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As competition for talent grows, startups are often bought just to get their employees

The Israeli startup CyberCubes was founded in 2016 by three entrepreneurs with an idea for protecting PCs used by large organizations. In March 2018, when the company was less than two years old, it was bought by Palo Alto Networks of the U.S. for an unknown amount and without the fanfare of a press release. CyberCubes’ employees, at least some of them, were given senior positions at Palo Alto Networks.

Why wasn’t there a formal announcement?

Because the company’s purchase was what’s known as an acqui-hire, when a company is bought mainly for the skills and expertise of its employees, rather than its products, services or technologies. It’s a kind of head-hunting where the new employer writes a check, albeit a moderately sized one, by the standards of high-tech exits.

Acqui-hiring has been practiced in Israel for quite some time, but it rarely makes the headlines. In many cases the startup was bought while still in stealth mode – its activities, or even its existence, were not publicized. In addition, the sums involved are relatively small.

How often do these acqui-hires happen?

According to the 2018 PwC Israel Exit Report, there were 52 mergers that year, nine of them valued at less than $10 million and another 24 between $10 million and $50 million. That’s a wide range of valuations, but it does show than more than half of all exits were small ones.

We are now in a period of stiff competition among startups for skilled personnel. As a result, companies are prepared to buy ready-made teams through acqui-hires whose contractual terms require the team to stay together for a predetermined period of time. The buyer gets a cohesive team with a track record of collaborative work.

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Another source of acqui-hires is big multinationals seeking a “turnkey” research and development center in Israel. Hiring scores of people is a difficult, lengthy process; the alternative is to buy a local startup, change the name on the front door and get to work.

One way to tell whether an exit was really an acqui-hire is to look at the money-employee ratio, says one consultant in the market. “Divide the [buyer’s] money by the number of employees. If it’s around $1 million, it’s an acqui-hire,” he explains.

It’s a little more complicated than that: A startup’s value depends not only on the team, but also on its technology and intellectual property. From the outside, it’s impossible to know the weighting of each factor in the startup’s total valuation in an exit.

Mike Rimon, a partner in the Meitar law firm, which publishes its own exit report with IVC Research Center, said it was hard to identify acqui-hire exits.

“When it is an acqui-hire and when it is just the purchase of a young company? Is the deal being done mainly for the workforce or is there also an IP element? There’s no exact data and often the deals aren’t even announced,” he said. “It’s hard for us to say there’s been a flood of them – it’s sporadic.”

He added: “Last summer AppLovin bought SafeDK of Israel and in 2015 Facebook bought Pebbles Interfaces in classic acqui-hire deals. Pebbles had raised $17 million and was bought for $19.5 million, a sum that returned the original investment and a little on top of that. There were 30 employees. Half were let go, half got on a plane to join Facebook.”

Media reports at the time valued the Pebble deal at $60 million.

The acknowledged champion of the acqui-hire game is Israeli cybersecurity company Check Point Software Technologies. In January 2019, it bought the Israeli startup ForceNock for $10 million, or about $3.5 million for each of its three founders. In November it bought Cymplify, an eight-month-old startup, for $5 million.

In December, Check Point acquired Protego Labs for $40 million, a much bigger amount than the other two acquisitions. Was that also an acqui-hire?

Alon Elie, Check Point’s vice president for corporate and business development, said the answer was no for all the acquisitions.

“The two small deals, ForceNock and Cymplify, were technology acquisitions from our perspective. They had developed a product that fit into our product road map and would have taken a year to develop on our own, if we succeeded at all. In both cases, we examined the product before we bought it and that was the basis for the valuation,” said Elie.

His definition of acqui-hire is narrower than that of many other people. “In our view, an acqui-hire is when the [company’s] product isn’t at all interesting. It’s a chance to acquire a strong team without paying any premium for the product itself.”

That said, at least some of the Check Point acquisitions contained mechanisms for retaining the staff of the acquired company.

Said one entrepreneur who was the seller in an acqui-hire deal: “When you form a company, you usually have a valuation in your head. If you think the company is worth $1 million, you’re pricing your expectations for the business against the risks. If tomorrow someone comes and offers you $2 million, he is valuing it at the risk-reward you saw. So you face a dilemma about what to do. In high-tech, this is almost always the dynamic – there is someone who likes risk and someone who doesn’t.”

Acqui-hire deals are not always stories of easy and rapid success. In many cases, the companies that are acquired are coming to the end of the line and are ripe for being acquired cheaply.

“We’ve actually seen fewer acqui-hires in the last few years; it was more common in 2014-15,” said one high-tech lawyer, who asked not to be named. “But since then it has become a lot easier for a company to raise capital, we’re seeing a lot fewer deals like that.” He said that in the last two quarters, he has seen an increase again.

Earlier this month was one such example: Sckipio, which had raised $50 million since it was formed in 2012, had run into trouble. Development of its G.fast technology used to speed internet traffic on copper cables was behind schedule and might never see the light of day. On the other hand, its staff included chip developers, who are in high demand in the job market. The company agreed to transfer 25 of its employees, two-thirds of its total payroll, to the French company Sequans Communications. The financial terms weren’t disclosed but the deal certainly saved Sckipio’s investors some of their losses.

“You have to remember that for every unicorn [a startup worth more than $1 billion] there are those that are less successful,” said a source who was involved in the deal but asked to speak without attribution. “In this instance, the employees understood their value in the job market and there was a shared interest to do an acqui-hire in which employees moved as a bloc to a new place of employment with very good prospects.”

One attorney specializing in high-tech attributes the acqui-hire phenomenon to the maturing of the Israeli startup sector. Most funding these days is done by a small number of companies looking for later-stage capital for growth.

“So what happens to companies that raised money in a seed or A round and can’t raise any more capital? The crisis comes after five or seven years when they’ve developed a sophisticated product that the market isn’t sold on. So, they look for the fastest way to do a deal before they have to close down – and that’s when they do acqui-hire,” said the lawyer, who spoke on condition of anonymity.

“The deal gives them back the money they invested until now and the team gets to continue working together and gets good compensation terms from the acquiring company,” he explained. “The line between a fire sale and an acqui-hire is very fine. The idea is, ‘Just before the liquidator arrives, let’s makes ourselves liquid.”