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Post LinkedIn, is there a wave of tech M&A deals coming?

By Kevin Kelleher , written on June 23, 2016

From The Money Desk

Finally, some good news for capital-hungry startups.

In the wake of Microsoft's $26.2 billion purchase of LinkedIn, there's likely to be a wave of tech M&A deals coming. There's also some bad news: There's likely to be a wave of tech M&A deals coming.

It's not just that acquired companies typically lose their hard-earned independence. It's more that, as often as not, M&A deals don't work out for either party. For every exception like a YouTube, an Instagram or a Booking.com, there are multiple deals that led to a promising innovations being smothered and eventually sunsetted inside a bigger company, or a popular service that fails to generate meaningful revenue, or a clash of corporate cultures that prompts an exodus of talent, or a years-long integration process that finishes only after the Internet has moved on to the next growth niche, or a – you get the idea.

And yet the M&A is starting to be seen as the exit of choice, if for no other reason than there seems to be no other choice left for many startups. Financing growth through cash generated by operations works for those that can pull it off, but some are struggling to contain cash wildfires. The IPO market, meanwhile, has its own challenges for those managing a growing company – the quarterly earnings circus, complex compliance processes, an uncertain outlook for stocks – beyond the fact that many tech IPOs in recent years have themselves fallen out of favor among public investors.

There is a sliver of hope that could change. On Wednesday, Twilio priced its IPO at $15 a share, above the $12 a share to $14 a share range it had initially proposed. That's good news for Twilio as it could raise $150 million in the offering, but it's also encouraging for other companies that may be considering an IPO because it suggests a growing appetite for well-run IPOs. Not a ravenous appetite, mind you. As we've said, a successful launch for Twilio won't have a major impact, but it could bring some much needed rain to the recent IPO drought.

Of course, a swoon in stock prices would cause the IPO market to dry up again. But it could also push the valuations of technology stocks down further, making them and their private peers more attractive to big companies with billions in cash and with access to low-interest loans. As Bloomberg noted this week, companies like Alphabet and Facebook have been quiet on the M&A front in the past couple of years as valuations rose. But the correction in many startup valuations over the past nine months has them considering deals again.

And that brings to mind a distinction between IPOs and M&As. Outside of a mania like the dot-com bubble, the pace tech IPOs quicken or slow according to the market appetite. Tech M&A's can take on a greater feeling of uncertainty, much like a game of musical chairs, as companies with their eye on desired targets are loathe to be beaten out by a rival. This can lead to bidding wars, as well as bold moves to move before a bidding war can take place. In 2010, Dell and HP entered a bidding war over 3Par, which soon led to a broader buying of storage startups.

Beyond lower valuations for many small and mid-sized tech companies, there are other pieces that have fallen into place to set up a rise in M&A activity. There are those mounting piles of corporate cash, mostly languishing overseas in hopes that a new administration will allow money to be repatriated to the US at a lower tax rate. Until then, there are loans to be taken at attractively low interest rates, not to mention tax deductions to be taken on the loan interest. Microsoft paid for the bulk of its LinkedIn purchase with new debt.

There is also a new willingness – if not a growing restlessness – among VCs to explore buyouts of their portfolio companies, especially now that big tech is drawn to the lower valuations. And not just tech. Health-care, automobile and other industries that are seeing software change their businesses could also become buyers of tech startups. Last week, Marc Andreessen said at a tech conference that “we see more deals in consideration or negotiation than we have in probably four years.”

Raising money in the private markets is also growing trickier. Beyond the reports of companies facing down rounds, or delaying new rounds to avoid that fate, some of the more celebrated unicorns are growing more creative about raising capital. Uber raised the largest ever investment in a private company this month, but had to turn to acontroversial sovereign fund to seal it. Two weeks later, it was seeking $2 billion in leveraged loans to raise more money. Airbnb, another IPO-averse company, is also raising $1 billion in debt.

Lower valuations, tighter markets for private fundraising, exit-seeking investors, a still tepid IPO market. All of this is so much kindling beneath what could be a M&A fire that could burn brightly for months. Expectations are rising among startups and investors for such a scenario. The only thing missing has been a few bright sparks to get things blazing. The Microsoft-LinkedIn deal was one such spark. More are likely to follow in the hot summer months.