Ask HN: Why do startups get acquired for a cost way more than the revenue made?

https://news.ycombinator.com/item?id=2084340

by newgrad • 16 years ago

17 25 16 years ago

news.ycombinator.com

Why do big companies want to buy the startup companies with prices way more than the revenues made (even if they were multiplied by many years)?

Is there any specific example where the startup's technology affecting the buyer companies significantly?

jcr2• 16 years ago

The most general answer is "talent acquisition" (you should do a web search on that, also a HN search will be very helpful). In short, the proposed value of the company is based on the value of the engineering team.

antirez4• 16 years ago

If that is common, it is very very bad. It means startups are not doing real innovation mostly. What is even worse is that once this starts to be established way of business, startups will be more and more group of good hackers producing a good product but perhaps not outstanding, waiting for some big acquisition.

In the long term this can completely killed innovation.

What was very good with the model of creating a startup to create things that really users want, in order to earn money, is that people tend to give money to a company only when the product they do is really something worthwhile.

This was what happened to the big startups in 70s and 80s. This drives innovation.

jcr2• 16 years ago

It is common, in fact, painfully common. As for whether or not it is "bad" that depends on who you are. If you need a bunch of innovative engineers and you are the current darling of the technical world (i.e. great people applying to your company), then your only solution is to buy out companies who have proven innovative engineering acumen.

If you are Microsoft, or even Google for that matter, talent acquisitions might be your best avenue for getting great people working for you.

There were some posts to HN about the estimated value of an engineer during an acquisition. I believe one of the folks from PowerSet or FareCast (both acquired by Microsoft) was talking about it in a blog post. The effect on valuation was roughly 1 million USD per engineer at the startup.

hmmm... my meatware memory is failing and I can't find a link, but I'm pretty sure it was PowerSet.

agotterer• 16 years ago

One reason could be user acquisition. It can cost a lot of money to acquire new users or reach a specific target market. So sometimes it makes sense to buy a company who reaches that audience, regardless of their revenue. Then you can roll that business into your existing product.

Other times it's worth a premium if you want to get into a particular business and have nothing or are playing catchup.

Helianthus16• 16 years ago

Because in a really bizarre way we're investing in the utility of a company rather than the money it makes.

jeremymims• 16 years ago

1. Brand and scale.

If a company buys a startup with a promising product that they can quickly sell to a large portion of their customers, they're willing to give up a portion of that future revenue. It may not be at all tied to past performance.

2. Talent

Facebook payed a premium for FriendFeed because they wanted their team to work on the Facebook platform. This team has developed more than $50 million in new value for Facebook.

3. To keep a competitor from having the advantage.

Google paid $1.5 billion for YouTube. They've lost money on owning it, but in the process kept their biggest competitors from controlling an asset that drives an enormous portion of all video traffic on the web. You'll see companies buy up companies they're not really interested in just to keep someone else from having them. Powerset was bought for $100 million by Microsoft because if they had developed some interesting or successful search technology, they couldn't chance letting Google have it.

asanwal3• 16 years ago

The above are spot on.

However, acquisitions are not always so rational. The other reason is hype. If you're in the hot area of today (cloud, location-based whatever, social gaming, photo sharing) and a corporation is hearing a lot about this, even if they don't know what it's all about, their desire to be part of this "thing that will be big" can motivate them and cause them to pay more than it may be worth.

DanielBMarkham2• 16 years ago

Big companies are using startups as proxy innovation labs. So instead of figuring out themselves what users are doing, they let startups. Then they buy the startups. Much easier to buy an audience and all the possibilities associated with a new brand than try to make it all work in-house.

Combine that with raw talent acquisition, and a lot of startups begin to look like highly-rewarded spec R&D work for big companies. Picking up that kind of talent, audience, and potential? It's easily worth it to BigCorp, even if there's no income at all.

(I hope the tone sounds okay on that. There's nothing wrong with gaining a million users and flipping your company to Google -- assuming that's what you want to do, of course)

Of course, there's a ton of startups that don't fit that model. But many do -- at least many in the valley.

antirez4• 16 years ago

That's something strange from my point of view.

I mean, imagine some big company opening a BigCompanyName-Seed division, where they do something like Y combinator is doing, but instead of giving a small amount of money for 6% they get 50% of the company for a bigger investment (at least in perspective, so if future investments are needed, there is no dilution up to a given sum).

But in the process of course the company doing this stuff should be smart enough to don't force any strict rule like technology to use, type of authentication, domain name, and so forth. Must be a startup with its own life. Just they can select things that are interesting in general, or are interesting for the general goals of the big company.

I'm not sure why this model could not work.

DanielBMarkham2• 16 years ago

Welcome to the study of how groups of people interact. We'll probably have it all figured out in a few hundred years or so :)

Couple good books come to mind. The best of which is probably The Innovator's Dilemma, for how new ideas get killed by companies.

There are a lot of reasons what seems obvious won't actually work -- even though many companies still keep kicking that can down the road. This whole area is like a siren's song both in the corporate world and in government. Everybody is building "centers of excellence" and "knowledge incubators", and whatever else buzzwordy thing they can come up with to spend money. But the record of such efforts is appalling. Just for one example, take a look at Microsoft -- tens of billions in cash, tens of thousands of brilliant people, and they're lucky to get a release of windows out in time. Too many reasons to go into in this short of a space, and of course there are a lot of true believers that would argue with my conclusion. Suffice it to say that smart companies have figured out it's easier just to write a check.

stanleydrew2• 16 years ago

"...but instead of giving a small amount of money for 6% they get 50% of the company for a bigger investment..."

I think one reason is that most seed investments don't need to be that large, and large investments can actually be detrimental to the progress of a startup.

fizx• 16 years ago

Yahoo!! tried this with Brickhouse. They opened a pseudo-startup innovation lab in SF. I don't know all the details, but iirc, it was 30-100 people for 1-2 years.

This failed utterly.

Why? Once a company is beyond a certain size, employees maximize their expected value by spending time seeking internal resources. Budget, headcount, etc. If the lab is still part of the parent company, these games are still played.

You also have companies like Hulu, that exist at the pleasure of their "investors." This might work a little better, but Hulu can't act fully in self-interest.

Perhaps the best thing I can think of is a spinoff with initial funding, control of its own board, and an irrevocable IP grant. This would potentially be a huge head start. But then what happens if a competitor acquires your spinoff (for the IP grant) right away?

I guess all this seems more fraught with risk than the simple buy a random startup model.

tptacek• 16 years ago

Because it's almost strictly better for them to acquire an outside company than it is for them to innovate internally, and it's easy to see why: many startups will vie to succeed with substantially similar ideas, and an acquirer can choose among them to optimize their outcome.

In some cases, the acquirer can win simply by waiting for a company to prove itself in the marketplace. They pay a small premium to instantly become the market leader relative to the risk-adjusted cost they'd have to pay to ensure an internal effort resulted in the same market position.

In other cases, the acquirer knows it's going to dominate the market once it enters with an acquisition. It wants to know whether a product is going to succeed, and what features customers are going to value most highly. So it can sit back, watch the market shake out, and then buy the best also-ran at a major discount to the valuation of the market leader.

These are decision factors that aren't open to companies that innovate internally. That doesn't make internal innovation bad; it just argues in some cases for M&A instead.

asanwal3• 16 years ago

In theory, this is an interesting idea. I'm not sure an entrepreneur who has (or believes they have) a truly big, scalable idea would want to give up 50% of his/her company for a first round of funding, no matter how large.

mattlong• 16 years ago

I believe what you are describing is more or less what Microsoft is trying to do with their New England R&D Center (NERD center as they like to call it) located in Cambridge, MA. They recruit big time out of MIT, host tech conferences (2009 jQuery conference among others), and let their "startup teams" work on pretty much whatever they want (I think).

Would be interesting if anyone has any more insider info about it to share.

smeatish• 16 years ago

Intel has a VC arm: http://www.intel.com/about/companyinfo/capital/index.htm

ABrandt• 16 years ago

There's a variety of reasons why you'll see M&A prices that are several multiples of a startups revenue. In financial terms, its a long term investment just like any other. Figuring in the net present value of money, the selling price must consider the asset's future value. Everything such as good will, userbase, and talent that comes along with the startup are simply indicators that the asset's value will grow with time.

chopsueyar• 16 years ago

I believe that is most businesses, not just startups.

ndl• 16 years ago

My first hypothesis is that it's a question of comparative opportunity cost, rather than absolute cost.

When a company gets very large, it usually struggles to keep innovating under inertia. Trying to build in completely new directions becomes both necessary and difficult. Buying a startup is often cheap compared to trying to fork an existing team to build new things. Furthermore, the startup's business model is already partially proven by time of acquisition - so they are buying some certainty compared to assigning a team to generate new ideas.

Another hypothesis is that with the resources of a large company behind it, the startup may grow very fast. Adobe seems to be good at this. Other companies don't seem as good at managing post-acquisition.

I have never been in or acquired by a large company, however, so what I say should come with a grain of salt.

stretchwithme• 16 years ago

I suppose its because the same code serving millions instead of thousands might be worth 1000x as much.

If you invented a process that turns lead into gold, how much has been converted so far really doesn't affect how much the patent is worth.

AndyParkinson• 16 years ago

Generally its because people who run/operate companies are terrible at allocating capital. Operating a business and effectively allocating capital are two very different skills, but smart operators seem to believe their intelligence carries over to capital allocation.

The fact is that most companies destroy shareholder value when they buy other companies. A recent example is the whole yahoo/delicious debacle but anyone reading this can think of a handful of other equally terrible examples off the top of their head. A far more difficult exercise would be to name the acquisitions that actually added long-term value. For example, Apple is generally great at only buying companies that add real value. They are an exception.

The fact that operators are terrible at capital allocation is great for founders and VCs. Its terrible for shareholders of the acquiring company!

Ask HN: Why do startups get acquired for a cost way more than the revenue made?

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