M&A or IPO?

Recently, my fellow Greylock investor Saam Motamedi and I examined the question of how the Covid-19 pandemic has affected venture investing, and what entrepreneurs should do in response. This week, I’d like to turn to the question of how current market conditions affect the approach entrepreneurs should take towards their exit strategy.

The fundamental choice that venture-backed entrepreneurs face is simple: M&A or IPO?

I discussed this at length in the most recent episode of Greymatter. You can listen to that here.

The short answer is that it almost never makes sense to start a company with the intent of selling it. You incur nearly as much risk, and shed as much blood, sweat, and tears whether you sell or go public. And even though only a small set of companies succeed in going public, the value of going public is such that the expected value of going public is mammothly higher.

In 10-plus years of being around the table at Greylock, I have never seen us invest in a company where we didn’t plan on going public. We’re looking for market opportunities where in about a decade, we can help transform an industry and build an iconic company.

The big problem with building to sell is that companies are bought, not sold.

There isn’t a marketplace for selling venture-backed companies like there’s a marketplace for selling computers. You can’t just roll up and say, “I’ve got one of X. Would you like to buy one of X at the market clearing price of Y?”

Companies make acquisitions based on strategic goal that are aligned with their inner workings. The larger company has to decide, “What you do is key to one of my strategies, so I’ll buy you.” Acquirers never think, “I’m in a buying mood–let’s see what’s for sale this week!”

As a result, in a very real sense, it’s harder to build your company to sell than it is to build it to go public because if you’re aiming to go public, at least you know what public market investors want to see.

Even worse, when you offer to sell your company, you are signaling that you as a knowledgeable insider are fundamentally worried about your company’s ability to succeed.

Fortunately, there is one approach that allows you to build to go public AND to sell.

If you build strategic value, then even if it’s still unclear how you’ll generate economic value, you’ll create an asset acquirers will want to buy. It could be a user base, a dataset, a unique technology, or some combination of the above factors.

This strategic value-oriented approach is one of the things that gives Silicon Valley its crazy reputation among traditional investors, who live and die by financial metrics. Those traditional investors ask, “What’s your business model?” When the answer is, “We’re not sure, but we’re going to work it out,” they conclude that the company is being built to sell.

That focus on short-term financial metrics is shortsighted. When you build massive strategic value, you can generally build massive economic value at some point.

Google began by building a better search engine, which mystified financial investors who had already concluded that search was low value. Google tried to make money by selling search appliances to enterprises. That effort failed, and more than a year into Google’s history, there wasn’t a viable business model. But even as there was no clear economic value, Google was building amazing strategic value in its index and traffic, which it eventually monetized with AdWords. (I’ll cover this story in greater depth with Susan Wojcicki in a future episode of Masters of Scale.)

One of the key insights of blitzscaling is that it’s worth it to blitzscale (i.e. prioritize speed over efficiency) when you believe you can build strategic value, even if there are many unknowns and uncertainties around the revenue model.

You blitzscale to win a valuable winner-take-most market. If you win that market, you’re going to be valuable as an acquisition. You’re also going to be valuable and attractive as an IPO candidate.

You don’t need to focus on your IPO financial metrics from day one. In fact, that approach is a catastrophic mistake, because it will likely make you slower than the competition to build strategic value.

Once you build sufficient strategic value, you have the choice of whether to sell or go public.

At PayPal, we built strategic value by focusing on building our payment network – buyers and sellers – rather than on building revenues. That gave us the power to choose our exit strategy. In fact, before we went public, Peter Thiel sent me out on a mission to sell the company for $600 million, which is what we felt was the fair value of the company at the time. Even though we got an offer for $550 million from VeriSign, we turned it down and continued to build towards an IPO.

Later, even closer to the IPO, we had discussions with eBay about acquiring the company. Our target price was $1 billion, and when eBay wouldn’t offer more than $850 million, we turned down their offer and went public. eBay finally acquired PayPal for $1.5 billion.

Now that PayPal has been spun out, and is a $200 billion company, some argue that selling to eBay was a mistake. I think this ignores the boost that PayPal’s business received from becoming part of eBay. Prior to the acquisition, eBay was actively discouraging customers from using PayPal, and we were handling about a quarter of eBay’s transactions. Afterwards, that headwind switched to a tailwind, and PayPal rapidly grow to substantially all of eBay’s transactions. A PayPal that stayed independent would probably be much less valuable today.

The PayPal example demonstrates that even companies that plan to go public are well-served by considering the possibility of M&A.

In fact, having this discussion is a valuable way to test what I call the “pivoting rationality” of the founders. When a founder tells me, “There’s no chance we’ll sell; I’m not going to think about anything other than going public,” I think, “Wow, you’re either lying to yourself or lying to me because nothing in life is that certain.”

I’d much rather work with an ambitious but adaptable founder who says, “We think we have a really strong chance to IPO. But we’re building incredible strategic value along the way, and even if we only succeed at building the following parts of our vision, we will be valuable to the following players.”

As a company builds towards its IPO, it’s critical to realize that going public is not the ultimate goal; it’s a means to achieving your goals, which means you should have explicit and clearly articulated business reasons for the IPO.

For example, at LinkedIn, going public was essentially a marketing strategy. We realized that a major chunk of our professional base, both individual professionals and the corporate recruiting customers that account for the majority of company revenues, pays close attention to the business press, and the business press pays close attention to IPOs. Going public allowed us to better tell our story to our users and customers.

One of the key storytelling tools for the pre-IPO company is its S-1 filing. A central part of an S-1 is accurately identifying your major risk factors and sharing them with investors. The companies that successfully go public tell a compelling story in their S-1.

Sometimes, of course, the opposite happens. WeWork’s S-1 is the canonical example of how this can go wrong. Not only did the S-1 reveal that its growth was due to massive expenditures, its vague and unrealistic assertions about its business repelled serious investors.

Of course, even after a company has been publicly-traded for years, it may still make sense to be acquired. Just as with the IPO, the acquisition should achieve a strategic purpose, but unlike the IPO, it needs to do so for both sides of the transaction.

When we sold LinkedIn to Microsoft, one of our primary motivations was that we felt that we needed to be a world-class enterprise software company. While LinkedIn generated most of its revenues from corporate customers, our focus was always on the individual unpaid users. We weren’t slouches at the enterprise game, but Microsoft is the best player in the world, and we knew we could learn a tremendous amount.

Meanwhile Satya Nadella wanted to bring in LinkedIn’s consumer focus and startup culture, which fit well with how he planned to evolve Microsoft. That’s why he took an unusual but brilliant approach to the acquisition.

A couple of months before the deal closed. Satya called Jeff Weiner and I and said, “Why don’t we put Jeff in charge of the acquisition?” This was an unprecedented move. I’m not a business historian, but typically the acquiring company appoints one of its executives to lead the transaction.

I’m certain there were people on the Microsoft side who thought Satya was crazy, but it was genius because Satya realized this approach was the clearest way to show Jeff that Microsoft was serious about preserving the LinkedIn culture and DNA, and that Jeff is the ultimate collaborator, and would try to find a way to make the transaction work for Microsoft as well. The intervening years have proven the brilliance of Satya’s idea.

In the end, the question of M&A or IPO is a question of means, not ends. They may help you translate strategic value into economic value, but the most important task is creating that value in the first place. If the best way to achieve lasting impact is to join forces with one of the giant tech companies, then find an approach to M&A that creates even more strategic value from the combination, as Satya and Jeff did with Microsoft and LinkedIn. But I think we’re moving towards a world with more giant tech companies, not fewer. And if going public allows you to accelerate your creation of strategic value, perhaps someday your company will be able to claim its place among the iconic companies, as PayPal eventually did.

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