This is a summary of the presentation I’ve given couple of this times this year at the Aalto University. My viewpoint is strictly from the viewpoint of a technology entrepreneur in the software business. And as my personal experience in this field is still limited, this may partially illusional. If so, please share your experience!
Why Do Big Companies Buy Small Companies?
Big companies buy small companies because small companies are simply better at innovation than larger companies. Employees of a big company do not want to be seen as trying out a new idea and then abandoning the venture midstream if it does not work. The career of managers wishing to move up the corporate ladder do not want to have failures in their history. Now the world of innovations is such where small companies develop new products and services, gather early customers at high cost, and then sell the business to a large company. These large companies can use their existing distribution and/or manufacturing organization to turn the company bought into a large profitable business.
Employees of a big company do not want to be seen as trying out something and then abandoning the ventures midstream if they are not working out as expected.
Should Your Company Be Valued Based On Financials Or Strategic Value?
Many entrepreneurs view the value of their company as being tied to generating revenue and profit growth, but fail to appreciate how this view limits their ability to fully exploit their company’s potential. The key to the strategic value is having developed a product which has the potential to reach a very high level of sales, if it is given the proper resources. A company can also turn out to be very valuable if it targets the existing customers of a large company, solves a compelling need, and has good sustainable competitive advantages.
You can read more about the subject at Masterclass for Entrepreneurs on Strategic Exits: Insights on how to leverage strategic value to achieve a very high price when selling a business
It’s also worth remembering that in an acquisition process it’s not the buyer who will remind you about the strategic value of your company!
Valuing A Small Company In A Strategic Acquisition
Strategic value of a small company is often biggest part of the purchase price paid by a large company. Quite often it’s the case where:
- The small company has developed a product or a service to a new market segment
- The product contains such Intellectual Property which is hard to work around or takes long time to replicate
- The product is a threat to the acquirer or can boost the sales of the acquirer if bought
- If the product would be bought by a competitor, would cause serious trouble to the acquirer
Four motivations for an acquisition:
Strategic value occurs when a small company creates an asset or capability which large company can exploit over a large customer base. Since the value to the acquirer is based on the revenue which they can make rather than the revenue or profit which the small company has achieved (or could achieve in the future), the acquirer may be willing to pay many times the conventional market value. Just imagine how valuable your company would be if the customer base would suddenly be 50 or 100 times larger.
The value to the acquirer is based on the revenue which they can make rather than the revenue or profit which the small company has achieved (or could achieve in the future)
The best (and only) way for the small company to get this value is by creating some competitive tension between competing acquirers.
It’s Always A Complex Formula…
When you are talking to professional advisors, investment bankers, and business brokers they will often focus their analysis of your business on what profit you are achieving now, and what your likely revenue and profit growth will be in the near-term future.
Most private companies are heavily constrained because of lack of finances, limited capacity, poor access to large distribution channels, or lack of some skills (just to name some obstacles). In the hands of a better resourced and more capable buyer, the underlying potential can be achieved quicker.
Growing Serial Entrepreneurs Makes Sense
So why should you consider the exit anyway? It may not be the most important thing to focus on the early days of a startup, but on the other hand, having no ideas regarding an exit may mean that you’re building something that turns out to be of low value. Worst of all, focusing on some specific segment at the same time as somebody else has already implemented it (copying) is not clever either.
But finally, after you have successfully sold your company, you can either start a new business, buy a stake in someone else’s business, or become a private investor. Serial Entrepreneurs are, after all, those who have started and exited several businesses. Just starting many businesses doesn’t count.