resources and related cultural problems.” 4 The second mechanism is the use of corporate venture capital (CVC) investments, which offer the incumbent a “window” on emerging technologies and markets, and thereby improves its odds of successfully acquiring a startup. 5 Taken together, these mechanisms—which have been studied mostly by quantitative methods—suggest that incumbent-startup interaction may facilitate the acquisition process and improve its outcomes. Strategic alliances and CVC investments are relatively formal and structured business mechanisms that are usually well documented by secondary sources.
In contrast, other types of interaction between startups and incumbents may be more difficult to pin down and thus call for a qualitative grounded approach. Qualitative research has documented that acquirers can gain better information on the true value of startups through “ecosystem involvement,” which implies broader participation in the targeted startup’s ecosystem. 6 The resulting information advantage (over other potential acquirers) may well help incumbents to identify good targets and not overpay. 7 It is also interesting that the interaction shortly before an acquisition has been shown to resemble a courtship. 8 According to this view, startups evaluate potential buyers in terms of “whether the buyer would ‘fit’ with the organizational ‘family,’ including employees.” 9 In addition, “sellers were more likely to be attracted to buyers with strong combination potential and to reject buyers without it.” 10 Finally, some startups may develop a clear preference for a particular potential acquirer, which practitioners then refer to as the “acquirer of choice.” 11
The literature has yet to develop a more complete account of the startup-incumbent interaction’s nature or of the process by which it unfolds and eventually leads to an effective acquisition process. Of particular interest is the question of how acquirer and target generate synergistic value through effective co-specialization. More specifically, what is the nature and evolution of pre-acquisition interactions between startups and their eventual acquirers from a startup’s inception until its acquisition by an incumbent? To what extent does such pre-acquisition interaction affect the startup’s successful exit via acquisition, including its effective post-acquisition integration within the acquirer?
To answer these questions, we examined the development process of seven targeted—and eventually acquired—Israeli startups in the information and communications technology (ICT) industry. We have tracked their patterns of interaction with their incumbent acquirers throughout their history, 12 from the startup’s inception until its acquisition. We identified three distinctive patterns of startup incumbent interactions, which in turn impact the three steps (the 3Cs) leading to effective co-specialization and successful exit through acquisition for the startup firm. These three are Complementarity of offerings, Customer endorsement, and Championship by acquirer executive. The first pattern is characterized by a set of close and critical interactions between the startup and the incumbent. This pattern is observed in acquisitions that are viewed as complementary to the incumbents’ offering and before the target makes a solid go-to-market commitment. The second pattern amounts to broader, more distant, and less exclusive interactions between startup and acquiring incumbent firms. This pattern occurs when acquisitions are relatively less complementary and/or when the startup pursues an independent (or even competitive) route vis-à-vis the incumbent, and it proceeds in parallel with the startup’s go-to-market commitment. A third pattern consists of startup firms engaging in limited or no interaction with incumbents. Here, the targets tend to be unaware of their relative standing with respect to incumbents and to exhibit reduced performance when acquired—especially if the acquisition occurs at an early stage of startup development.
Method
For confidentiality reasons, we use fictitious names for all firms involved, startups and acquirers. We studied seven startup firms: two of them (Platinum and Actinium) exhibited close collaboration with the incumbent, three exhibited moderate interaction with incumbents (Palladium, Osmium, and Silver), and, finally, two had little or no interaction with the incumbent (Erbium and Lutetium). Finally, four of the startups were acquired by Columbite, a technology infrastructure provider, and the other three were acquired by Scandia, an enterprise software company. All the acquirers and targets belonged to the ICT industry and were predominantly product firms and not service firms. See Table 1 for data on all startups. The selection of startups for the study was driven by the intention to cover wide variance in the collaboration experiences between startups and incumbents. 13
Description of Cases.
Note: PMI = post-merger integration; R&D = research and development; CTO = chief technology officer; M&A = merger and acquisition.
The two acquirers, which operated in different segments of the ICT industry, each had a market share of about 40% in their respective segments. Whereas Columbite was the more acquisitive company, Scandia had historically relied on organic growth and so had less experience with acquisitions. All the sampled startups were located in the larger Tel Aviv metropolitan area. Israeli startups, most of which are located in Tel Aviv or in its vicinity, offer a suitable setting to address our research questions because the country exhibits the combination of thriving entrepreneurship and an active market for corporate control. 14
Our study relies on the “triangulation” of multiple data sources and types: publicly available data, internal archives obtained locally from the companies in our sample, interview data, and follow-up interviews with the multinational acquirers’ executives both locally and at the acquirers’ headquarters. As detailed in Table 1, we accessed both local and international sources in hand-collecting archival descriptive data on the sample firms from internal and publicly available documents. To achieve a fine-grained understanding of the issues, we carried out 45 in-depth, semi-structured interviews—an average of 6.5 interviews per case. Each interview lasted from one to four hours. Table 1 lists the interviewees in two columns according to whether they are associated with the startups or the acquirers. In the next stage, interviews were transcribed by one of the authors and systematically coded. 15
Data from each interviewee were compared with data provided by different interviewees 16 and also with secondary data from a wide range of sources. 17 Emerging concepts were then identified, categorized, 18 and analyzed, 19 eventually shaping into a conceptual model. The model is depicted in Figure 1.
Startup-incumbent acquisitions interactions: 3 steps (“3Cs”) leading to co-specialization.
Initial Startup’s Embeddedness as an Antecedent to the 3Cs Process of Startup-Incumbent Co-specialization
In essence, the entrepreneurial process consists of spotting viable opportunities and taking action to exploit them for the purpose of fulfilling social and economic needs. 20 Accurate identification of an opportunity early in a startup’s life may reduce unnecessary costs and expedite the development process, an advantage given that “time to market” is paramount in this industry. Most of the literature on spotting opportunities has been concerned with antecedents reflecting an entrepreneur’s individual attributes—such as prior knowledge, experience, and education 21 —that enable recognition of emergent opportunities. According to the innovation literature, information about opportunities is imperfectly distributed. 22
The entrepreneurship literature describes the ramifications of social embeddedness in this way: “On the premise that entrepreneurship is the creation and extraction of value from an environment, being or becoming embedded must impact upon the entrepreneurial process.” 23 Thus, embeddedness is defined as the nature, depth, and extent of an individual’s ties to the environment. This literature has established that social embeddedness plays a role in passing initial screening processes with ecosystem partners and also that a poorly embedded entrepreneur is less likely to engage with such partners—that is, since he fails to attract them at the outset. 24
Our findings provide support to the crucial role of startup’s embeddedness in spotting entrepreneurial opportunities through increased information gained by interactions with incumbents at an early stage. Initial embeddedness—which varied widely across the seven startups—affected startups’ ability to learn how the incumbent viewed the focal opportunity. Such information advantage in turn enables the startup to initiate a more informed opportunity-spotting process. The analysis of our seven cases reveals how incumbents may provide superior information for opportunity identification by startups and may even help the startup refine opportunities via direct interaction. In contrast, weak former ties to the industry made it difficult to start a candid and open dialogue with an incumbent concerning an identified opportunity. The key points relating to the startups’ various development stages are summarized in Table 2.
Key Points of Startup Development..
Note: VCs = venture capitalists; IPO = initial public offering; OEM = original equipment manufacturer.
Our results also demonstrate why collaboration with incumbents figures so prominently in a startup’s search for viable market opportunities. First, all the studied cases are technology startups; so here an important aspect of entrepreneurial opportunity identification is having an intimate knowledge of the state of the art in both current and emerging technologies. Hence, prior embeddedness in the industry is useful because it provides knowledge of the preexisting technologies that underlie an incumbent’s products and technologies as well as, in some cases, insights into how they might be improved. Second, our findings indicate that—direct technological insights aside—prior social embeddedness may facilitate continued close incumbent-startup interaction and may also yield strategic feedback from the former regarding the business aspects of any opportunities being pursued by the latter.
1st C: Establishing Complementarity of Offerings, Funding, and Appropriate Capabilities Development
When deeply embedded into the incumbent’s ecosystem, the startup firm is more capable of assessing the incumbent’s attitude toward the startup and its innovation. In particular, it is important for the startup to assess whether the incumbent will consider it a competitor, as a market shaper, 25 or, alternatively, view the startup’s offering as complementary and compatible to its own offering. The assessment of the degree of complementarity is important for several reasons. First, this information is vital because it helps guide the startup’s choice between pursuing an independent strategy and collaborating with the incumbent. Second, understanding how the startup is positioned vis-à-vis the relevant incumbent increases potential investors’ clarity on the chances of a successful exit, hence increasing the startups’ likelihood of attracting funding when they pursue a viable strategy. Third, it allows startups to properly allocate resources to develop the necessary capabilities along its value chain, contingent on the envisaged positioning vis-à-vis incumbents. Taken together, incumbent-startup interactions should yield valuable information on how the parties can enhance their compatibility and complementarity as a first step toward co-specialization, which implies endogenizing the synergy between acquirer and target in the case of an eventual acquisition. 26 Finally, in some less-frequent cases, incumbent interaction may even inform the startup about de novo opportunities that align well strategically with the incumbent’s interests and about which the startup would not otherwise have known. 27
For example, Lutetium—which was founded by two entrepreneurs new to the market and with no connection with incumbents—lacked prior embeddedness and internal knowledge of incumbents’ underlying technologies. Its chief technology officer (CTO) and co-founder, an industry outsider who himself came up with the idea around which to build the startup, encountered considerable skepticism. He commented, I got feedback that it wasn’t good enough (never mind that Actinium, which was acquired by Columbite, had the same idea, and it was good enough [for Columbite], and I got the feedback that it wasn’t good enough), and also that I need a prototype, a patent, and a letter of intent from customers.
Lutetium’s CTO and co-founder had to go it alone for a long period before he managed to raise any funding: “I started as a self-financed activity for a year and a half . . . I worked at home.” Eventually, Lutetium managed to get some limited funding from a governmental program, but it failed to attract follow-on investments. It devoted most of its scarce resources to developing its technology. According to one of the company’s founders, “We were a total of six people: CEO, CTO, and a research and development (R&D) team of three developers, and one quality guy.”
Actinium, operating in the same segment as Lutetium but founded by highly regarded ex-academics from a prestigious engineering university, was somewhat better socially embedded owing to the founders’ previous academic affiliation. Yet Actinium’s founders, too, were unsuccessful in their independent attempts to identify a viable market opportunity. As one founder recalled, Actinium was initially very theoretical, detached from reality, a little bit premature from that perspective (we were in academia) . . . It was almost like a solution looking for a problem . . . And so we built a solution and then realized that, for various reasons, the problem is either solved by other means or the market is not there or the market is already taken by similar and good enough products.
Owing to their academic reputation, the co-founders of Actinium raised capital with relative ease. As one of them revealed, “We raised two million dollars out of slides . . . it was more investing in us than anything else.” Moreover, one of the investors was a fund known for its intimate collaboration with Columbite. However, lack of strategic clarity skewed the resource accumulation process toward the technology side: It was a very technology oriented company, and very little business oriented. We were focused on technology first and then came the productization; less emphasis on the product envelope than on the core technology than you would really want if you want to build a long-term company . . . For the first year, we had nothing but engineers.
This orientation did not change until investors associated with Columbite demanded that Actinium changes its priorities: “And then we brought a VP [for] marketing from the U.S. who basically started to put some business framework around it.”
The founders of Erbium likewise sought a problem for a solution they already had in mind, one “rolled over” from an unsuccessful startup with which they were previously involved. These founders were also poorly embedded in the incumbents’ ecosystem, with one notable exception: an “angel” investor who happened to be an executive working for Scandia. However, that person refrained from assisting Erbium in order to avoid any perceived conflict of interest with his employer. In the same vein, the founders of Erbium raised relatively little money: “Half of it from VCs [venture capitalists], the other half from angels.” The difficulty in raising capital drove the company to seek revenues. As one of the co-founders described, We figured out we can no longer live on just raising money, we needed a real business model, and we made a shift from looking at fundraising and gearing the company towards fundraising, to gearing the company towards a P&L [profit-and-loss] structure.
However, the firm failed to make this transition—largely because of the insufficient financial resources at its disposal—and realized that generating sales would come at a prohibitive cost while possibly failing to generate enough revenue.
Osmium was better embedded in the target market because one of its co-founders had once been a consultant in that market and therefore had some knowledge about incumbents’ existing products. Osmium quickly found a customer for its nascent product and then developed the technology around this customer: “We had a local customer that we built the solution around them, kind of experimented and verified that this is something that could operate.” Osmium raised money from a government fund whose mission was to assist startups’ commercialization efforts, but it was unable to attract any investment by venture capitalists (VCs). One of its founders explained, “Venture capital—it wasn’t that easy, I think the market size, the scalability of this business is not as attractive as other products are.” Osmium managed to generate sales, but it recognized the difficulty of funding its growth from internal sources alone. One of the firm’s founders commented, It wasn’t that much funding which we got. We managed to get some positive income and revenue from customers . . . but it didn’t allow us to really grow and set up a sales organization outside of the country or any kind of more aggressive sales effort . . . in this business you need very powerful consulting teams which will actually do the pre-sale and the post-sale implementation. We didn’t have enough resources for doing it, so we looked at different alternatives . . . So then we went more to look for strategic partners like this U.S. company that we had this OEM [original equipment manufacturer] agreement with. We actually had discussions with a competitor of Scandia.
The founders of Silver enjoyed closer proximity to industry incumbents, having previously worked for one of Columbite’s rivals. In their prior company, these entrepreneurs had recognized that the market was offering no scalable solutions and believed that they could develop a technology to overcome this limitation. One of Silver’s R&D managers indicated that the idea behind the company was a technology idea and not a market need . . . Everybody understood there is a scaling problem . . . Silver took it to the next level of actually putting it into a completely different approach. It was a bold move in the sense that you have to educate the market altogether into that approach.
A senior executive of the company revealed that its founders identified the technology opportunity while working for their previous employer and then they left “to do this company and from the onset they wanted to sell it to Columbite.” However, the firm did not attempt to gauge whether its product would complement or compete with the incumbents’ product offering. The strong background of Silver’s founders allowed it to raise sufficient capital from local and national venture capital funds with strong ties to the relevant industry. However, the strong technology orientation of the firm’s founders initially skewed the resource accumulation process toward the technology side. The strongest founder was described by one of the firm’s executives as a “brilliant technical visionary with absolutely no management skills.” The company developed the product and then later developed a second generation, practically redoing the entire R&D. In contrast to its strong technology team, Silver’s sales, marketing, and business development teams were weak; also, the first VP for marketing lacked relevant experience: But she was American, so they figured that her English was good enough and the rest is a piece of cake . . . Then came a succession of CEOs, but this founder always found a way to kill them.
Both “Platinum” and “Palladium” were founded by the same team of three experienced technologists. One of the co-founders, a former employee of Columbite, approached his previous employer to assess its reaction to the opportunity addressed by the new venture. As he recalled, The idea was basically an idea that I had for a new component. It’s basically something that I did at Columbite, my previous employer, just before I left them, and I thought there is a better way, more optimized way to build it . . . I went with the idea of the component, and shopped it with some of my old colleagues in Columbite, and they said: “We don’t like this idea, but we like another idea.” So I came back and said: “I smell blood, and there is room here for two companies. One [Platinum] is what Columbite wanted as the new thing, and the other one [Palladium] is the original idea that we had, the component, but we need to evolve it.
This exchange of critical information about entrepreneurial opportunities worth pursuing was enabled by the embeddedness of one of the Platinum and Palladium co-founders, who observed: “Because I knew the people from Columbite at the time, I knew the way that they were thinking, and I knew about the need in the market.” The openness with which Columbite continued to exchange information with this co-founder proved to be valuable for both startups, though in different ways.
First, it informed both firms about the incumbent’s attitude toward the opportunities they pursued: the collaborative view of Platinum, for which the idea came from Columbite, and the competitive view of Palladium. Indeed, this co-founder reported, “They said very clearly and up front that they don’t care about this [Palladium]. I found out later on that they had other investments that were conflicting.” The co-founder who previously worked for Columbite explained, The most frightening thing related to my meetings with Columbite was something that I couldn’t see when I was inside, as an employee, but when I got out I realized that the NIH [not invented here] of the company is so high that they will never acquire . . . specific technologies from outside. They would develop it themselves because this is more of a core technology . . . But this is an example of something that you can only realize when you are outside.
Second, the prolonged interaction provided essential information on the appropriate products’ definitions. According to the R&D manager of Platinum, Columbite practically defined the product to be highly compatible and complementary. Columbite sought to promote a new standard, so it needed a product that would be compatible with this standard and complementary in the sense that it would provide the functionality Columbite was missing, thereby enabling it to provide a complete solution. Hence, Columbite agreed in advance that Platinum would develop a compatible and complementary product and would do so quickly, as befitted Columbite’s needs. In contrast, the Palladium product was less complementary with respect to Columbite’s offering. The early interaction with Columbite provided guidance on how Palladium should modify the product after Columbite decided not to collaborate—in other words, so that it could be sold independently in the product market. So in this case, the acquirer-startup interaction resulted in the development of a stand-alone product that could be sold and used independently.
Third, knowing Columbite, the co-founders decided that they needed to ascertain that this incumbent was committed to the idea of Platinum, and hence they took some time to verify that we can really make significant business progress with Columbite. So we did some minimal thinking about the idea, but we were mainly interested in testing how serious Columbite was about that. Once we realized, it took us about a month and a half.
Both Platinum and Palladium were well funded. One of the major investors in Platinum was Columbite itself, which maintained contact with Platinum throughout the latter’s life. In contrast, Columbite had no interest in making an investment in Palladium. One of this startup’s co-founders stated, I told them what Palladium was going to do and they looked at it and came back . . . They didn’t say, “You don’t need this,” they said, “We will never need this.” That was the quote of Columbite at the time . . . We were fortunate enough to be able to attract some of the heavyweights on the investment side who got a good feel for it. I don’t think they completely understood the details of the vision, but they had a good feel for “We can build something big here.”
For Platinum, the resource allocation process deliberately refrained from unnecessary downstream investments; the reason is that its founders knew the exit would be based on M&A. According to one founder, we didn’t build a big sales and marketing force. We had only two people in the [United] States at the acquisition time . . . So there was basically no need to build a huge presence in the States and a huge sales force . . . We didn’t even go to a [trade] show.
Palladium made sufficient investments along its entire value chain. One of its founders remarked that “you always have acquisition as an avenue for exit, but you cannot build on it exclusively, and we were building a real company going for an IPO [initial public offering].” Another founder commented, “It’s obvious that you needed more money for Palladium [than for Platinum]. The operation in the U.S. is always expensive. The overhead is huge, and the cost of employees was about 2:1 there.” The capacity to interact with customers was crucial for Palladium being able to define a viable product envelope, as one of its co-founders explained: We had basically a very sophisticated technology, and we had many, many applications that could have been served by it. But we couldn’t find anything that would cause the company to go in a very narrow way. It’s a typical marketing problem. Usually you start very broad, and you are doing something very generic: you can do this, and you can do that, and one of the problems early on is to make the right bet that you are on to the right thing. In this case I remember, we met some customers, and these people told us about problems that they are having, and for me it was an event because I said, “Wow, the Palladium technology can solve this problem that the customers are telling me about.”
These cases highlight the key role of embeddedness and its impact on resource funding and development. When deeply embedded into the incumbent’s ecosystem, the startup firm not only has the opportunity to gain deeper information and be more effective in spotting relevant opportunities, it also increases the odds of receiving funding from incumbents through greater visibility and interest alignments. Startups that were weakly embedded in the acquirer’s ecosystem met challenges to find funding. In contrast, startups that were embedded in the industry received adequate funding. Furthermore, we find that incumbents’ involvement in the funding process enhances a startup’s ability to raise additional funding from other investors and thus increase its odds of properly developing the necessary value chain activities. For most technological startups, the resource accumulation process is skewed toward the technology side for a host of reasons such as a lack of marketing experience, a shortage of financial resources, or the technological focus of the entrepreneurs. Most of the startups in our sample were much more focused on upstream, product-related activities than they were on such downstream activities as sales and marketing. The cases we examined revealed that startups lacking connections to industry incumbents were even more likely to underinvest in marketing and sales.
2nd C: Generating Customer Endorsement and Acquisition Type
Investing in sales and customers’ relationships is key for making progress in the acquisition process, and startup firms can benefit from the incumbent’s close ties with some of its key customers. Referrals made to the incumbent by such customers, especially when made at their own initiative, amount to a credible signal that increases an incumbent’s confidence in the startup’s value. However, a startup can benefit from this mechanism only if it has a working product that could be tested in the market. Failure to demonstrate the product to key customers compromises the startup’s ability to signal its value in this way and has a negative effect on how it is viewed by the incumbent.
In the absence of any referrals from Scandia’s strategic customers, Lutetium started collaborating directly with Scandia on the technology side and deployed one of its Beta systems there. Scandia ultimately acquired Lutetium after the former’s first evaluation of the technology. However, without a product envelope endorsement by key customers, Scandia planned to integrate the technology by itself, after the acquisition. Scandia thus demanded that, prior to the acquisition, Lutetium discontinue all its marketing efforts with potential customers. One of Lutetium’s founders recalled, We had to shut down the customer activities. It was a barrier. We had to collect all the pilots, and we had to bring from the customers a letter that they had no claims from us. Without that, we could not have closed the deal . . . The business activity was addressed as a liability [that] we need to completely resolve before the deal.
Erbium was also unable to demonstrate its value by working with Scandia’s key customers. Much as Lutetium had, Erbium attempted to validate its products directly with Scandia. One of its executives recalled, We came to them and understood the needs, pitched something, and they said, “Hey, we’re not so interested.” After a few months, we met again. After about half a year, there was some initial interest. After an additional three months, a lot more interest . . . it started as a discussion of being a customer, and then very quickly moved into an acquisition. They came at a point where we already were looking for a buyer, and they were looking . . . And then we said, “Hey, you know, since we are waiting for a term sheet from another company, just be aware.” And then it kind of escalated.
Scandia’s first in-country acquisition, that of Osmium, occurred at a later stage of startup development (i.e., the product stage, not the technology stage) and at a higher price. Unlike Lutetium and Erbium, Osmium did enjoy having one of Scandia’s biggest customers make a glowing referral to Scandia. One of Osmium’s co-founders commented, Neon [a large consumer goods company that was Osmium’s, and one of Scandia’s, biggest customers] helped us: they actually introduced us to Scandia, and they also gave a lot of positive feedback to the management of Scandia about the solution and the fact that Scandia is lacking such a component in their portfolio, and that was really what made Scandia acquire us.
The acquisition of Actinium also evolved from the interest of a potential customer, “Magnesium,” which was a top-tier bank and a major customer of Columbite. One of Actinium’s founders recalled, Magnesium came to us and said: “We like your technology [but] where are you going to be two years from now? Who are your customers? You’re not established.” And they called Columbite and told them they like this technology, and then Columbite called us, and they started to do a survey among other customers, so they said: “Wow, that’s very interesting.” That’s how it evolved.
The acquisition of Silver was more problematic because its technology required intimate and widespread integration into Columbite’s products, and hence there were differences in how the respective parties viewed this acquisition. Columbite just wanted the technology, but Silver believed it had a complete product. An R&D manager at Silver recalled, “Silver didn’t look at itself as an infrastructure company . . . when they talked about the valuation, we said that a comparable company was sold for $300 million.” A senior executive at Silver commented that Columbite reached the proper valuation after talking to customers: Part of the due diligence was who are your customers, come to talk to them, what did they write . . . We had to have products sold, working, happy customers, customers Columbite could talk to, ask for a reference figuring out what our future sales were going to be . . . When they calculated the price we calculated how much sales are we going to generate based on our product.
The acquisition of Palladium involved strong customer endorsement, as described by its CEO: We managed to get a strong relationship with some of the world’s key customers. What we did made a lot of sense to them. So all those big customers go through executive briefings with Columbite on a regular basis, and more and more of them kept telling Columbite “this is a capability you’ve got to have.” We’re looking at Palladium to do this for us. But you guys are being left behind. So this is where we got the first call to say, can we talk about . . . and honestly, when they called us to say can we talk, they looked at a very narrow aspect of what we did at the time; we had a much broader vision. So when we came in, we educated them that this is why customers want us, but this is where we’re going. And suddenly it became a very intensive discussion. And again, we tried to say, how about we partner? We tried to say, can we OEM the products through you, all of which they said it doesn’t work, which now I know is true. But since our sales weren’t high enough, we didn’t think this would be an interesting time to go, and we felt that we were getting engaged with the right customers. So we . . . and the process came up and went away and came up and went away for almost a year. But it was the customers driving the field driving the business unit who were approaching us.
As our cases illustrate, the nature of the interaction in the triangle of the startup, the incumbent, and shared key customers serves to signal the startup’s quality and helps the incumbent assess its true value. Interaction between the acquirer and the startup will impact the target’s ability to invest in go-to-market capabilities and to secure customers’ endorsement, both being crucial pre-acquisition activities for the startup.
3rd C: Championship by Acquirer Executive and Successful Acquisition Implementation and Post-Merger Integration (PMI)
Acquirers of technology startups are threatened by uncertainty and information asymmetry. 28 Incumbents therefore depend on their superior ability to assess the quality of a startup’s technology and the market potential of a fully developed product. Our data reveal that the support of an executive champion or sponsor at the incumbent firm increases an incumbent’s ability to create synergies with the potential target.
The support of an executive champion 29 or sponsor 30 at the incumbent acquiring firm is essential for validating the quality of a technology startup before its product gains market validation. These roles are well known (e.g., in the technology management literature) but not in the context of acquisitions. Our data show that the commitment of a prominent executive, one who takes responsibility for sponsoring the startup and the acquisition integration, is critical for the successful absorption of an acquired target. Similar roles have also been discussed in the literature on “intrapreneurship” 31 —as one might expect given that, after a technology acquisition, the acquiring firm still bears considerable risks in bringing the product to market. 32 Executive champions are important for intrapreneurs, who must rely on a higher level person in the firm to serve as lead advocate for any new initiative and to provide it with support and protection.
Without a committed sponsor, Lutetium founders felt demoted and frustrated following the acquisition. One of them commented, They were very, very poor in the integration. There was a “not invented here” culture, arrogance, and it took four years to be accepted. It’s an anti-acquisition culture.
Erbium also lacked the support of an executive champion. Of Erbium’s 20 employees at the time of the deal, only six joined Scandia—and they were tasked with translating their software from one platform to another. A co-founder who stayed commented on the period following the acquisition: You had to every day sell your company from the beginning each time to a new person. So why did they buy your company? How much money did you make? Everybody was trying to prove you . . . there was a lot of NIH syndrome.
Scandia’s first in-country acquisition, that of Osmium, occurred at a later stage of startup development (i.e., the product stage, not the technology stage) and at a higher price. The result was a different PMI process. Unlike Lutetium and Erbium, the successful acquisition of Osmium owes much to a senior individual within Scandia who championed further relationships between the companies as early as the first meeting at Scandia’s headquarters: We presented the product and we started discussing some kind of a cooperation and this guy was very excited and actually this guy—I was with him kind of since then until he left, and he was kind of my mentor and sponsor inside the company. So he was actually the one that was pushing it and we were really surprised that he said, “let’s meet in Israel in two weeks,” and actually they did come to Israel two weeks after with like 4-5 people, got into additional discussion and then the first agreement was signed to start doing some kind of interfacing between Scandia and our solution . . . [and they have paid] up front for this kind of integration, assuming that the next step they will go into acquiring it, and this really happened.
This acquisition was successful despite Scandia’s relative lack of experience: Scandia was completely not organized for really getting a new company in . . . I think we kind of integrated together with Scandia’s existing team. We managed very quickly to bring new ideas and new directions into the team, but it wasn’t like given, and that’s a Scandia style . . . It’s not a very hierarchical company where everything flows from the top and cascades down. Things really happen at the bottom . . . It wasn’t clear that they owned the roadmap or we owned the roadmap. We kind of worked together. We had some ideas about how we could really boost the positioning and the functionality of the existing solution, which we managed to convince them of and actually execute it. In a relatively short time, we really changed the perception about this part of Scandia’s solution and significantly increased the number of customers that they had. So this was very successful, but it could have failed if the people on the other side were not that willing or accepting and we were not that pushy, because it was like: “Okay, try to do your best.” They were not really giving us a clear guidance about this.
The acquisition of Silver was more problematic. As one of Silver’s R&D managers explained, There were people who wanted to close Silver immediately, there were people who were looking for visionary things, but there was no one to think about the execution problem of taking this evolutionary path of what was there and turning that into something new, and put it through a reality check. I think it’s poor execution, not only strategically, but also engineering wise.
The acquisition of Palladium involved a strong executive champion within Columbite. The CEO of Palladium commented, Now there’s always an internal champion in processes like this. Without somebody inside who has the passion, who gets it and knows that this is something that has to happen, it’s important for the business, and [who] is willing to spend a lot of time evangelizing internally because out of pure belief, it’s hard to get those deals done. So there were some key people within Columbite, not very senior, but smart enough to understand what we were doing and what the customers were looking for, who kept hounding to say we’ve got to do this, we’ve got to look at this. And they looked at . . . once they decided to look at the space, they looked at the space, not just us. We had a very good interaction with them, and we had, I think, a key position in the field, which is important for them.
Platinum also enjoyed the support of a senior executive. As one of its co-founders described his role: “He had to sign in blood, that he owned this, and he is responsible for making it profitable and justified that he had the budget to sustain it above and beyond the acquiring price.”
The outcome of Platinum and Palladium’s acquisitions was different, as one of the co-founders of both firms observed: “In the case of Palladium, it was a bigger acquisition, and Palladium was, at least initially, a business unit by itself. In the case of Platinum, it was a smaller acquisition—we joined another business unit.” It is interesting that the main post-merger challenges were related less to integration than to how well they could compete against other products: In the case of Platinum, the biggest difficulty was to push a new vision into the market [on behalf of Columbite] . . . There was more than one way to solve the problem to the customer . . . In the case of Palladium, very similar—there were other products or other technologies that could have competed.
Following the acquisition, the challenge for Palladium was to transition its sales channels to those of Columbite. Palladium’s engineers were sent to train the sales organization on the newly acquired products. The CEO of Palladium noted that sales still took some time to ramp up: “first quarter was pretty bad, after acquisition. Second quarter was [still slow], and then it started picking up, sales guys really liked it. But it took almost two years to feel good.”
The R&D manager of Platinum said this about his development team: “we were kept as an organic group, and after a year we started dissolving.” For Palladium, the integration process was much slower because the company was a few years older and more complex with “groups in the company, ties to other companies, partnerships. You have more sales, your sales are more complex, ties to the industry that you need to actually re-do.”
The startup’s ability to validate its value—which is a function of the startup’s stage of development and of its congruence with the incumbent’s strategic focus (i.e., if the incumbent is interested in the technology alone or in the product as currently configured)—determined the acquisition outcomes: its type and price as well as the subsequent PMI process.
Although our findings relate to different stages of the startup development process, they are connected as by a fil rouge. 33 In each stage, achieving a requisite capability milestone is a necessary but not sufficient condition for reaching the next milestone. 34 Throughout this process, collaboration with the incumbent has a positive effect on rendering the next milestone more achievable.
Three Patterns of Startup and Incumbent Relationships and Impact on the 3 Cs
Three patterns emerge from the various observed characteristics of our focal acquisitions: Pattern 1 (co-specialization), Pattern 2 (some interaction), and Pattern 3 (minimal interaction). We find that the most successful acquisitions of startups by incumbents followed either the first or the second pattern of interaction. Through close and frequent interactions with incumbents that reflected an intended co-specialization pattern (Pattern 1), Platinum and Actinium managed to
strategically align their product offerings (complementarity of offerings);
increase the likelihood of the startup offering’s endorsement by a customer, thereby reducing acquirer uncertainty about the startup’s value (customer endorsement); and
alleviate PMI challenges through the efforts of the acquirer’s executives who voluntarily championed the targeted startup not only during early interactions but also during the entire PMI process.
These outcomes are the 3 Cs of co-specialization: complementarity, customers, and championship.
Palladium and Osmium followed the second successful pattern of interaction (Pattern 2). Given their prior knowledge of the industry and early engagements—predominantly with customers and in a nonexclusive manner with incumbents—these startups followed a pattern of distant interaction with a parallel process of building up stand-alone capabilities in the service of an intended route to independence. Both Palladium and Osmium benefited from the second and third Cs listed above (customer endorsement and championship by acquirer executive), which facilitated the acquisition and led to a favorable PMI experience.
Silver followed a more hybrid path; its founders had previously worked with an incumbent, learning about the market. Yet, when attempting to engage incumbents, Silver found that its product was not complementary enough (since it aimed to replace an existing technology); at the same time, the firm failed to build any stand-alone capabilities (especially those related to marketing). Hence, customers did not give unsolicited endorsements to the incumbent, and both the acquisition and subsequent integration were less successful than in the case of startups that closely followed Pattern 1 or Pattern 2.
Among our seven cases, the least successful startup acquisitions were those of Lutetium and Erbium. These cases followed Pattern 3 (little or no interaction with the incumbent), which resulted in poor strategic alignment with incumbent offerings and in the failure to build broader capabilities alongside the technology development. These two startups were acquired at an earlier stage of development, which usually corresponds to a lower price and to a reduced probability of enjoying high post-merger status. Unlike the targeted startups that interacted more with incumbents, these firms fared poorly at managing technological, organizational, and strategic tensions—throughout the development process, their eventual acquisition, and PMI.
Finally, as the development patterns of the different startups reveal, incumbent interaction and collaboration throughout a target’s development process improved its alignment with incumbents: either to complement them (Pattern 1) or to pursue a viable independent path (Pattern 2). Successful product-oriented, complementary acquisitions that transpired before the startup making a true go-to-market commitment (Pattern 1) were preceded by a focused collaboration with the incumbent. In contrast, acquisitions exhibiting less target-incumbent complementarity (Pattern 2) were consummated after the startup had established itself in the product market; hence, they were characterized by (and benefited from) a broader, more superficial, and nonexclusive process of engagement.
Discussion and Conclusion
Opening the “black box” of startups’ collaboration with incumbents prior to their acquisition sheds light on some of the critical stages of the entrepreneurial process. 35 Such collaboration is more likely when the startup’s founders enjoy strong social embeddedness in proximity to incumbents, but it can also be formed throughout the startup’s independent life. Either way, early target-acquirer interaction may result in better positioning vis-à-vis incumbents by clarifying whether the startup is likely to be perceived by the incumbent as a complement or as a competitor. In the former case, collaboration can continue to develop, initiating a chain reaction that drives even closer collaboration and co-specialization. Conversely, in the absence of any such interaction, startups might find themselves ill-positioned to complement incumbents and, at the same time, poorly positioned to challenge them in the product market by pursuing an independent trajectory.
In summary, we identify three co-specialization mechanisms that operate prior to an acquisition. The first entails establishing the degree to which the startup is complementary to the incumbent. Incumbents are generally defensive in those areas they consider their core. In contrast, in areas perceived as adjacent, incumbents often see potential in complementarity vis-à-vis startups. Early collaboration focused around establishing that the startup presents opportunity rather than threat to the incumbent provides important insights for both parties. The second mechanism involves leveraging the incumbent’s key customers to validate the startup’s value. When the incumbent’s key customers provide an unsolicited endorsement to a startup, it often serves as a strong signal attesting to the startup’s quality. Third and finally, relying on executive champions to sponsor and “evangelize” the acquisition is an important mechanism for aligning expectations at both the incumbent and the startup prior to the acquisition, and taking managerial responsibility and providing executive support to the startup during the PMI stage. The prevalence of these mechanisms across many of the studied cases led us to coin the phrase, “3 Cs of pre-acquisition co-specialization.”
This study bears several important points for practitioners. First, many of the interviewees did not expect interaction with incumbents to bear such significance for the startup’s strategy and development trajectory. Second, even former employees of incumbents benefit from further interaction with incumbents—for instance, because they were unable to recognize from within in which areas the incumbent may be open for outside innovation and in which cases not. Third, even those startups that aspired to be acquired had better developed the necessary downstream capabilities to be able to provide incumbents with a credible signal of their quality—that is, by enjoying unsolicited referrals by some of their customers, which are also key customers of the incumbent. Fourth, successful startups that sought an acquirer refrained from making their interest explicit, instead disguising their interest as a business collaborating initiative. Finally, the studied incumbents held a “configurational” approach involving clear acquisition categories 36 and internal guidelines on the range of reasonable prices to pay for acquisitions in each category.
In sum, collaboration between startups and incumbents can create value long before the acquisition occurs, and it can also reveal the stages through which a collaboration process unfolds. The market for M&As between incumbents and technology startups can be of a collaborative nature—not only during the deal process itself but also from the startup’s inception through the PMI. The combinative value created from this collaborative process benefited startups and incumbents alike.
Footnotes
Acknowledgements
We wish to thank the Editors and anonymous reviewers for their constructive feedback and helpful comments.
Funding
We acknowledge the financial support of INSEAD and The Henry Crown Institute of Business Research in Israel at Tel Aviv University. The first author acknowledges that part of this work was done during his affiliation with INSEAD.
Notes
Author Biographies
Nir N. Brueller is a visiting scholar at Tel Aviv University’s Coller School of Management (email:
Laurence Capron is Professor of Strategy at INSEAD (email: