News & Analysis

Adobe's planned acquisition of Figma for $20 billion brought a jolt of excitement to an otherwise somber VC landscape shaken by the slump in technology stocks.

The design tool developer originally had its eyes set on going public. But in a drought year for tech IPOs, a sale to a strategic acquirer for double the $10 billion valuation Figma fetched just 15 months earlier proved too enticing to pass up.

The deal is one for the record books—the largest price for a VC-backed company at the time of the agreement, as well as reportedly the highest revenue multiple ever paid for a late-stage software firm and one of the biggest retention packages offered to a management team. Still, being bought by Adobe wasn't co-founder and CEO Dylan Field's ultimate goal.

While few startups can dream of a comparable outcome in today's environment, exiting via an acquisition could quickly become a reasonable, albeit not ideal, option for many late-stage VC-backed companies.
 

This article appeared as part of The Weekend Pitch newsletter. Subscribe to the newsletter here.

In many ways, this market environment is what corporate M&A groups have been waiting for.

Despite having plenty of cash on their balance sheets, public tech companies' success at scooping up late-stage startups has been relatively rare in recent years. That's not for lack of interest.

Many corporations have long had a wish list of private companies to buy, but—disciplined by nature and beholden to their shareholders—they couldn't match the public markets or enthusiastic private investors when it came to the price they were willing to pay.

What's more, if a startup was open to selling, corporations were outbid by private equity buyers so often that they barely participated in sale auctions in the latter half of 2020 and 2021, according to a software investment banker.

But now, with the climbing cost of debt financing, PE firms are pumping the brakes on their buyout activity.

This environment provides an opening for corporates to start exploring potential acquisitions. Indeed, there is an increase in interest from strategic acquirers, the banker said.

But whether the initial overtures result in deals is still very much uncertain. The price disconnect between what buyers would pay and what sellers would accept seemed to be narrowing at the end of the summer.

Since then, the Federal Reserve has doubled down on an aggressive interest rate hike plan, sending the stock market lower. As a result, about a dozen potential M&A deals have been put on hold, according to the banker.

That context, of course, makes Figma's record-setting acquisition an even greater outlier.

Unlike Adobe, which paid top dollar to take over what many called an existential threat to its core business, most corporates in this environment would only be willing to purchase venture-backed companies at a discount to their last valuation. While VCs have been advising their weakest portfolio companies to look for a home at a larger business if they don't want to go belly up, most other startups are hoping their cash runway will buy them enough time to catch up to their last price.

The gap in valuation expectations is holding back M&A activity. So far in Q3, 173 acquisitions of VC-backed companies were announced or closed, on track to be the lowest quarterly deal count since 2015, according to PitchBook data.

This week, SPAC magnate Chamath Palihapitiya opted to unwind two blank-check vehicles, citing the mismatch of pricing expectations between buyers and sellers as a primary reason. "It's hard to find good risk/reward in tech right now, because there's been no broad-based agreement among private tech companies to re-mark assets," he told Axios.

For now, 2021 valuations are still fresh in people's minds. But the economy will suffer as a result of tight monetary policy, leading to a slowdown in growth rates. Under those circumstances, startups will be hard-pressed to hang on to last year's valuations.

Bankers and venture capitalists are predicting that significant M&A deals will start taking place next year, but how many sizable transactions materialize depends largely on the state of the public markets. The longer the IPO window stays closed, the more likely it is that large startups would be open to being bought.

While it may take years to evaluate whether Adobe overpaid for Figma, other corporations may soon have a chance to pick up their favorite startups at more reasonable price tags. For their part, startups would do well to accept the market reality that 2021's prices are not coming back anytime soon and consider striking a deal before the full impact of fiscal tightening becomes evident.

Featured image by Drew Sanders/PitchBook News