Setting the right valuation for a company you plan to acquire is more art than science. Each type of acquisition comes with its own set of considerations as you set a valuation. However, there is also a common set of things to look at when determining your willingness to pay.
Valuation factors to assess for all three types of M&A
What is the “target’s” cash position? If they only have 3–6 months of cash left, they will not have a lot of time to negotiate, raise more money, or find other buyers.
How desperate are the founders or management team to sell? Founders and management teams can get tired. Do the founders want to exit? This was famously the motivation behind Flickr’s exit to Yahoo!
Is the acquisition competitive? Who else might be bidding and what would they pay for it? If your stock is perceived as having more upside (e.g., if you are Airbnb at a $1 billion valuation), then you should be more financially convincing as an acquirer than Google (which is unlikely to increase its value by 10X again anytime soon).
Is the acquisition defensive? Is it important that you block someone else from buying the company, so you avoid their entry into your market? For example, Google’s purchase of Waze may have been in part defensive, to prevent Facebook or Apple from entering mapping well.
How truly unique is the target you want to buy? If you are looking to buy a mobile team and there are a dozen of them running out of money, it is a different scenario than trying to buy Instagram, which is a one-of-a-kind asset.
Team buys or aqui-hires
Team buys have a range of potential valuations depending on the following factors:
Team quality. How strong is the team? Do they come out of brand-name companies or schools? Have they launched or built awesome products in the past?
Unique expertise. Right after the iOS App Store launched, the value of mobile client developers was high and companies would pay a lot to buy these teams. Similarly, today Google and Facebook appear to pay large amounts for deep learning expertise. What expertise is your team missing that could move your company forward?
Acquirer desperation. Google paid through the nose to acquire “social” product managers, designers, and engineers during its Google+ heyday. Are there skill sets that your company desperately needs?
Celebrity cofounder or engineer. Does the prospective team have any well-known engineers, designers, businesspeople, or entrepreneurs on board? These “celebs” can help your company recruit exceptional talent once they are on your team. They may also have an outsized impact on your company due to their own personal networks or skill sets.
In general, on the low end, an acqui-hire means a 20% signing bonus to founders and standard salaries and packages for everyone else, with the cap table (i.e., the company’s investors) getting no money back. This is more common than people think, and many touted and tweeted acquisitions turn out in reality to be hiring a subset of a team and shutting their company and product down.
For a true “team buy,” companies will typically pay $1 million to $3 million per engineer, designer, and product manager who ends up getting an offer to join. Businesspeople, operations, etc., are typically viewed as anything from a marginal bump in valuation to a potential negative if severance packages need to be generated for them. 1 Depending on how the acquisition is structured, much of the per engineer value may go to pay off the cap table (e.g., the $5 million invested by VCs in the company) or to retention packages for the team.
Most companies ask to interview the employees of a startup before making a team buy, and reserve the right to cut team members who do not meet the bar. This could reduce the final acquisition price further. In other words, you may drop the price on an acquisition if the target company’s engineering talent is inconsistent in caliber and you only want a subset of the team to join your company. This is, as expected, a tough conversation to have. See more in the section on interviewing teams you acquire.
Product buys
Beyond the generic valuation considerations mentioned above, you may also want to assess the following factors when considering a product buy:
How much time will this save us? What product hole will this purchase fill? Can the team be repositioned to fill this hole?
What is the estimated quantifiable impact of this purchase? For example, how many more users will this get us and what is the expected value per user we have? Or, how much more revenue or cash flow will this generate at what margin?
How will the strategic market landscape change if we make this purchase? Do we block a competitor’s ability to do something? What does this enable us to do?
General rule of thumb for a product buy: You want employees of the target company to get at least a 20–50% bump in their compensation packages over what they could have gotten if they walked in off the street to interview with your company. Since they do not have a choice on where to go, paying them a little more up front discourages them from leaving your company two months later. Some of the early employees from a product or strategic buy may actually make dramatically more than this, so this is meant more as a “worst-case” scenario.
Strategic buys
True strategic buys accomplish one of the following for your company:
- Change the overall market structure in your industry.
- Provide you with a key, non-reproducible/defensible asset.
- Block a competitor from a major action, market position, or the like.
- Dramatically change some aspect of your business (cost structure, distribution channel, etc.).
In most cases, a strategic buy will involve multiple potential acquirers with deep pockets bidding for the same asset. For example, Google, Facebook, and Apple all supposedly bid on AdMob as a way to increase their market share and capabilities in mobile ads. (It eventually went to Google for a reported $750 million in 2009.)
Key questions to ask for a strategic buy:
How does this purchase change fundamental aspects of my business? Does it consolidate a key market? Allow me to cross-sell products? Enter a new business area?
Is there a way for me to otherwise reproduce this asset on my own or via an alternative set of purchases?
Will a competitor buying this asset cause an existential crisis for my own company or product line?
Can this company become a major competitor to me in its own right? Can I buy it before it competes with me directly or gains more traction?
Is there unique talent at this company, or a unique team, that can change the trajectory of my company?
What is the P&L of our combined entity? What revenue do we project this purchase will generate? How can costs be cut?
What is the set of metrics I can use to set a purchase price?
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