In Business Negotiation, Beware Overbidding: Lessons from Facebook

By — on / Business Negotiations

Facebook’s $19.6 billion acquisition of text-messaging start-up WhatsApp seemed exorbitant when it was negotiated back in February. But as it turns out, the final price tag on the fifth-largest technology deal ever turned out to be even higher.

Facebook agreed to pay WhatsApp’s owners primarily in stock and only $4 billion of the $19.6 billion in cash.

Because the deal relied so heavily on Facebook stock, its final cost was uncertain, reports Steven Davidoff Solomon in the New York Times. It took about eight months for the deal to secure regulatory approvals. By the time it closed, on October 6, Facebook’s stock price had risen from about $68 a share in February to $77.56 a share. As a result, the final value of the deal climbed from $19.6 billion to $21.8 billion. WhatsApp employees will be able to begin selling their Facebook shares at the end of October.

Paying More Than You Should? The way negotiators pay may affect how much they pay

Thus, Facebook ended up paying $3 billion more because it issued stock rather than paying for WhatsApp entirely in cash. A few billion might be “chump change” for Facebook, but the amount clearly had value to the company’s shareholders, notes Solomon.

The discrepancy between WhatsApp’s initial and ultimate price to Facebook highlights the fact that the way negotiators pay for their purchases affects how much they pay for them. As Solomon writes, companies that plan to pay for their purchases with cash are bound to be more concerned about overpaying than those that include a significant stock component in their deals. The hit to their bottom line will feel more “real” if they pay cash than if they promise stock that won’t be paid out until a later date.

As a result, those that pay cash are likely to offer their targets less, drive a harder bargain, and get a better deal. Outside Silicon Valley, acquiring firms appear to recognize this. Cautionary tales from the technology bubble and bust, such as the AOL/Time Warner merger, are leading a majority of them—67% in 2013—to pay for their purchases completely in cash, according to Solomon.

The situation suggests a risk faced by both individuals and organizations that are thinking about making a significant purchase. When we plan to pay cash, we are likely to be more frugal, due to our awareness of how much lighter our wallets and balance sheets will be after the deal is signed. By contrast, if we are funding the purchase with a loan or with stock, we may be tempted to overpay just to win the prize. After all, funds that we won’t have to pay until later can seem like so much “funny money.”

Focusing on Short-Term Costs at a Long-Term Expense

Taken to the extreme, this tendency explodes into a disaster like the subprime mortgage crisis, where banks gave unqualified borrowers loans they had no chance of paying off. But all of us are susceptible to focusing on short-term rather than long-term costs when bidding on a desired commodity.

Clearly, the first key to avoiding this temptation is to pay in cash when possible. When that isn’t possible, to consider if this is reason enough to walk away.

When you are seriously thinking about using long-term financing to make a major purchase—whether it be a car, a house, or a company—thoroughly research the commodity’s worth, and consult with financial advisors who have no stake in the sale to determine what you can realistically afford.

Business Negotiation Strategies

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