The second thing often misunderstood about tech valuations: How M&A acquirers decide how much money to pay for companies they buy. The key: The value of a tech company to public or private markets may be completely unrelated to the value of the same company to a corporate acquirer. Value of company X to acquirer Y often = Potential impact to acquirer Y’s business, which has a lot more to do with Y than X.
For example, in product businesses, you’ll often hear the term “attach rate” — acquirer Y can attach company X’s product to Y’s sales engine. Example: I sell $20B of servers/year; I buy storage company X doing $100M revenue/year; and I can attach X’s product to 20% of my server sales. I can generate new $20B*20% = $4B/year of storage sales attached to my server business. X’s standalone revenue is irrelevant. So I can pay up for storage company X based on its projected impact on MY business, way beyond X’s independent valuation.
Of course, for the deal to be good, I have to deliver that attach rate. But when it works, and it often does, it’s magical and worth doing. This is the literal meaning of attach rate, but there are other, such as, maybe I know how to better monetize something I buy than they do.
Large dollar acquisitions of small companies that seem irrational to outsiders almost always have a rigorous plan like this within the acquirer. It’s just nearly impossible to see from the outside, which is why many outsiders get so confused and upset at the time of acquisition.
But, on the other hand, we do not consider it safe for a tech startup to have a plan that DEPENDS on a large acquirer applying this logic. We only invest in startups that have a plan to be large independent dominant companies on their own, with great businesses in the long term. And the act of building for long-term independence makes you more attractive to potential acquirers, not less. So you can win both ways.