Billion-Dollar M&A Club Admission Guidelines

Posted Jan 25, 2014 by Glenn Solomon (@glennsolomon) Editors note: Glenn Solomon is a Partner with GGV Capital. Some of his re ent in!estments in l"de Pandora, S" essfa tors, #imble Storage, $silon, %omo, S&"are, 'endes(, )"instreet and *lien+a"lt, -is .ersonal blog,goinglongblog.com, fo "ses on growth/stage entre.rene"rs who are thin(ing big, 0ollow him on 1witter @glennsolomon, Average valuations for venture-backed M&A deals typically come in a pretty tight range. According to the ational Venture Capital Association ! VCA"# in $%&' there (ere ')) total M&A e*its of venture-backed companies (ith mean pricing of +&,& million. -his compares (ith total deal count of .// and .00 and mean pricing of +&.' million and +&)' million in $%&& and $%&$# respectively. 1very once in a (hile# ho(ever# a +& billion or even multi-billion M&A deal for a venture-backed# relatively young company pops up# such as the recent est2Google announcement. -hese deals defy conventional valuation logic since the ac3uired companies are early in their revenue curve or sometimes even pre-revenue. 4here do these billion-dollar deals come from and (hat factors are involved in their creation5 6elo( 78ve identified three primary drivers that motivate ac3uirers.

6illion-9ollar M&A 9rivers Rocket !i" Riding. :ometimes a target achieves such incredibly fast early gro(th that ac3uirers become enamored (ith the .otential for the future. ;articularly in the consumer 7nternet conte*t# these companies are often pre-revenue# (ith gro(th coming in other key metrics. <acebook8s +& billion ac3uisition of 7nstagram is a good e*ample. <acebook clearly sa( 7nstagram8s gro(th as both a threat to its o(n popularity and an opportunity to continue to e*pand engagement among its core constituents. ;rice didn8t matter as much as this future potential. Google8s near +& billion ac3uisition of 4a=e (as similarly driven by the traffic app8s gro(ing popularity and Google8s recognition that it could integrate 4a=e functionality into Google Maps# further enhancing its o(n product line. #ear o$ %osing &ut. 7n addition to perceived potential# fear is also a very po(erful motivator. Ac3uisition prices can be driven up to billion dollar levels (hen an ac3uirer develops the fear# real or not# that they might lose an opportunity# either to a competitor or to the target itself gaining enough traction that it (ill remain independent and become a threat to the ac3uirer over time. 4hen 9oubleClick (as ac3uired by Google for +'.& billion# Microsoft (as (idely rumored to be aggressively pursuing the deal# as (ell. o matter that 9oubleClick had been ac3uired by private e3uity firms >ellman & <riedman and ?M7 13uity for appro*imately a third of that price @ust a fe( years earlier. -he perception that the inventory 9oubleClick controlled (as e*tremely strategic gained footing in Google8s board room# similar to Microsoft# (hich led to the outsi=ed outcome. 4hen VM4are ac3uired early-stage icira for +&.' billion# VM4are e*ecs sa( this as a move to protect their core server virtuali=ation franchise and e*tend into net(ork virtuali=ation# as (ell. 4hen looked at from this vantage point# the price makes more sense. %otter' (ick on Dra$t Da'. 7nnovation is rarely a core competency at large tech companies. 7n fact# e*ecutional e*cellence# at (hich large tech companies usually e*cel# often runs counter to the culture of risk taking re3uired to spa(n ne(# disruptive initiatives. 1*ecs at large tech companies kno( this and it can be very frustrating. -his can motivate the desire to bring in a team of people (ho are perceived to have skills and abilities to drive innovation that other(ise (on8t occur. 4ith this logic# ac3uisition price becomes a minor issue. Google8s recent +'.$ billion est ac3uisition must have been driven# at least in part# by Google8s desire to bring in a talented consumer hard(are team# headed by -ony <adell# that can innovate in the connected home area.

-his is a market Google has identified as important# but (ithout a tiger team like the one from est# Google e*ecs recogni=e they (ill likely never get from here to there.

Consideration and Considerations Although entrepreneurs (ho end up selling for +& billion or more rarely begin their @ourneys thinking they sell their companies# there are several issues that should be considered carefully if this becomes an option. Cas! vs tock. 4ith gro(ing piles of cash on the balance sheets of many large tech companies# the ability to pay cash for some or all of the purchase price in a billion-dollar M&A is more common these days. Cash obviously removes any uncertainty (ith respect to the ultimate price. :tock prices can plummet# adding possible risk to a stock deal for entrepreneurs# their employees and investors. 1specially if you8re being ac3uired as a lottery pick# e*pect ac3uirers to (ant you and your key team to stay for many years. -he purchase price (ill highly incentivi=e you to stay# including stock vesting. 1ach entrepreneur has a very uni3ue and personal situation and needs to (eigh the pros and cons carefully. Certaint' o$ Closure. 4hen an ac3uirer floats a very large ac3uisition price# the risk of the deal not going through to completion increases. Aecogni=e that someone at your potential ac3uirer is probably staking her or his career on the decision to pay up to ac3uire your company. 7ts human nature to get cold feet. ;ay close attention to (ho the ac3uirer is B (hat8s their reputation is for going through (ith ac3uisitions5 (hat8s the status of the company right no(5 ho( po(erful is the board and2or C1C and are they behind the deal5 7t8s not atypical for a target to go (ith a lo(er price from an ac3uirer (ho has a higher perceived certainty of closure versus other higher offers from riskier (ould-be ac3uirers. #it and Alignment. <or entrepreneurs# there8s no rule that you must accept an ac3uisition price once it hits a certain level. Many potential ac3uisitions don8t consummate because the perceived cultural fit and2or alignment on the future vision doesn8t completely align. Most entrepreneurs (ith (hom 78ve spoken (ho have sold their companies !(hether at billion dollar levels or lo(er" regret the decision later due to poor fit (ith the ac3uirer. 7t8s critical to get this right. <or many entrepreneurs# their o(n indomitable (ill doesn8t (aver# even in the face of a billion-dollar M&A offer# and it8s go long and go big or bust. <or e*ample# :napchat appears to be on this path# at least for no(. <or some others# the appeal of taking a billion dollar offer is high enough to veer off the independent path. 7nstagram (ent this route. -here isn8t a right ans(er. 6ut# recogni=ing the motivation of (ould-be suitors B be it rocket ship# fear of losing out# all-star draft picks# or some combination of the above B can help navigate the (aters.