High Growth Handbook

by Elad Gil

  Examples: Instagram and WhatsApp purchases by Facebook. DoubleClick, Motorola, and YouTube acquisitions by Google.

  How you approach the negotiation and execution of each of these three types of purchases will differ wildly. The large, strategic buys tend to be heavily negotiated and often involve the CEO of the acquirer. They may be more about connecting with the founder of the target company and painting a big picture of why they would want to join forces with one another. These can be very emotion-driven sales. On the other end of the spectrum, small team buys may be desperation moves by founders shopping for a “soft landing” for their startups as they run out of money or realize they lack product/market fit.

  M&A road map

  You should have a member of the corporate development, product, or business development teams (depending on your organizational structure and resources) develop an M&A road map. That individual should get input on that road map from (i) key hiring managers on the types of people or teams they would most like to acquire, (ii) product and engineering leaders on product road map holes, and (iii) the executive team on key “big picture” strategic buys the company should consider.

  If I were to imagine the M&A road map at Facebook circa 2012, it speculatively may have looked something like this:

  Hiring M&A. Facebook needs to build out its mobile team, and is being pressured by Wall Street to increase its ad business. Therefore, we should buy teams of 3–10 people with strong backgrounds in (1) mobile engineering/product/design or (2) advertising products. Teams will be broken up and added to the areas of greatest hiring need. We should also buy machine learning or data science heavy teams as we can not hire enough of them.

  Product M&A. Buy Snaptu to enable mobile clients in LATAM/ASIAPAC, an email-scraping company to help with international growth efforts, and an IMfocused team to reposition for Messenger.

  Strategic M&A. Build relationships with founders of the top five social apps on mobile and the web. Set up quarterly 1:1s for Zuck to meet with the CEOs of WhatsApp, Instagram, Pinterest, Twitter, and Weibo. Determine when to pull the trigger and make a bid on each.

  Building your M&A road map is a crucial first step. Next, we’ll take a look at how to assess what your prospective acquisitions are worth—so you can move forward on an offer.

  General considerations when buying a company:

  Can we absorb a team of this size without screwing up our culture?

  What will the org chart and reporting structure be?

  Will the leadership of the team we buy have an impact more broadly in our company? Are there areas we are struggling with that the incoming entrepreneur can own?

  Managing internal stakeholders

  Internal pushback to M&A

  It is common for employees or executives at a company to push back on M&A. Pushing back on acquisitions may reflect a strategic or tactical insight. Alternatively, pushing back may reflect a lack of understanding or pragmatism about the inability of the company to do everything with the limited resources it has. Or, it may reflect jealousy around the acquisition price and financial outcome for the founders of the company you are buying. In general, more junior employees or company old-timers tend to push back more on M&A than experienced executives who have seen the value of doing acquisitions well at another company.

  The set of companies you are looking to buy should be considered an internal secret and not something widely discussed with the entire company at an all-hands. This should be kept quiet because:

  1. Word may leak. This can cause a number of bad scenarios including (i) competitive bids on the startup being acquired (ii) disruption of that company’s operations—for example if one of your employees tells their friend at the company that you are thinking about buying them (iii) lobbying of regulators by your competitors to block the acquisition.

  2. Most employees won’t have context. Many of your employees may lack the broader strategic context, or experience, to understand how M&A may be used as a tool. They may also not understand that you may talk to ten companies but only buy one, and there is the potential for employees to get upset or worried about acquisitions that will never happen. Why cause organizational churn or questioning for no reason?

  3. It makes it harder to bid on the same company again later. If you publically try to buy something, and then publically pass, it may become harder to justify to your team another attempt on the same company. Strategic imperatives, financial models or other items may change and it is best to maintain flexibility.

  4. Members of your team may try to inappropriately block the acquisition. See below for common objections.

  Dealing with objections

  Common objections from the internal team may include:

  1. Couldn’t we just build this ourselves for cheaper? Why buy a small team with a nascent product for $20 million when that same $20 million could allow us to hire 100 people for a year?

  Answers may include:

  In reality there are lots of things your company could do but it is limited by resources (including the ability to hire that many people quickly). If you do not buy the company, this strategic objective will not get done or will be delayed dramatically.

  You are also buying a team that has thought deeply about the area and will not need time to ramp on it, as well as brings it own unique insights to bear.

  The company being bought will bring its own leaders that will help drive this initiative forward.

  The financial value if this team succeeds and gets things done a year earlier may be worth much more than the $20M being paid for the company.

  2. We are going to crush this competitor! Why would we buy them? In some cases it does not make sense to buy any competitors and to indeed outcompete everyone in the marketplace.

  Your answers to this objection may include:

  This competitor has been driving down margins by competing for every deal. By taking them off the market we make back the value simply by having less competition.

  This acquisition is accretive, e.g., we are trading for 10X revenue but only paying 5X revenue for this competitor. So we gain market share, grow our market cap for more than the stock we spent to buy the company, and may also lower our costs or get efficiencies via scale.

  This buy is defensive. Buying this competitor will block large-scary-co from entering this market. If large-scary-co cannot get a toe-hold via acquisition, this market is ours long term. If they decide to buy this competitor and put resources behind it, we will have real competition for once.

  3. Does the team really meet our bar? There are concerns on the engineering team that this team does not meet our hiring bar. A friend of one of our tech leads says the team is not very good.

  Response (for a team acquisition):

  We will continue to maintain our high bar. We will be taking the team through our interview process and will make the acquisition contingent on us bringing on board a big enough subset of the team. We will not add (or will give a short trial period to test out) employees that we are uncertain about.

  Response (for a strategic acquisition):

  We are buying this company for its core asset and market share versus just the team. Once we start the integration we will assess each individual team member and decide where, how, and whether to slot them into our organization. If anyone on their team wants to switch teams after the acquisition, they will need to do a full interview circuit with the team they want to switch to. This will ensure our high bar is maintained.

  4. It will take a long time to integrate. Don’t we need to port over their stuff? It will take a year or two to rewrite their code for our stack! We could have our own team build the same thing faster.

  Response:

  We do not, and will likely not, have the headcount for this project in the near term. Given that this team has a live product we can distribute, we think it is faster to buy this team and either (i) let them continue on their own stack or (ii) have them port over to our infrastructure.

>   In parallel we will have a product in the market and will attract customers or scare off or block competitors.

  5. What if the acquisition fails? All new projects can fail and some will certainly do so. What if this acquisition is one of those failures?

  Response:

  We do not have a 100% success rate for our internal new products and that is by design. If nothing fails it means we are not taking enough risk. Similarly, for acquisitions some will work out and some will not. However, if enough of them work out they will more than pay for the acquisitions that do not. No matter what, we will also end up getting talent into the company that might be hard to hire directly otherwise, simply due to the risk profiles of the people involved.

  M&A interview processes

  One of the key areas that matters to your employees (outside of price, which may cause its own gripes) is whether new acquired employees meet the bar (particularly in the case of a team buy or small product buy). This gets complicated if your team is largely composed of more junior, less experienced people whose only professional experience (outside of internships) is your company. In general, less experienced employees may not do a good job of interviewing senior people. If the company being acquired is a team of very senior engineers from, for example, Google or Facebook, it is possible the senior engineers will not pass the interviews with your more junior team. There are a few ways to ensure that the company being acquired gets a fair shot. For example, for engineering interviews:

  1. Standardize interview processes and questions per the “Recruiting, Hiring, and Managing Talent” chapter of this book. If you do not have a consistent set of questions hiring feedback may be arbitrary. Make sure your interview questions work well for senior as well as junior engineers—sometimes coding questions can reflect recency of a computer science degree (more emphasis on certain aspects of theory for example) versus ability to code.

  2. Put mainly senior engineers with cross-company experience on pre-set panels for M&A. This ensures your employees will have the context and bar to interview and assess more senior hires.

  3. Remind the interview panel that most of the people who are interviewing were just told that their company is for sale, and may not have had time to prepare for interviews.

  4. Do references (if it makes sense to do so) and weigh them highly. The employees of the company being acquired do not have a say in where they are going (their company’s founders are driving the acquisition) and they are unlikely to have interviewed recently. As such, they are unlikely to have prepared for interviews with your team and they will also lack context for the acquisition. As such, discount some standard interview items like “do they have passion for our company” that you may have if you hired someone off the street.

  You can do the analogous situation for other company functions.

  M&A: How to set a valuation for companies you buy

  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 acqui-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.72 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.<
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  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?