We see it all the time: “BigCo Acquires 3-Year-Old Startup NewCo for $X Billion!” Sometimes, we say “WOW! What a great strategic move, even at that price!” Other times, we scratch our heads and try to figure out exactly why that big business would value that little startup at THAT amount of money. In my years at EY, we saw both scenarios regularly. Why acquisitions occur is usually straightforward. The reasons companies overpay for their acquisitions require more digging under the hood.
Why They Buy
Most acquisitions occur for very specific reasons. The amount of money the acquirer pays for their new company varies greatly. Many times, the press release announcing the acquisition doesn’t include those reasons. Here are four very specific reasons that I have encountered over many years in the M&A world:
- Manufacturing capacity – every maker will need to expand at some point, so they can either build it or buy it.
- Intellectual Property – patents and new product ideas are a very common trigger for acquisitions.
- Customer lists – sometimes you don’t need the product or service, but you do need the customers.
- Market defense – building a wall (or a moat) buy acquiring smaller players in an industry is a common means of establishing barriers to entry.
Why They Overpay
Acquisitions happen all the time, for the reasons above and many more, but what makes acquirers overpay? There are many very specific reasons for that as well, but those reasons don’t make it onto the press release announcing the acquisition. Here are three very common reasons a large corporation will overpay to acquire a smaller company.
- Can’t replicate it – buying a competitive product can often be seen as a wise strategic move; however, behind that move may be the acknowledgment that the acquirer simply could not build a better product.
- Promised the street – public companies set guidance every quarter with Wall Street analysts. If promises are made, sometimes those promises have to be kept, even if that means overpaying to keep them.
- Analysts’ growth expectations – In any growth industry, the top competitors are expected to grow in order to maintain their market cap. When revenues don’t meet growth expectations, public companies can (or more likely have to) grow by acquisition.
As they build up their own customers, distribution, intellectual property and other strategic advantages, startups must pay attention to possible acquirers and their needs driven by financial market expectations. The best time for a startup to raise money is before they need it, and the best time for a startup to be acquired is when the acquirer really needs it.