When Facebook offered Jan Koum $19 billion for WhatsApp, including $3 billion for the company’s founders and staff, observers might have wondered what Mark Zuckerberg was thinking. The rival messaging app was lean and simple where Facebook was large and complex. Facebook at the time was a social media application but it was also a photo-sharing application, an advertising channel, a data collection service, and a casual gaming platform that could turn companies like Zynga into multi-billion dollar firms. Koum’s desk had a handwritten note stuck to it that said “No ads! No games! No gimmicks!” It didn’t look like a match made in heaven.
A year after the purchase, that huge price tag for a business with no clear revenue system didn’t look so crazy. Techcrunch noted that Facebook had previously underbid for Snapchat, which it had tried to buy for $3 billion (a failure that no longer looks so unfortunate). Zuckerberg, Techcrunch said, would have been so worried about other rivals buying WhatsApp that it should have been willing to pile on the dollars. “Most obviously, Google could have used WhatsApp to jumpstart its late-to-the-game Hangouts messenger,” TechCrunch said. “Suddenly, Facebook would be battling a deep-pocketed competitor to replace SMS as the way the world chats.”
But Facebook’s acquisition of WhatsApp wasn’t just notable because of its price. Those practical reasons for the purchase were also unusual. Mark Zuckerberg has previously explained that his approach to buying startups is to focus on the people rather than on the product. He sees—or he saw—Facebook as an entrepreneurial platform for founders in the same way that McKinsey is a training school for business leaders. Buying small firms and bringing them into Facebook gives entrepreneurs a chance to scale quickly and test their ideas on a large user base.
“We have not once bought a company for the company,” he said. “We buy companies to get excellent people.” And of course, if those excellent people happen to develop an excellent product while working at Facebook, Zuckerberg’s company would own it. Facebook has now bought 79 different companies.
Other corporations have taken a different approach to purchasing rivals. In fact they’ve taken a multitude of different approaches. A company might buy a rival for its intellectual property, for its customer base, for its economies of scale, and to create marketing efficiencies. Often one company will buy another just to shut it down. When you can’t beat them, one option is always to buy them and bury them.
Ola, an Indian Uber competitor, bought TaxiForSure in 2015 for $200 million. A year later, that rival was closed. In 2016, Verizon shut Vessel, a kind of upmarket YouTube that it had bought two years earlier. Verizon would merge Vessel into its own platform. In 2018, Slack bought the intellectual property underpinning HipChat, a rival workplace chat service, from software giant Atlassian. The deal also gave Slack the ability to buy HipChat’s user base, as well as the user base of Stride, another chat and collaboration tool from Atlassian. The Verge noted that the partnership came just as Microsoft was ramping up Team, its own collaboration tool for Microsoft’s 135 million Office Cloud subscribers. Absorbing a rival gave Atlassian a stake in Slack and it gave both companies the strength to take on Microsoft, something neither company could do alone.
McKinsey on Acquisitions
McKinsey itself has found that companies that successfully buy other firms tend to have “specific, well-articulated value creation ideas going in.” Less successful deals are more likely to have vague strategic rationales such as international growth or filling gaps in the company’s portfolio. The consultancy has identified six types of successful acquisition.
One acquisition targets businesses to improve their performance. This is a strategy usually followed by private equity firms and often involves cutting costs to improve margins and raise cash flows. Buyers may also purchase a company with the aim of reducing capacity. McKinsey cites the petrochemical industry as an example. “Companies often find it easier to shut plants across the larger combined entity resulting from an acquisition than to shut their least productive plants without one and end up with a smaller company.”
Another kind of successful acquisition provides better market access for either the target’s or the buyer’s products. The idea is that small businesses can struggle to reach the large audiences that a bigger firm can reach. McKinsey notes that between 2010 and 2013, IBM acquired 43 companies, paying an average of $350 million each for them. IBM then used its own global sales force to increase the revenues of the companies it bought by as much as 40 percent within the first two years of acquisition.
Acquisitions also help companies add technological capabilities that they haven’t developed themselves. Siri and Android are now closely identified with Apple and Google respectively but both features were acquisitions rather than in-house developments. Both enhanced the buyers’ products and allowed the targets to reach audiences that they wouldn’t have been able to reach otherwise.
Companies might also buy other firms to enjoy economies of scale, either in production or in purchasing, a strategy that McKinsey considers difficult to pull off. “Economies of scale must be unique to be large enough to justify an acquisition,” the company says. Finally, some big firms buy up small, promising firms long before others recognize what they can do. That makes them more like venture capitalists, with all of the attendant risks.
In addition to those six strategies McKinsey also recognizes a number of other approaches that can create value but warns that “in our experience they do so relatively rarely.” Those strategies include buying small businesses to join together fragmented markets; consolidating to “improve competitive behavior” and stop a price war; transforming one or both the companies; and picking up firms for less than their intrinsic values, an opportunity which is unsurprisingly rare.
Each of those strategies has two things in common.
First, they show that growth by acquisition is clearly as much a part of a corporation’s strategy as product development, customer acquisition, and the creation of intellectual property. Buying small firms, whether to grab their technology or achieve economies of scale, is just something that big companies do.
But it also has to be done carefully. It has to be done well, and it has to be done at the right moment.
When businesses begin, they start by looking to rivals, identifying their flaws, copying their advantages, and trying to improve on their services. If that works, they start to build a user base. The feedback from those users enables them to improve. The more satisfied those first customers feel, the more word about the service spreads and the more the company grows. WhatsApp’s early growth strategy depended entirely on word-of-mouth recommendations. The company had a policy of not advertising for users and not even doing press interviews. A recommendation from a friend was always more powerful than a write-up in a newspaper, they argued.
As they grow, small companies can expect to receive offers from larger corporations who want to absorb their teams, take their tools, and sell to their customer bases. But if they can resist the temptation to cash in and sell up, they will at some point find themselves wondering whether the time has come for them to buy a rival.
For any small business, that’s a big moment. Money is tight for entrepreneurs. Initial pitch decks lay out strategies for customer acquisition. They don’t show venture capitalists a path towards buying other businesses doing similar things. If that was part of the vision, investors would be throwing their money at the rivals, not at them. So the decision to buy always comes once a business has moved beyond the initial stage of development and appears to be overtaking slower-footed rivals. It’s not something that new businesses do. It’s something that established businesses do—or at least businesses that have won enough trust from investors to have acquired the capital to make those purchases. That moment is a sign that the company has come of age, but it’s also a sign that the officers of the company feel that they can now do better than their competitors.
For Facebook, that move came relatively early. The company registered its domain name on August 23, 2005. Its first acquisition came just 23 months later when it bought ParaKey for an undisclosed sum. Eleven months later, when Facebook was still less than three years old, it paid $31 million for ConnectU, then coughed up another $47,500,000 in August 2009 for FriendFeed.
That’s a remarkable degree of confidence for a relatively young firm. In less than three years, it had spent more than $78.5 million buying rivals and talent.
Few firms are going to be in a position to spend that kind of money, especially in such a short period of time. But it’s certainly possible that within a few years of launch, a new business will be familiar enough with its competitors to know which would fit in its stable—and it will have the stability and revenue flow to consider a purchase.
How to Buy out Your Rival
That’s where the trouble begins because buying a rival is never straightforward.
The first issue will always be money, both where it comes from and how much to pay. Corporations like Google or Facebook have enough spare cash and valuable enough shares to be able to finance the purchase of just about any company they want. They also have the means to both outbid any other buyer and wear down the resistance of founders. Few entrepreneurs have the steadfastness of Snapchat’s Evan Spiegel who turned down a $3 billion offer from Facebook when he was just 23 years old—and is said to have also rejected an offer ten times that amount from Google. Most other owners would have taken the money and ridden off into the sunset in their Ferrari. Knowing that turning down an offer from a giant often means competing with them can make that choice either an impressive vote of confidence or a terrible act of foolishness.
For smaller businesses, especially those making their first purchases, the financing will be a tougher proposition. They’re unlikely to be able to hand over a wad of shares in return for the target company and they may not be able to pay for it out of cash flow either. Venture capital funded businesses like an early Facebook might have the means to make the purchase but everyone else is more likely to be looking at a mixture of shares and cash that leads to a merger of the two firms.
Financing is another option. The funds might come from the usual lenders of capital such as banks but sometimes sellers will agree to finance the sale themselves by accepting the payment in instalments with interest.
There are no hard and fast rules about these things. Every transaction will have its own challenges, and every buyer and seller will have their own priorities. A merger between two complementary businesses in the same field owned by entrepreneurs who respect and like each other, and who want to work together will be relatively easy to arrange. A deal in which a larger company tries to swallow and kill a smaller competitor but doesn’t quite have the cash to make an offer that the target company can’t refuse will be a lot more painful.
That’s why even if you can value the target company accurately and arrange the financing, the battle is still a long way from being finished. You’ll have to do due diligence on the company which means persuading the target that you’re serious enough to let them open their books to a competitor. When Andrew Youderian sold TrollingMotors.net, he put all of his business’s most important stats on his website, placed a high price then dropped $10,000 every week until he received a bid. Anyone interested in purchasing the firm could see exactly what they were buying. (It sold for $170,000, a multiple of around 1.8 on earnings.)
More usually, the buyer has to do some rough calculations based on estimates of revenues and audience sizes to come up with a ball-park figure of what they’re prepared to pay. Then they have to make an approach.
Again, that’s not straightforward. Some businesses put themselves up for sale so that the owners can cash in but it’s also common for buyers to approach business owners who weren’t thinking of selling. The identity of the buyer will affect the price; the larger the buyer, the more confident the seller will feel about demanding a higher sum. But it will also reveal much about a competitor’s strategy. A company looking to buy a rival with better technology is effectively admitting their rival’s superiority and declaring that they don’t believe that they can do better.
That’s why some businesses use intermediaries to make the approach and help them make the initial assessments. Merfield & Schine, for example, offers a free consultation, researches a competitor’s business status, and will approach a target company for less than $350. The company argues that buying a competitor can “increase your business quite literally overnight”; deliver greater price control; provide synergies though economies of scale, combined customers lists, and market efficiencies; and of course, eliminate a competitor. Merfield & Schine will also create a detailed evaluation of a company for between $1,000 and $1,800, a fraction of the $8,000-$10,000 it says that a valuation usually costs.
But the price of the company is only one part of the negotiation that takes place when one company buys another. An acquisition contract won’t just pass ownership from one business owner to the next. It will also include a host of conditions. It might include bonus payments to the company’s executive team but make them conditional on the team staying in place for a certain period of time. It’s also likely to include a non-compete clause that prevents the business owner and founding team from selling their company then starting the same business and building it again. Both of those conditions can be harder to negotiate than the price itself. Mark Zuckerberg might have seen Facebook as a training school for entrepreneurs but few entrepreneurs want to work for someone else. When Markus “Notch” Persson sold his company Mojang, the creators of Minecraft, to Microsoft for $2.5 billion, he took the money and left the company. Other team members were offered $300,000 after tax if they agreed to stay for at least six months. At least one member of the team refused the offer.
It is worth nothing though that although the sale made Persson into a billionaire rich enough to buy a $70 million Beverly Hills mansion, the money hasn’t brought him happiness. Being offered a giant bag of money by a competitor might look like an offer too good to refuse but for an entrepreneur the better option is often to be the buyer, not the seller.
Recent Comments