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Take Advantage of Expensive Paper

We’ve recently seen a number of deals where founders/employees and in some cases early investors have taken money off the table in high priced late stage rounds. Yelp - Elevation , Zynga - DST & Facebook - DST are the highest profile recent examples.

These are great deals for the industry, as they provide liquidity and/or growth capital at very attractive equity prices for companies not quite ready for the public markets (for many valid potential reasons). We need more of this kind of liquidity in the marketplace.

Another very powerful way to take advantage of expensive equity is through acquisitions. The best time for a company to do deals is when they benefit from high priced stock.

This is effectively the opposite of taking money off the table — it’s increasing the capitalization base of a company by issuing new shares to targets that hopefully add more value to the overall enterprise than the equity given up for them.

The theory is that if you get a fair price for the assets you purchase and the value of your stock is fully priced by the market, the acquisition should be accretive and you should gain value.

Determining whether an acquisition is accretive or not is very tough to do when you’re dealing with companies that have little to no earnings. But these deals can be very strategically accretive, especially when a larger company is acquiring a much smaller one.

A great example of this is the Google - YouTube deal.

Even though the YouTube deal looked incredibly expensive at first blush, Google got enough lift in their share price on the day of the deal announcement to entirely cover the cost of the acquisition. This was the market applauding Google’s ability to use high priced stock to acquire a strategic asset by pushing that stock even higher.

Now there is always debate as to whether acquisitions are a good thing for companies or whether they are distracting, especially for earlier stage businesses without the ability to effectively integrate (hard for any company, let alone a young one).

My answer — like everything else, it depends on many factors. But if done correctly, an acquisition strategy can be very powerful.

So what kind of deals should companies do?

The most interesting potential targets are those that provide a boost to R&D and/or HR, by bringing in great technology and/or great people to the organization. Secondly are businesses that collapse the value chain, by either adding monetization capabilities to a business with a lot of user traction or adding a direct relationship with users (businesses or consumers) for companies with a proven monetization platform.

In terms of size, my general take is that businesses should look for smaller (~10% of total capitalization or less) strategic acquisitions. Otherwise, things tend to get very messy with shareholder interests and governance on both sides. Bigger deals are certainly doable, but need to be very strategic and are usually much more complicated.

We’ve seen Google being a very aggressive acquirer as a public company. Twitter and Zynga have done a handful of smart strategic acquisitions in the private markets. We’ve even seen Apple enter the fray recently, something we have not seen from them before.

I expect to see a bunch more of this.