Chapter 7 - Start Up Exits
IN THIS LESSON
Acquisitions and Valuations
Figuring out the valuation of a company being acquired is like a dance. It can move many times before being settled. The approach to valuation for the two types of acquisitions is very different from each other. It’s a complex topic, but the following introduces you to the basics that you need to know when considering the two types of acquisitions and their respective valuations.
Accretive acquisitions
Accretive acquisitions tend to be extremely cost-sensitive. Since the goal is buying the revenue and profit stream of a company, the acquiring company knows how much they can spend where the result is positive for them. A discounted cash flow valuation can get them very close to a price limit for the purchase.
As such, an accretive acquisition leads to more of an operational approach to valuation. The acquiring company looks at the financials, including projected future cash flow, of the targeted company to acquire and discounts the proposed price for the acquisition based on these factors. Things like technology, intellectual property or market growth opportunities don’t come into play to move the valuation in favour of the acquired company. The price for an accretive acquisition is usually tame (at least compared to strategic acquisitions) and in line with the company’s revenue stream and cash flow.
An example of an accretive acquisition is the buyout of Oculus Rift by Facebook, a purchase that immediately drove up the value of Facebook stock.
Strategic acquisitions
Strategic purchases – due to their vaguer (non-direct goals) objectives – allow for a lot of flexibility in price for an acquisition. Most of the super-high, mind-boggling acquisition prices you might see fall into this category of strategic acquisitions. The idea is that the benefits extend beyond the revenue stream itself. For example, a company buying a key supplier might do it to secure supplies and have cost savings on manufacturing, instead of caring about the revenue of the company they are acquiring.
Technology and the scalability of the company’s tech services are evaluated from every angle. Talented people, attractive IP and technology platforms all have strategic value, even if the revenue model is unclear. In a strategic deal, the addition of the acquired company creates much more value that goes beyond earnings. Even an improved perception in the marketplace has value, leading to more sales in the future.
Examples of strategic acquisitions include Disney’s purchase of both Pixar and Marvel, Google acquisition of Android, Exxon’s buyout of Mobil, and Facebook’s takeover of Instagram. These deals were strategic moves designed to gain a strategic advantage in key markets.
All things considered; start-up CEOs/founders should optimize down the path of strategic valuation. But be aware that if a team of VCs tries to buy your company, they will likely use the operational-oriented accretive model, leading to a discounted valuation of your company. Always be prepared to talk about the strategic value of your company.