Tag: M&A

  • How to Regulate Big Tech

    There’s been a fair amount of talk lately about proactively regulating — and maybe even breaking up — the “Big Tech” companies.

    Full disclosure: this post discusses regulating large tech companies. I own shares in several of these both directly (in the case of Facebook and Microsoft) and indirectly (through ETFs that own stakes in large companies)

    Source: MIT Sloan

    Like many, I have become increasingly uneasy over the fact that a small handful of companies, with few credible competitors, have amassed so much power over our personal data and what information we see. As a startup investor and former product executive at a social media startup, I can especially sympathize with concerns that these large tech companies have created an unfair playing field for smaller companies.

    At the same time, though, I’m mindful of all the benefits that the tech industry — including the “tech giants” — have brought: amazing products and services, broader and cheaper access to markets and information, and a tremendous wave of job and wealth creation vital to may local economies. For that reason, despite my concerns of “big tech”‘s growing power, I am wary of reaching for “quick fixes” that might change that.

    As a result, I’ve been disappointed that much of the discussion has centered on knee-jerk proposals like imposing blanket stringent privacy regulations and forcefully breaking up large tech companies. These are policies which I fear are not only self-defeating but will potentially put into jeopardy the benefits of having a flourishing tech industry.

    The Challenges with Regulating Tech

    Technology is hard to regulate. The ability of software developers to collaborate and build on each other’s innovations means the tech industry moves far faster than standard regulatory / legislative cycles. As a result, many of the key laws on the books today that apply to tech date back decades — before Facebook or the iPhone even existed, making it important to remember that even well-intentioned laws and regulations governing tech can cement in place rules which don’t keep up when the companies and the social & technological forces involved change.

    Another factor which complicates tech policy is that the traditional “big is bad” mentality ignores the benefits to having large platforms. While Amazon’s growth has hurt many brick & mortar retailers and eCommerce competitors, its extensive reach and infrastructure enabled businesses like Anker and Instant Pot to get to market in a way which would’ve been virtually impossible before. While the dominance of Google’s Android platform in smartphones raised concerns from European regulators, its hard to argue that the companies which built millions of mobile apps and tens of thousands of different types of devices running on Android would have found it much more difficult to build their businesses without such a unified software platform. Policy aimed at “Big Tech” should be wary of dismantling the platforms that so many current and future businesses rely on.

    Its also important to remember that poorly crafted regulation in tech can be self-defeating. The most effective way to deal with the excesses of “Big Tech”, historically, has been creating opportunities for new market entrants. After all, many tech companies previously thought to be dominant (like Nokia, IBM, and Microsoft) lost their positions, not because of regulation or antitrust, but because new technology paradigms (i.e. smartphones, cloud), business models (i.e. subscription software, ad-sponsored), and market entrants (i.e. Google, Amazon) had the opportunity to flourish. Because rules (i.e. Article 13/GDPR) aimed at big tech companies generally fall hardest on small companies (who are least able to afford the infrastructure / people to manage it), its important to keep in mind how solutions for “Big Tech” problems affect smaller companies and new concepts as well.

    Framework for Regulating “Big Tech”

    If only it were so easy… Source: XKCD

    To be 100% clear, I’m not saying that the tech industry and big platforms should be given a pass on rules and regulation. If anything, I believe that laws and regulation play a vital role in creating flourishing markets.

    But, instead of treating “Big Tech” as just a problem to kill, I think we’d be better served by laws / regulations that recognize the limits of regulation on tech and, instead, focus on making sure emerging companies / technologies can compete with the tech giants on a level playing field. To that end, I hope to see more ideas that embrace the following four pillars:

    I. Tiering regulation based on size of the company

    Regulations on tech companies should be tiered based on size with the most stringent rules falling on the largest companies. Size should include traditional metrics like revenue but also, in this age of marketplace platforms and freemium/ad-sponsored business models, account for the number of users (i.e. Monthly Active Users) and third party partners.

    In this way, the companies with the greatest potential for harm and the greatest ability to bear the costs face the brunt of regulation, leaving smaller companies & startups with greater flexibility to innovate and iterate.

    II. Championing data portability

    One of the reasons it’s so difficult for competitors to challenge the tech giants is the user lock-in that comes from their massive data advantage. After all, how does a rival social network compete when a user’s photos and contacts are locked away inside Facebook?

    While Facebook (and, to their credit, some of the other tech giants) does offer ways to export user data and to delete user data from their systems, these tend to be unwieldy, manual processes that make it difficult for a user to bring their data to a competing service. Requiring the largest tech platforms to make this functionality easier to use (i.e., letting others import your contact list and photos with the ease in which you can login to many apps today using Facebook) would give users the ability to hold tech companies accountable for bad behavior or not innovating (by being able to walk away) and fosters competition by letting new companies compete not on data lock-in but on features and business model.

    III. Preventing platforms from playing unfairly

    3rd party platform participants (i.e., websites listed on Google, Android/iOS apps like Spotify, sellers on Amazon) are understandably nervous when the platform owners compete with their own offerings (i.e., Google Places, Apple Music, Amazon first party sales). As a result, some have even called for banning platform owners from offering their own products and services.

    I believe that is an overreaction. Platform owners offering attractive products and services (i.e., Google offering turn-by-turn navigation on Android phones) can be a great thing for users (after all, most prominent platforms started by providing compelling first-party offerings) and for 3rd party participants if these offerings improve the attractiveness of the platform overall.

    What is hard to justify is when platform owners stack the deck in their favor using anti-competitive moves such as banning or reducing the visibility of competitors, crippling third party offerings, making excessive demands on 3rd parties, etc. Its these sorts of actions by the largest tech platforms that pose a risk to consumer choice and competition and should face regulatory scrutiny. Not just the fact that a large platform exists or that the platform owner chooses to participate in it.

    IV. Modernizing how anti-trust thinks about defensive acquisitions

    The rise of the tech giants has led to many calls to unwind some of the pivotal mergers and acquisitions in the space. As much as I believe that anti-trust regulators made the wrong calls on some of these transactions, I am not convinced, beyond just wanting to punish “Big Tech” for being big, that the Pandora’s Box of legal and financial issues (for the participants, employees, users, and for the tech industry more broadly) that would be opened would be worthwhile relative to pursuing other paths to regulate bad behavior directly.

    That being said, its become clear that anti-trust needs to move beyond narrow revenue share and pricing-based definitions of anti-competitiveness (which do not always apply to freemium/ad-sponsored business models). Anti-trust prosecutors and regulators need to become much more thoughtful and assertive around how some acquisitions are done simply to avoid competition (i.e., Google’s acquisition of Waze and Facebook’s acquisition of WhatsApp are two examples of landmark acquisitions which probably should have been evaluated more closely).

    Wrap-Up

    Source: OECD Forum Network

    This is hardly a complete set of rules and policies needed to approach growing concerns about “Big Tech”. Even within this framework, there are many details (i.e., who the specific regulators are, what specific auditing powers they have, the details of their mandate, the specific thresholds and number of tiers to be set, whether pre-installing an app counts as unfair, etc.) that need to be defined which could make or break the effort. But, I believe this is a good set of principles that balances both the need to foster a tech industry that will continue to grow and drive innovation as well as the need to respond to growing concerns about “Big Tech”.

    Special thanks to Derek Yang and Anthony Phan for reading earlier versions and giving me helpful feedback!

  • The Four Types of M&A

    I’m oftentimes asked what determines the prices that companies get bought for: after all, why does one app company get bought for $19 billion and a similar app get bought at a discount to the amount of investor capital that was raised?

    While specific transaction values depend a lot on the specific acquirer (i.e. how much cash on hand they have, how big they are, etc.), I’m going to share a framework that has been very helpful to me in thinking about acquisition valuations and how startups can position themselves to get more attractive offers. The key is understanding that, all things being equal, why you’re being acquired determines the buyer’s willingness to pay. These motivations fall on a spectrum dividing acquisitions into four types:

    • Talent Acquisitions: These are commonly referred to in the tech press as “acquihires”. In these acquisitions, the buyer has determined that it makes more sense to buy a team than to spend the money, time, and effort needed to recruit a comparable one. In these acquisitions, the size and caliber of the team determine the purchase price.
    • Asset / Capability Acquisitions: In these acquisitions, the buyer is in need of a particular asset or capability of the target: it could be a portfolio of patents, a particular customer relationship, a particular facility, or even a particular product or technology that helps complete the buyer’s product portfolio. In these acquisitions, the uniqueness and potential business value of the assets determine the purchase price.
    • Business Acquisitions: These are acquisitions where the buyer values the target for the success of its business and for the possible synergies that could come about from merging the two. In these acquisitions, the financials of the target (revenues, profitability, growth rate) as well as the benefits that the investment bankers and buyer’s corporate development teams estimate from combining the two businesses (cost savings, ability to easily cross-sell, new business won because of a more complete offering, etc) determine the purchase price.
    • Strategic Gamechangers: These are acquisitions where the buyer believes the target gives them an ability to transform their business and is also a critical threat if acquired by a competitor. These tend to be acquisitions which are priced by the buyer’s full ability to pay as they represent bets on a future.

    What’s useful about this framework is that it gives guidance to companies who are contemplating acquisitions as exit opportunities:

    • If your company is being considered for a talent acquisition, then it is your job to convince the acquirer that you have built assets and capabilities above and beyond what your team alone is worth. Emphasize patents, communities, developer ecosystems, corporate relationships, how your product fills a distinct gap in their product portfolio, a sexy domain name, anything that might be valuable beyond just the team that has attracted their interest.
    • If a company is being considered for an asset / capability acquisition, then the key is to emphasize the potential financial trajectory of the business and the synergies that can be realized after a merger. Emphasize how current revenues and contracts will grow and develop, how a combined sales and marketing effort will be more effective than the sum of the parts, and how the current businesses are complementary in a real way that impacts the bottom line, and not just as an interesting “thing” to buy.
    • If a company is being evaluated as a business acquisition, then the key is to emphasize how pivotal a role it can play in defining the future of the acquirer in a way that goes beyond just what the numbers say about the business. This is what drives valuations like GM’s acquisition of Cruise (which was a leader in driverless vehicle technology) for up to $1B, or Facebook’s acquisition of WhatsApp (messenger app with over 600 million users when it was acquired, many in strategic regions for Facebook) for $19B, or Walmart’s acquisition of Jet.com (an innovator in eCommerce that Walmart needs to help in its war for retail marketshare with Amazon.com).

    The framework works for two reasons: (1) companies are bought, not sold, and the price is usually determined by the party that is most willing to walk away from a deal (that’s usually the buyer) and (2) it generally reflects how most startups tend to create value over time: they start by hiring a great team, who proceed to build compelling capabilities / assets, which materialize as interesting businesses, which can represent the future direction of an industry.

    Hopefully, this framework helps any tech industry onlooker wondering why acquisition valuations end up at a certain level or any startup evaluating how best to court an acquisition offer.

    Thought this was interesting? Check out some of my other pieces on how VC works / thinks

  • Our Job is Not to Make Money

    Let’s say you pitch a VC and you’ve got a coherent business plan and some thoughtful perspectives on how your business scales. Does that mean you get the venture capital investment that you so desire?

    Source: Toothpaste for Dinner

    Not necessarily. There could be many reasons for a rejection, but one that crops up a great deal is not anything intrinsically wrong with a particular idea or team, but something which is an intrinsic issue with the venture capital model.

    One of our partners put it best when he pointed out, “Our job is not to make money, it’s to make a lot of money.”

    What that means is that venture capitalists are not just looking for a business that can make money. They are really looking for businesses which have the potential to sell for or go public (sell stock on NYSE/NASDAQ/etc) and yield hundreds of millions, if not billions of dollars.

    Why? It has to do with the way that venture capital funds work.

    • Venture capitalists raise large $100M+ funds. This is a lot of money to work with, but its also a burden in that the venture capital firm also has to deliver a large return on that large initial amount. If you start with a $100M fund, its not unheard of for investors in that fund to expect $300-400M back – and you just can’t get to those kinds of returns unless you bet on companies that sell for/list on a public market for a lot of money.
    • Although most investments fail, big outcomes can be *really* big. For every Facebook, there are dozens of wannabe copycats that fall flat – so there is a very high risk that a venture investment will not pan out as one hopes. But, the flip side to this is that Facebook will likely be an outcome dozens upon dozens of times larger than its copycats. The combination of the very high risk but very high reward drive venture capitalists to chase only those which have a shot at becoming a *really* big outcome – doing anything else basically guarantees that the firm will not be able to deliver a large enough return to its investors.
    • Partners are busy people. A typical venture capital fund is a partnership, consisting of a number of general partners who operate the fund. A typical general partner will, in addition to look for new deals, be responsible for/advise several companies at once. This is a fair amount of work for each company as it involves helping companies recruit, develop their strategy, connect with key customers/partners/influencers, deal with operational/legal issues, and raise money. As a result, while the amount of work can vary quite a bit, this basically limits the number of companies that a partner can commit to (and, hence, invest in). This limit encourages partners to favor companies which could end up with a larger outcome than a smaller, because below a certain size, the firm’s return profile and the limits on a partner’s time just don’t justify having a partner get too involved.

    The result? Venture capitalists have to turn down many pitches, not because they don’t like the idea or the team and not even necessarily because they don’t think the company will make money in a reasonably short time, but because they didn’t think the idea had a good shot at being something as big and game-changing as Google, Genentech, and VMWare were. And, in fact, the not often heard truth is that a lot of the endings which entrepreneurs think of as great and which are frequently featured on tech blogs like VentureBeat and TechCrunch (i.e. selling your company to Google for $10M) are actually quite small (and possibly even a failure) when it comes to how a large venture capital firm views it.

    Thought this was interesting? Check out some of my other pieces on how VC works / thinks