(Originally published on November 6, 2014)
Google. Apple. Facebook. Yahoo. Twitter. AOL. Amazon. The list of big companies that choose to buy their way into a product or market rather than build it themselves. And these are just tech companies. What about Berkshire Hathaway? Merck? GE?
The tech industry is a fun one to ponder because here are companies with arguably some of the smartest people working for them and with at times limitless resources. So why then would they want to buy when they can certainly build for less? Not only can they build for less, but many, like Facebook or Google, have the built in network effects to instantly scale what they've built. Just look at Facebook Messenger.
Build versus buy is a question that still has me shaking my head at wonder, and while I have partially lived it, yesterday, I had the chance to talk to two entrepreneurs who used to be intrapreneurs. They shared their personal experiences of what it is like trying to build internally and why they left.
The two entrepreneurs are not from the tech industry but the events industry. It is an industry that I have grown to love, even though in our tech centric world, saying you create events causes those high on the tech juice to look at you with a mix of sympathy and bewilderment, as though they are trying not to say out loud, "Oh you poor thing. Could you not get into a tech company?"
Assuming for a moment that some of those outside of tech have valid insights on business, I thought I would share what for me are two really interesting reasons why companies buy. They are reasons that until recently I didn't have enough insight or exposure to understand, and these intra-turned-entre-preneurs represent one of each.
There Is No "I" in Bureaucracy but there is "Money"
Big company bureaucracy is a pretty obvious reason why entrepreneurs leave. But the "bureaucracy" is often not just a function of size. It's usually about money and increasing or at least protecting their valuation. We're not talking about the valuations based off non-financial metrics like users or market potential but those based off revenue and earnings… something large event companies do very well.
So, we'll use an example from the events world. New events are like any business. They require investment, and very rarely do they make money on the first go round. Compounding things, rarely will you know from the gate whether something is worth doing again. Assume then that a large events company wants to launch a new brand, and for simplicity's sake every test will cost them $100,000. If they allow ten tests (which could be five shows for two years or 10 for one year), that is $1.0 mm in costs. If they are valued at 10x earnings, that $1.0mm off their bottom line, represents $10mm off their valuation.
Yet, if they purchase even a marginally profitable company for $10mm, even though they have technically spent $10mm, their valuation doesn't just stay the same, it can increase. And, given that their business is one of real revenues, it means they most likely have access to debt at attractive rates so that they can spend this money against future earnings (from the acquired company) rather than using their own cash.
It may sound simplistic, perhaps selfish, but if someone makes a company a lot of money, at some point in their career, they will start to weigh the value they feel they have created against the value they have received in return.
This is such a slippery slope, full of ego, entitlement, and exaggeration. But, for every number of those who do add value but are clearly smoking something with respect to what they feel they deserve, there are those who are truly capable of creating shareholder value from scratch in a new entity with them being a much larger shareholder.
Shareholder value is of course revenue but equity, and if someone is special and able to create both, then a company is truly lucky. But, that existing company structure almost always is the downfall, as it is virtually impossible to manage the company's valuation and pay the person in some direct fashion (without then hurting the valuation). The same way that food at a restaurant has baked into not just the food costs but all other overhead, a company at scale has to use the value created to distribute across the whole company even if one person plays an outsized role.
If you are not first, you aren't exactly last, but you aren't ever going to get a straight percentage upside. Each incremental dollar created means less directly to you. It's slightly perverse, but it's the reward a company gets and you get, but only if it is your company.
My thanks to these two business builders for sharing.