Investment Banking's Unbundling triggered by SAAS & Startup M&As?

"Disruption" by Technology is often synonymous with "Democratization" by Technology. In a large part- this has to do with the elimination of middlemen.

Whether it's in vanilla businesses of Real Estate Rental or the complex multi-stakeholder industry of Stock Markets, the elimination of middlemen has been a big trend in businesses that went digital in any measure.

Some of the highest amounts of value-extraction and value-creation has been happening in the middlemen-run industry of Mergers & Acquisitions.

However, some interesting developments happening in our world that are slowly unbundling the M&A industry; niche by niche, tool by tool. Here are some of them-

The digital world becoming more Intangible, leaving old Accounting obsolete.

In 2011, Mark Andreessen might've been late in declaring "Software is eating the world", but he wasn't wrong. It USED TO BE the case that most company's value stemmed from their finished products, coming out of the assembly lines of their plants/properties. Now- Software, IPs, data etc., make the bulk of our world's enterprise value. There's a great article explaining this phenomenon written by Tanay Jaipuria which should be read to understand this more deeply.

Quoting an example from Tanay's article to convey this observation-

"Suppose an Old Company has spent $10 million in a plant with machinery that's expected to have a useful life of 10 years, and so it depreciates the value of the factory by $1M each year. ?So in year 1, the impact on earnings of this investment is $1M expense, and $9M sits on the balance sheet.

On the other hand- there's a New Company which has spent $10 million in R&D to create software. This software will continue to be useful in the future, but per GAAP accounting, it will expense all of the $10M this year. So in year 1, the impact on earnings of this investment is a $10M expense, and the balance sheet reflects nothing. In addition, let’s say they spend $10M to acquire recurring revenue customers. They will earn revenue from these customers for many years in the future, but many of the costs are expensed immediately. In addition, their customer base has grown which will lead to recurring revenue in the future that doesn’t show up on their balance sheet."

"Two things stand out from this example:

1. Earnings can basically become meaningless when companies are investing in growth.?Companies are being penalized in that their expenses are not being matched to the revenues. While they will continue to earn revenue from a software or a customer in the future, the expense is the cost to build it or acquire that customer immediately. This artificially?deflates earnings.
2. The balance sheet isn’t really reflecting all the assets that a company has built up?and so can also be somewhat meaningless because many key intangible assets that result in the creation of these intangible assets are not showing up on it."

So to summarize, we see how old accounting seems to be not doing a lot of justice to the intangible world.

Visa's recent NFT purchase move

Visa's NFT move (buying a CryptoPunk for $150,000 ) is bringing a paradigm shift by turning the "sunk costs" of marketing into an "asset on balance sheet". By buying a CryptoPunk, Visa has effectively taken a red line item on the Income Statement, and turned it into a possible profit centre.

Read it again. The implications of this are so massive, I think it's severely underrated. We're not even talking about the market cap bump that VISA received. This is yet another move of our world- towards intangibles!

Apple's per engineer valuation method for doing M&A- quiet Acquihiring.

One would expect that a cash-loaded big corporation like Apple would have bulge bracket Investment Banks carry out M&As for them. Doesn't seem like the case. In fact, Apple is buying a lot of smaller startups while others (in Big-Tech) spend more on established players. Apple had bought about 100 companies in the past six years, which means they buy a company every 3-4 weeks. This makes it look like a deal-making machine, but only a handful of those deals have been large transactions like the $3 billion deal for headphone maker Beats Music in 2014. The vast majority have been for significantly smaller companies without a major public presence.

According to a CNBC article- Apple follows an "acquihire" strategy where it focuses on getting talented technical staff from smaller companies to speed expansion in fields where it needs technical talent or it sees a specific technology that could set it apart from its rivals. Apple values these acquired companies in terms of the number of engineers working there, and quickly and quietly (low-key & unannounced) integrating them into teams at Apple.

"For smaller deals, Apple doesn’t typically deploy bankers. Apple’s M&A team does due diligence, interviews team members and keeps the transaction on track to close. One person who declined to be named because of NDAs said that Apple’s team was unusually trustworthy and professional compared to other companies he had engaged in talks with, although they knew what they wanted to pay for the company when the process started, he said" ~ CNBC article.

Marketplaces like Microacquire doing it for startups.

SaaS has always been a niche where bootstrapped startups have made it big. Certainly in terms of liquidation events. However, such liquidation events were/are hard to come by. By the time liquidation opportunities arrive for the scaled VC funded startups- the founders are already so diluted (most of the time) that it ceases to be as life-changing an event as it would've been if they were bootstrapped.

This is slowly changing. Andrew Gazdecki - a founder who had two exits with his previous startups (one of which was bootstrapped) is now trying to bring liquidity to SaaS bootstrappers with his new venture- MicroAcquire. It's a SaaS startup acquisition marketplace backed by some (almost all) of the most active Silicon Valley personalities-

Microacquire has already seen some successful acquisitions take place in its marketplace and continues to add rich features to facilitate more such events. Some of the noteworthy features being-

1. M&A bankers as free agents on the marketplace for hire (almost/just like deal-specific freelancers). Wouldn't be surprised if this feature alone turns out to be a "Substack - but for M&A bankers"!
2. Revenue Financing and Acquisition Financing options. Microacquire has partnered with other companies like Pipe (a company that operates on a tradable Annual Recurring Revenue model) and Capchase (a company that allows startups to grow with a non-dilutive growth capital).
3. A 30 day time period for sellers and buyers to complete the transaction. Almost like what Opendoor does in the Real Estate marketplace.
4. Want to measure up yourself? Microacquire offers a SAAS Valuation Calculator. While arriving at or justifying a valuation by third party M&A advisory is important in any transaction... tools like this calculator are actually the beginning of middlemen-replacement.

A16Z setting up its own Stock Exchange - Long Term Stock Exchange (portfolio company).

The frustration with the public market’s focus on near-term profit led the nation's tech elite to launch the Long-Term Stock Exchange (LTSE). Backed by prolific silicon valley executives and investors like Mark Andresseen and run by Eric Ries, LTSE focuses on the distribution of voting rights based on the gestation, vesting and ownership schedules of its companies shares. The idea is to give more ownership/power (in terms of voting rights) to people who have the "company's best interest in their heart" because of being larger and longer-term shareholders who are focused on future growth over a longer horizon.

"The exchange has five listing standards companies have to adhere to and that they have to create policies around:

1. A long-term strategy, with metrics that measure progress towards meeting those goals.
2. A stakeholder engagement plan for the community, employees and the environment, along with a diversity and inclusion plan.
3. A blueprint for engaging with long-term investors.
4. Board oversight responsibility for long-term strategy.
5. Executive and board-level compensation that is tied to that strategy." ~ Link

In the absence of definitive long-term data, we're not even discussing alternative routes of going public like SPACs or Direct-Listing and their effects on this larger unbundling trend. Also omitted is the role of Fintech services aiding this trend.

However, as this article's heading suggests- these are just some segments of the VAST Investment Banking industry that are being unbundled. It will take a long time to unbundle the industry completely. Maybe it never even happens and the industry reinvents itself. Irrespective, these are definitive trends that trigger what could be seen as the "Unbundling of Investment Banking".

Many SAAS products started out unbundling MS Excel features and continue to see growth for their services...but their rise didn't come at the cost of MS Excel's departure or decline. Investment Banking's fate might just end up like its favourite software! :)

#SAAS #InvestmentBanking #Unbundling #Banking #Startups #Mergers&Acquisitions