Abdullah Alzamil

Managing Partner

Abdulaziz Almajed

Trainee Associate

A Guide to Startup Mergers – What is it and How to Proceed?

Published on
January 2, 2023
Updated on
January 2, 2023
Read time
7 min read

Getting snapped up by or absorbed into a larger entity validates the company’s growth path and allows them to do better work on a more extensive playground. But what happens when the merger is between startups?

Startups, by definition, are typically still feeling their way into their industry. While some will be further along in their vision and execution than others, their very recognition as startups presupposes that they are still in the planning stage.

Despite this, a startup merger can be an excellent idea for various reasons. A startup's merger is well worth considering for counterparts looking to accelerate their growth, surveying alternative ways to scale, or simply exploring how to craft a better MVP.

Photo by Pixabay
Why are Merging Startups So Rare?
  • Urge to grow: Every startup results from a vision that drives the founders and early development team. While that vision is still young, there is an urge to build up that vision than exit or merge with another fledgling vision.
  • Attraction of Venture Capitalist and Angel Investors: Apart from the validation and funding that a capital raise brings, Venture Capitalists and Angel Investors typically come in with advisory expertise. Securing the funding and expertise they need without diluting their vision will be attractive to certain startups.
  • Valuation and stock: With two early or mid-stage companies without much of an established market or product, equity and valuation figures will likely be all over. Also, because both companies must agree on each other’s valuation, the process can become even more complicated very quickly.
When is a Startup Merger a Viable Idea?
  • Complementary assets and skills: There is no better reason for a merger between startups than this. For instance, a merger between a tech startup with robust technology but little in the way of a market or an MVP with another can bring a growing demand and product structure that will benefit both parties.
  • Aligned visions: Both startups must be on contiguous or complementary pathways. It doesn’t make a lot of sense for the startups to merge and then start pulling in opposite directions soon after (or ever).
  • Natural fit: Both companies need to have a natural fit in culture, talent, organization, procedures etc. The more obstacles there are to melding both companies into a complete whole, the less likelihood that a successful merger will result.
  • Willingness to see it through: Even where all the figures and projections are right, If the founders are not all in, then a merger is terrible.
What a Startup Merger Can Bring In?
  • New competencies and resources: A shrewdly planned merger can save both companies years of research and development, bringing assets, skills, competencies, and resources that would have been unavailable to both parties without serious investment.
  • Speedy growth strategy: A merger can immediately add to the value and size of the merging companies.
  • New markets and products: A well-planned merger can bring access to new markets that would have required expensive market research to enter.
  • Larger market share: A merger can quickly add to the combined market share of both companies, giving them PR that neither would have otherwise.
  • Look after your customers: Lastly, the right merger can let a company leave its customer in good hands with access to better products.
Photo by Pixabay
What Are the Drawbacks of Startup Merger?
  • Complex and expensive: The average merger process takes months, and some can take over a year. Be sure that the time and resources needed will be available before even starting.
  • Disruption of structure: No matter how well-planned a merger is, it will still bring challenges with integrating teams, procedures, culture, and more.
  • Costly distraction: Mergers can be time-consuming and distracting, especially without a dedicated M&A team. Founders that choose to run the gamut by themselves risk losing focus on day-to-day operations, which can be damaging.
  • Unpredictable outcome: A merger can turn out awry for both parties, even with the best of preparation and intentions. The merging parties may miss critical issues that can lead to big problems later.
Achieving a Successful Startup Merger
  • Attentively structuring the deal: How you structure a startup merger depends on the companies' value and how they wish to proceed.
  • Consider finances and sales figures: Valuation will likely be a sticky point for all parties, especially if both are early to mid-stage. Factors in the funding rounds that the companies have raised, asset values (including IP), and intangible advantages such as market reach or goodwill should all be considered meticulously.
  • Stakeholders on board: Although the decision to sanction a merger primarily rests with the founders/owners, it is vital to carry critical stakeholders along, for instance key clients, talents, etc.
  • Competently drafting contractual documents: Depending on the merger structure, you should invest heavily in the drafting of contractual documents (including primary documents such as: exclusivity agreements, NDAs, etc.), which must efficiently reflect the structuring of the merger.
  • Clarify ownership and transition of intellectual property: Intellectual property - comprising products, client lists, processes, etc. - will be amongst the most valuable assets that the merging startups bring to the deal. Ensure that the ownership of these assets is clearly identified and protected.
  • Due diligence on pending or anticipated legal disputes: Although disputes are a fact of business, there may be a tendency to ignore or downplay their significance with a merger in view. That would be potentially problematic. Conduct due diligence to uncover these disputes early in the process so they can be properly assessed, and their significance mapped.
  • Discovery and assessment of contracts: Discovering contracts and agreements arms the merging parties with sufficient notice about the obligations they are potentially taking up. Depending on what the contracts disclose, the parties can better decide whether to proceed with the merger or not.
  • Orderly transition of contracts: The parties must also provide for the transition of contractual obligations from the merging entities to the resulting entity. This helps ensure continuity of contracts and goals a long way to protect the interests of the clients and strategic partners of both merging entities.
  • Clear management structure: With a merger, both companies bring founders with a significant attachment to their company, who are also accustomed to leading. Without a precise arrangement on their role within the merger, the companies might have a potential power struggle.
Startup Merger: Regulatory and Compliance Matters in Saudi Arabia

Quite a few laws and regulations must be closely observed for a felicitous merger, most notably:

  • Companies Law and Regulations: It's a clear as day. Companies' Law and regulations, and particularly merger provisions, are the main course to be taken.
  • Labor Law and Regulations: Labor Law and regulations play a significant role in the merger process as to many matters, e.g., change in the legal status of the employee and the employer and its effects.
  • Tax Law and Regulations: When there is a foreign investor with the parties aiming to merge and based upon the structure of the deal, Tax Law and regulations will be mostly invoked.
  • Foreign Investment Law and Regulations: In matters in which a foreign investor is present, the rules and restrictions set out in the Foreign Investment Law and regulations must be observed, whether regarding the activities in which the foreign investor may invest, capital requirements, or otherwise.
  • Competition and Monopolistic Law and Regulations: Although you might think that the Competition Law and regulations is irrelevant as this is a startup merger who are mostly early or mid-stage companies, this may be true in some cases. However, this is not the case in other cases whereas factors such as dominant market position and economic concentration are at play.
  • Sector-Specific Regulations: Perhaps the parties to the merger are operating within a regulated sector that regulates mergers further, then it is indispensable to be alert to the requirements, restrictions, and needed approvals.

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