Let’s play a quick round of “Which Investment Is Less Risky?”
Here are your choices:
Start-up A: 7 years in business. Millions in revenue. Current value of $10 billion.
Start-up B: 1 year of business. Hardly any revenue. Current value of $1 million.
OK, so which investment is less risky?
The answer might surprise you.
Buy High… Sell Higher?
Remember the old investing proverb, “Buy Low, Sell High”?
There’s a reason it’s stood the test of time:
But recently, the start-up world seems to be trying out a new saying:
“Buy High, Sell Higher.”
Venture funds, hedge funds, and mutual funds are pouring capital into start-ups…
And valuations (i.e., a private company’s value) have been soaring:
Investors put about $150 million into Wayfair, an e-commerce company, at a $2 billion valuation.
They put $740 million into “big data” company Cloudera at a $4 billion valuation…
And they’re talking about putting $500 million into Airbnb at a $10 billion valuation.
These investors are buying high.
They’re willing to do so because they believe they can sell higher…
But are the odds in their favor?
The Real Range For M&A
Statistically speaking, the odds aren’t good.
There are two ways to sell higher. A company can go public, or it can be acquired.
Going public tends to be a long shot. Sometimes the markets are just hostile.
And according to PricewaterhouseCoopers and data from Thomson Reuters, most technology M&A (Mergers & Acquisitions) takes place below $100 million.
In fact, if you look at the M&A patterns of acquisitive tech giants like Google or Yahoo, you’ll see that most of their deals are in the $30 million to $50 million range.
Sure, Yahoo bought Tumblr last year for $1 billion…
But that sort of price tag is the exception, not the rule.
In the same time frame as the Tumblr acquisition, Yahoo bought Summly for $30 million, Lexity for $35 million, Xobni for $40 million, and Qwiki for $50 million.
Those are typical M&A prices. That’s the real range for start-up M&A.
Keep in mind that acquisitions in this range can benefit everyone:
The big companies get innovation and talent at a price they can afford…
And for a start-up that raised its seed capital when it was valued at, say, $5 million, a $50 million acquisition would earn its investors a 10x return.
Not too shabby.
Remember The Odds
Occasionally, there’s a good reason to buy high…
If a company has tons of customers and substantial revenues, conventional wisdom says it’s a less risky business – and that should be reflected in its valuation.
But just because a company’s not at risk of going out of business, that doesn’t mean it’s a less risky investment.
Remember: Most M&A takes place in the $30 million to $50 million range.
If you’re looking for a 10x return (10x is the bogey for many professional investors), the data suggest that you should be investing at valuations of $5 million or less.
If you’re investing at a higher valuation than that, you should be expecting the company to be acquired for more than $50 million…
Or you need to lower your return expectations.
Bring Me That Deal!
Are there any good deals out there that you can “buy low”?
It’s called Bring Me That. It’s an online food delivery service for small and medium-sized cities.
It has a strong team, a good product, and a big market opportunity. (It also has a great lead investor – a professional VC who you can “follow” into the deal.)
If it’s acquired in the future for about $15 million, you could potentially make 10x.
That sounds like our kind of deal…
(Please note: Crowdability has no financial relationship with Bring Me That, or with SeedInvest, the platform where its crowdfunding campaign is hosted. Crowdability is an independent provider of equity crowdfunding research and education.)