'Reverse acquihires are incredibly dangerous': Tech lawyer Mike Turner

0:00Hello and welcome to The Sifted Podcast, the show where we help you get to know the brightest and boldest people and companies in Europe. startup ecosystem. I'm Amy, Sifted's editor and your host. And today for a special episode ahead of the Sifted Summit, I'm joined by Mike Turner, partner at law firm Latham & Watkins, the headline sponsor for the Sifted Summit, our two-day event in early October where the best founders, operators and investors in Europe congregate under one roof in London. Mike and his team have a bird's-eye view of everything going on in Europe's startup ecosystem. As lawyers, of course, they're always very careful not to name names to the great disappointment of a journalist, but they know which were the hottest deals, which sectors are on the up and which are on the down, which VCs play nice and which don't, and which companies might be looking to snap up others, as we talk about today.

0:48So Mike, thank you so much for joining me on the pod. Great to be here, Emi. What has been keeping you busy this summer? Gosh, if I didn't start with AI 1, 2 and 3, you'd be very surprised. right across Europe from Gen.ai to AI applications, also representing a lot of European and Middle Eastern investors, US AI opportunities as well. If you put that on one side, and that's probably 50 % of what we've been doing, if I'm being truthful. I think defense tech has been the other big one for us. It's been a very vibrant market, as I know you know from your own reporting, right across Europe. and a lot of not only specific defence tech investors, funds which are dedicated to defence tech coming on the scene, but also a lot of the more generic investors are now starting to add defence tech companies to their portfolios.

1:49And what are some of the crazy things you've been seeing when it comes to either AI or defence? There's a lot of FOMO going on at the moment, isn't there? There is a lot of FOMO going on. And what does FOMO mean? It means that the investors are being pressured into really hurrying their investment decisions because there is so much competition to get into around. So what it means is the companies have the negotiating strength. They are delivering in our world. They're delivering up or we are delivering up if we're representing the company. We're delivering up the documents and they're virtually sign here material.

2:25There's not much negotiation over key deal terms that's going on because investors know that somebody else may accept something they're not going to accept and then get into the round. So it's the classic stuff. We've seen it over the years. We're now seeing it a huge amount in AI. Yeah, I think the big difference in AI to anything I've seen historically is that companies are able to raise money, serious amounts of money, with very few employees. So we're really very much pre-product, pre-proof of product. It's a much, much earlier stage bed. And what are you seeing in terms of term sheets? What's the record number of term sheets you've seen an AI company get offered?

3:14Great question. I think, I can't think immediately in terms of sort of a record number. I've seen, if we're investor side, obviously you don't get to see the other term sheets, but you do get to hear a lot of noise about there being a lot of other term sheets out there. If we're company side, actually the companies are much more educated. The founders are way more educated than they have been historically about who they want to attract money from. And I think that's the big change. It's not necessarily that there are a huge number of investors coming to the table, but there's just a limited number of investors who the company might want, but a limited number competing very vigorously with each other.

3:57And what tends to help an investor win? Is it brand name? Is it the valuation? their offering or are there other kind of terms at play that help an investor be the one that leads the deal? Again, I think founders have slightly changed their narrative now and it used to be very much about where the money was coming from geographically. So we had a very intense period in Europe where European tech companies thought they needed to raise capital from North America, I think that has changed dramatically now. And I think it's the quality of the capital that is counting much more. Clearly, valuation is important.

4:39But we've seen a number of situations where the founders have not accepted the highest value term sheets. I think it is really about that old-fashioned thing about what the investor can do to help grow the company's business. And to that end, we're seeing significantly more corporate investors, now corporate venture capital investors who can really add a huge amount of potential value either as a customer or as a development partner to the company in which they're looking to invest. Interesting. And you're seeing the mix of investors that are active change in other ways. Are sovereign wealth funds more involved, family offices?

5:19What about the geographical mix? What does that look like at the moment? So let's start with the geographical mix first. I think that it's fair to say that the mix has really broken down now so that you're seeing investors from all over the world, investing in companies all over the world. So some of the straight jacket constraints they put on themselves in terms of we only invest in countries X or Y or sectors that A or B or C, that has changed and broken down. So I think you're seeing much more fluidity in the operations of investors. I think where they're coming from thematically, The sovereign wealth funds are probably the biggest change that I've seen in the market in the last 12 to 18 months.

6:05Significant amounts of capital to be deployed, significant interest in lots of emerging technologies, and the ability to deploy globally from the get-go. So probably the Middle Eastern sovereign wealth funds are the ones who've jumped off the page as they're looking to transform their own economies. But then we have some interesting dynamics at play here, don't we? There was recently a funding round into the UK semiconductor startup paragraph almost fell through because it got held up by the Times reported six months by checks for the UK's National Security and Investment Act because the Middle Eastern sovereign wealth fund Mubadala was investing.

6:44Do you think we're going to see more of this, more European governments sort of get involved when a company's either taking a significant check from a sovereign wealth fund or potentially going to get acquired by a foreign company? Yes, I think that's undoubtedly the case. And I think it is a challenge for a lot of governments to understand the dynamics of the sovereign wealth funds, what it is they're trying to achieve, how they're going to behave and so on. The whole world has got its eyes on the US and their approach to CFIUS, which is the US foreign direct investment rules. So whenever an investor from outside the US is investing in a business which has a large element of its property in the US, that's when CFIUS comes into play.

7:32And the government will look at that and say, is this investor approved from our perspective? Which again is much more focused now than it ever has been. So for us, whenever we're looking at any transaction now, the whole subject of FDI, foreign direct investment, is pretty important. Because if you had a UK headquartered startup, it could have operations in two or three other countries, all of which can be relevant to the discussion. Sometimes you can find that the smallest operation in the smallest country, you can hold up the entire project. So we think it's very important for that focus to be there very early on in the transaction to prevent the kind of delays you're talking about.

8:17Are you seeing more deals get held up as a result of these kind of checks? Yes. And it's more and more commonplace as the check sizes are getting bigger as well. They're getting more attention. It's a geopolitical subject and governments are interested, of course. And do you think investors and founders, have they sort of wised up to this or is it a bit of an evolving picture? I mean, you know, we heard about this company, Powergraph, it, you know, almost ran out of runway because it was reliant on this deal getting done and it was six months later than they expected. Are you seeing other companies maybe factor that in a bit more?

8:55Is it still a bit early? I think they are factoring that in. They are much more aware of it. But it goes back to something I said earlier about what it is that the investors are bringing to the table beyond their checks. Because if there is an opportunity being discussed for a commercial partnership in, let's say, the jurisdiction where that investor comes from in the Middle East, then that's going to get much more attention, I think, because it is far more than just the pure investment. It's actually more of a joint venture. And that's why I think the governments are becoming more interested.

9:32Interesting. What about VCs? What are they kind of worrying about at the moment? What else is going on in the market that's perturbed them? The VC behaviour has traditionally been to look back on what's happened in the last two to three years and try to learn from it. And so I think what we are seeing from the earlier stage, VCs, is a lot more focus, I think, on the founder relationship. Venture capital used to be unequivocally the right type of investor investing in a founder, an idea, an opportunity. They were backing a founder. Today, I think they are more focused on the question of what could go wrong with that relationship because they've had the experience over the last few years of it having gone wrong on occasion.

10:23Or the founder may be being brilliant at his or her job at the early stages of the company, but needing to be moved into a different role and more professional C-level expertise being brought in. So I think there's more thought being given to how to remove a founder, how to encourage and incentivize founders maybe slightly differently to how they have been incentivized in the past, perhaps not allowing a founder to take too much secondary off the table too early, but allowing the founder to take some secondary off the table because they don't want them to be pressured into pushing to exit the company too early.

10:57So there's definitely a lot of focus on the founder relationship. What does that look like in practice? What kind of structures are in place or vesting arrangements that maybe mean that investors can maybe have a bit more flexibility when they might want to remove a founder and how they would go about doing that. Founder vesting, which is where a founder has restrictions on his ability or her ability to enjoy their shares for a period of time, is really there to encourage a founder to stay. We're seeing the founder vesting term, founders being asked to revest at Series B, where the vesting might have fallen away post Series A.

11:41So we're seeing that a little bit. We're also seeing more private equity style provisions being brought into investment documents to allow investors to remove a founder or to change a founder's role based on a particular voting threshold, or a particular set of circumstances perhaps. You know, the company hasn't delivered against certain milestones or whatever it happens to be. Or a board decision if the board is constructed in the right way. So we're seeing far more of that, whereas historically I think founders have been fairly untouchable. Yeah, and we saw recently that N26 co-CEO and founder Valentin Stauf got ousted after what seems behind the scenes to have been quite a lengthy battle to boot him out.

12:26Are you seeing that happen more and more CEO founders getting edged out at the moment or has it always been the case? No, it hasn't always been the case. It's interesting. We're definitely seeing more conversation around that. More conversation around actually this company has not grown into the value that we invested at. Therefore, what are the reasons for that? Do we have the right senior leadership team? Do we need to do something about it? What do founders make of that? If we're advising a founder, I would say, look, don't be scared of that. Be alive to it. You know, the other big learning from the last few years is that there have unquestionably been some terrific private company founders who struggled hugely in the public company world.

13:14And the SPAC and the de-SPAC situation that we lived through was very much a cause of that, where everyone was just going up and to the right, not even thinking really about changing the executive team at the company, going from a private to a public situation. So I think now founders are getting much smarter about realising their own ambitions and their own abilities, and perhaps themselves volunteering to move sideways or into a different role within the company at an early enough stage where that can all be worked out properly with the investors. And I guess we're probably still seeing some of the fallout, aren't we, from the post-COVID hype where companies were raising these kind of crazy valuations with crazy expectations.

14:01And so inevitably, a lot of founder CEOs aren't going to have been able to meet them, are they? No, and none of us should be surprised. I think it is so obvious that a terrific founder of a startup is probably able to grow that startup through a particular stage of its life, but then needs help, clearly needs help and may well be better off. You know, they could be a terrific people person or they could be the exact opposite. And at some point that's going to become really relevant to the ability to grow the company or not. Where are you seeing a big decrease in investment activity over the past 12 months?

14:43What is no longer hot? I think the easiest one to call out, and this won't be any surprise, Amy, is climate tech. I think it has been, not because it's a bad thing, quite the opposite. It's because it has been the subject of such unexpected geopolitical pressure that it has really forced investors to say, gosh, we didn't know that the world was going to change in that particular way in terms of its sentiment or government sentiment or big corporate sentiment or perceived sentiment to the climate ag world. And we're now not quite sure what the monetisation model is. So I think it's things like that.

15:28Whether it's AI or defence tech, there's a lot of sectors where there's a huge amount still to be learnt about the economics of those particular sectors. And we're beginning to go, I've been listening to quite a few things over the last few weeks and we're now beginning to get a lot of people calling the bubble in certain sectors, AI being the most obvious, where when people start to do that, you know it's because people know it can't carry on going up and to the right. They know it is going up and to the right at the moment, but there's some pressure there which has to be brought to bear and it's going to be.

16:09Which bit of the bubble do you think is going to burst first? I think there will be an increasing amount of focus on a smaller number of companies, particularly in the Gen AI world. I think it's going to be incredibly difficult. I think the pure startup, the two-person startups that are raising tens, if not hundreds of millions of dollars, I think that will stop soon. I think that because we're getting a little bit more maturity in the market, which will drive investors far more to the slightly more established companies. The flip of that is I think those companies are going to grow M-value even quicker.

16:51And do you think we're going to see a bunch of M &A happen here? Or do you think a bunch of those companies that don't really make it, don't break through, have too much churn, whatever, or just fall by the wayside? I think what you're hearing a lot about at the moment, the founders saying they're getting unsolicited inbound, but that they are resistant to it because they all want to grow multi-billion dollar companies. That has to give at some point. So I think you will see a lot. I think you will see the beginnings of the startups buying startups in the AI world, which is where the company which is being acquired is looking at itself in the mirror and saying, I don't think we can grow through to that fantastic valuation that we aspired to.

17:36So actually, this inbound opportunity we've got now might be the best place for us. And actually, as founders, it might be a terrific opportunity for us to go and grow the business within the purchasing entity. And are the companies making the offers generally sort of big tech companies, the Metas, the Googles, or are they also the kind of unicorn AI companies like the Mr. Owls, the Synthesias? You're beginning to see the mistrials and the synthesias being the startups buying startups that I was alluding to. I know you've reported on it recently. We are in this very difficult and I think dangerous world of the reverse acquires as well, where for whatever reason, the big companies are coming in and they're looking at an opportunity and saying, we can't buy it because the investors won't sell at the current point in time.

18:29or we can't buy it because it's just too sensitive from a regulatory perspective. So we'll get around both of those problems by the founders. Why do you think that's dangerous? I think it is incredibly dangerous because it totally undermines the whole venture capital and growth capital market. Because if I'm investing in a company, I'm predominantly investing in the founders, notwithstanding what I just said. If those founders are ripped out of the business and there's nothing I can do about it, then that is a fundamental challenge to the whole thesis of my investment. Are there provisions investors can put in place or is there anything happening to kind of counter this trend?

19:08You can probably do much more about it in Europe than you can in the States. The challenge with California in particular is non-competes a relief. So a founder going to competitive business can be stopped as such. It's much easier to prevent that contractually in Europe. And then I think there's going to be much more, there is, I know, because we're involved in it ourselves, much more focused on the value of the IP and protecting the value of that IP within the company so that the founder is very restricted in terms of what he or she can do when moving across to the company who's buying him or her.

19:46Got it. So you can still potentially buy the amazing, whizzy engineer, but you can't buy the latest project that they've been working on or the knowledge they've built around that. Well, I'm going to say yes and no. I'm going to say as a lawyer, yes, you can absolutely stop that. But the no is that, look, in reality, if you're buying the person, you're buying the history of what it is they've done. and these big companies will be very, very careful about how they deploy that knowledge and use that knowledge. What about M &A in other sectors? We, as if you've been reporting a fair bit on fintech M &A, we've seen Starling Bank by Ember, GoCardless reportedly being on the hunt for a buyer.

20:27Are you seeing consolidation pick up in any particular sectors? Yes and no. I think it's fairly spread actually. I think you're seeing, firstly, we're seeing a lot more M &A activity coming from the strategic buyers. So a lot more roll-up activity. A lot of it is in the less sexy sectors, you know, in enterprise technology, in enterprise software businesses, where you can easily see the benefits of that being done. They're slightly off-market in terms of their publicity, those transactions. FinTech, yes. What I'd call out is we're seeing a lot in interactive entertainment. And until relatively recently, the entertainment world and the tech world have been two very different worlds.

21:15We've seen them really start to overlap to a very significant extent over the last few years. And we're seeing a lot of big tech buying into the entertainment world as the world has become so much more digitized and online in terms of consumer content and consumer behavior. That's one area where I think you're definitely seeing a lot of M &A. Otherwise, it's fairly broadly spread. But I do think, going back to something we said earlier, that the startups buying startups, because startups are getting so much more valuable, I think they will naturally grow through M &A activity in a way that we perhaps haven't seen in the tech sector for many years.

21:57Are those generally good outcomes for the founders and their early investors? The companies who are being sold? Yeah. I think it depends very much on the attitude of both buyer and seller going into the transaction. It can be a terrific outcome. It can be the next stage in the growth of your company. You're selling it into another company which can do more to accelerate growth and allow you to do what it was you wanted to do. You can be bought in through the terms of the acquisition to the equity in the new companies So I have a really strong vested interest in seeing that happen. You could be brought into the central management team and have a much more exciting role as a result.

22:40Or you could be orphaned. And I think it's the companies which are orphaned, where there's a piece of technology or a particular person or something which has driven the acquisition, which are the ones which fail in that sense, fail in terms of the eyes of the selling party. What about when it comes to VCs? What are the challenges there? Are they still really struggling with liquidity? Yes and no. I think the secondary market has allowed a lot of the VCs to do what they never really thought of doing when they first set up in business, which is selling early, getting pretty decent returns on their own investments.

23:20So there's definitely an opportunity to exit early. and you will have done a number of these interviews over the years where you've talked to VCs about the misses that they've had in terms of opportunities to sell early and to get liquidity early and they've hung on and they've gone into a public company situation and seen a big crash in terms of the value of their investments. Driven again by history, you're seeing VCs being much more flexible about what it is they want to do and when in terms of getting liquidity. I've also heard from investors that they're pre-empting deals a lot more as the kind of competitiveness of AI and defence maybe in particular picks up.

24:01Are you seeing that too? We're definitely seeing that. And I think different funds are doing that in different ways. Some are only fair to say, some it's very much a gut reaction. And they're going to get there by offering the founder a higher value or a sweetheart term in the deal, which may just separate them out from the crowd. Others, I think, are being much more sophisticated about looking for the opportunities early, getting to know companies much earlier, and talking to them about why they would be a great investor for that company almost before the company is looking for the capital. That's a great way to preempt a transaction.

24:44So it's, look, I think we're the right investor for you. So as soon as you're ready to raise, come and talk to me and we'll get the shape of the round correct together. and we'd love to lead it. We're seeing a lot more of that. If you could gaze into your crystal ball, Mike, what do you think we're going to see over the next six months? Change. And I would say that almost every six-month period. I think that's the whole beauty and the fragility of the whole start-up and the venture capital world. We have to learn from our mistakes. We have to learn from the market changes. We have to learn from government intervention.

25:22venture, we have to learn from all the things that are impacting what it is we do every day of every week. There's no playbook. And historically, the market has moved significantly. Different investors have come in, different investors have left. So there will be plenty of change. And the smartest companies will raise the best money from the smartest investors and vice versa. A great way to end. Thank you so much, Mike. Thank you very much. And that's all we have time for. If you enjoyed this episode, please take the very, very quick podcast survey, which is linked in the episode description, and one lucky listener will get to win a rather nice pair of headphones as a thank you.

26:03Plus, if you want to hear more from Mike, please do grab your ticket to the Sifted Summit before they all fly away. It's happening in London on the 8th and 9th October, and it's going to be splendid. Find all the information you need at summit.sifted.eu. This podcast was produced by Maya Durampal-Hornby.