Tech investors are minting money right now…
Especially the ones who invest in private start-ups:
In 2014 alone, acquisitions have netted them more than $100 billion.
With tech M&A running at its highest level since 2000, you might think you can blindly bet on any company, at any price, and make money.
Fan The Flames
Despite splashy IPOs like Alibaba (NYSE: BABA), the hottest part of the market right now is Mergers & Acquisitions.
And “mega” transactions, like Facebook’s $19 billion purchase of WhatsApp, or Apple’s acquisition of Beats for $3 billion, are continuing to fan the flames.
Many factors are contributing to this trend – from the mountains of cash that big acquirers like Apple have on their books, to a rush to buy young companies that have figured out the all-important mobile market.
Competition among the “usual suspects” hasn’t hurt, either:
In the last twelve months alone, Yahoo! has acquired twenty-four different companies. Google’s acquired thirty-six of them.
Facebook, Microsoft and Twitter have acquired dozens more.
An Overlooked Insight
But there’s a downside to all this activity:
As the market gets hotter, it’s driving up the valuation of early-stage companies.
“Valuation” is the private-company equivalent of a public company’s “market cap” – and paying attention to it is an essential part of making money in private equity.
The reason it’s so important might seem obvious…
But it’s an insight that’s often overlooked by private investors:
The price you pay for an investment determines how much money you can earn.
And the smartest people don’t pay up.
How The Professionals Play It
The professional investors who’ve been sharing their strategies with us over the last year showed us the data, and they pointed out the math:
First of all, M&A – getting acquired – is the most common type of “exit” for a start-up.
Secondly, despite the multi-billion dollar acquisitions that we read about, most M&A takes place under $100 million.
And lastly, if you dig deeper… you’ll find that most of those acquisitions take place at about $30 million to $50 million.
So the math becomes pretty clear:
If your goal is to earn 10 times your money on a start-up that might get acquired for $30 to $50 million (and yes: 10 times your money should be your goal for each investment), you need to invest at valuations below $5 million.
Furthermore, as we learned from the pros, all those sub-$50 million exits – all the singles, double and triples – can really add up:
Average annual returns for professional angels are 27% – that’s almost 4 times higher than the average stock market return of 8% per year.
The Wall Street Journal recently reported that average start-up valuations in Q1 2014 were up 85% over the previous quarter.
We’re beginning to get into the danger zone.
Sure, since you often read about start-ups getting acquired for billions, you might think it doesn’t matter if you “pay up” a bit…
But before you pay up, remember the stats:
Most acquisitions take place between $30 million and $50 million — not at $19 billion.
So never forget:
When you’re investing in early-stage companies, you should be investing at valuations below $5 million.