More than $100 billion in technology mergers and acquisitions has been announced in the United States so far this year, a level not seen since 2000, according to financial software company Dealogic. Among the most notable acquisitions, Google paid $3.2 billion for thermostat and smoke alarm maker Nest Labs in January, and Facebook shelled out a stunning $19 billion for instant-messaging service WhatsApp in February.
Not only are the number and size of the deals raising eyebrows but so is the way they’re being conducted. Typically when a large company is thinking about expansion, its first step is to hire a Wall Street investment bank to seek out worthy targets, evaluate their financial health, and lead any negotiations that follow. As their clients’ agents, bankers are expected to bring a wealth of experience and know-how to the table in exchange for their hefty fees.
In Silicon Valley, that model is changing. Technology firms are increasingly choosing to rely on in-house corporate development teams to find targets, conduct due diligence, and negotiate, David Gelles reports in the New York Times. The percentage of companies that negotiated acquisitions without an investment bank in deals exceeding $100 million leaped from 27% to 69% in the past 10 years, according to Dealogic. Apple, Facebook, and Google have all recently made billion-dollar-plus deals without the help of bankers. As we will see, the trend suggests both the pros and cons of negotiating in a complex environment without an agent.
The rationale for going it alone
At least three factors have inspired Silicon Valley executives to shun the services of investment banks in their dealmaking:
1. Clashing objectives. The decision to conduct negotiations in-house may be rooted in fundamentally different goals for conducting acquisitions. Because bankers typically favor deals that will bolster the acquiring company’s earnings per share, they may lean toward pitching acquisitions of well-established companies. Indeed, Facebook’s vice president of corporate development, Amin Zoufonoun, told Gelles that bankers used to advise Facebook to buy up industry stalwarts such as Yelp and PayPal.
By contrast, Silicon Valley executives tend to be less interested in maximizing short-term earnings than they are in finding ways to adapt and innovate. As a result, they’re constantly on the hunt for start-ups that could produce the next big app or other technology. And many high-tech leaders believe they’re better positioned than bankers to identify promising technology start-ups in the relatively close-knit community of Silicon Valley.
2. Relationships instead of transactions. Some high-tech executives focus on building relationships with the heads of potential targets before even discussing the possibility of a transaction. To take one example, Kevin Systrom was a promising engineering student at Stanford University when he met Facebook CEO Mark Zuckerberg. The two kept in touch, and Zuckerberg began inviting Systrom over for dinner after Systrom founded Instagram. Their philosophical discussions transitioned naturally into conversations about how they might work together, and before long a $1 billion acquisition of Instagram was born. Zuckerberg forged a similar friendship with WhatsApp co-founder Jan Koum before opening up deal talks.
This gradual process of getting to know potential partners appears to be common in Silicon Valley. Compare that to the more transactional approach followed by many firms and their bankers, in which the idea of a deal usually precedes rapport building. This approach risks an overly narrow focus on reaching agreement on price to the exclusion of other important issues, such as how well the companies and their cultures will integrate and to what degree.
Given that banks are paid for their advisory services before deal implementation begins, they typically don’t have strong incentives to take a long-term perspective. To take one extreme example, in 2007, JPMorgan Chase advised real estate mogul Sam Zell to purchase the Tribune Company despite the private concerns of JPMorgan CEO Jamie Dimon and others at the bank that the deal was unlikely to be profitable over the long term—as turned out to be the case when the Tribune Company went bankrupt a year after the sale.
“The most important thing is that soft stuff,” Facebook’s Zoufonoun said to Gelles, referring to culture and vision. “And that soft stuff is more challenging for a bank or an adviser to tap into.”
3. Efficiency and cost. Some technology firms have calculated that hiring their own full-time bankers is more efficient and economical than paying by the deal, Gelles reports in the Times. Facebook, for example, hires bankers from Wall Street firms and allows them to run deals from start to finish, a change from the usual model of banks assigning analysts to different tasks.
Keeping a team of advisers on staff should theoretically give analysts stronger incentives to consider the firm’s long-term interests, as they can be held directly accountable for disappointing results. Yet just as banks face incentives to proceed with bad deals, in-house advisers may feel pressure to support deals that are championed by their bosses.
Notably, cost concerns seem to fly out the window when the next great start-up is accepting offers. Thanks to their deep pockets, technology firms may feel more comfortable going it alone than companies in many other industries.
Deciding when to seek help
The largest Silicon Valley companies have the financial latitude to take great risks with the expectation that their bottom line won’t suffer even if the deal doesn’t pay off. But how can the rest of us avoid the twin perils of giving too much responsibility to our agents and getting in over our heads?
1. Beware overconfidence. When executives with little dealmaking or financial experience run an acquisition, they can end up giving too much weight to their intuition and other subjective standards. Consider the “toothbrush test” that Google CEO Larry Page reportedly applies when considering whether an acquisition is worthwhile. According to Gelles, Page asks himself: “Is [the technology] something you will use once or twice a day, and does it make your life better?”
Though these are fine questions to ask, indicators of a firm’s financial health and stability should be given at least as much weight. When you lack expertise or connections in a particular dealmaking area, beware the tendency to be overconfident in your ability to get up to speed quickly. Lawyers, bankers, and other specialists take years to master the strategies, rules, and laws relevant to their work. Don’t assume that you can absorb this knowledge on the fly—or that your rules of thumb trump rational analysis.
2. Identify compatible strengths. Hiring an agent doesn’t have to be an all-or-nothing proposition. Even as they focus on finding targets and negotiating in-house, many tech companies continue to consult bankers for financing advice and fairness opinions (assessments of whether the deal terms are fair).
With this in mind, when meeting with potential agents, take ample time to discuss what you each bring to the table. Which one of you is better equipped to identify deal opportunities? Who should lead the negotiation, and should you both be present? What special insight can the agent provide into a deal’s merits? A good agent will recognize the strengths you bring to the table and be willing to divide up duties.
3. Align your values. Before hiring an agent, take steps to align her incentives with your values. This might mean negotiating a long-term financial arrangement with the agent, such as withholding some of her fee (or giving her a bonus) based on the agreement’s success a year or two down the line. You could also encourage your agents to take a long-range view by offering them positions in your organization, as many tech companies are doing. Finally, hire agents who have a reputation for executing deals that last—rather than those who simply take the money and run.
Working with the other side’s agent
Even when we carefully negotiate a relationship with our own agent, we typically overlook opportunities to use the other side’s agent to our advantage, according to Harvard Business School and Harvard Law School professor Guhan Subramanian. Here are three tips to help you do just that:
1. Capitalize on differing incentives. Just as your incentives will never be perfectly aligned with your agent’s, so it is across the table. If the other party’s agent would personally gain nothing from negotiating side issues such as contract duration and bonuses, you may be able to take advantage of this fact by pressing for concessions on these issues.
2. Threaten to go over their heads. Suppose you’re stuck in contentious negotiations with someone’s agent. You might be able to break the impasse by threatening to bring the person or people he represents to the table, particularly if the agent is misrepresenting his principal’s interests for his own benefit.
3. Work your way to the top. Even if the other party is planning to negotiate with you directly, you can recruit those around her as de facto agents: Try to sell them on your ideas, and encourage them to make the case to their boss.