The Toothbrush Test

Who do you think the Technology firms in the Silicon Valley contact when they want to acquire a startup or some other established company? If you answered Wall Street Bankers, then you clearly aren't up to speed with the way Silicon Valley deals with Mergers & Acquisitions in the 21st century. It isn’t new for the technology companies to behave like investment banks but this is the first act by them of replacing Wall Street firms in its entirety. But the fact that the technology firms are successfully able to make deals on their own is only baffling to the investment banks and no one else!

The term “Toothbrush test” was first coined by Google co-founder & chief executive Larry Page. For the past few years there has been a lot of wheeling and dealing in the technology industry in terms of buyouts and acquisitions. Recently Apple closed a deal worth $3 Billion to buy headset company Beats Electronics. After the deal was finalized, Apple CEO Tim Cook announced that there was no involvement from Wall Street Banks either in terms of financing or advising which shocked very few people. Earlier in the year when Google bought Waze for $1.1 billion and when Facebook bought WhatsApp for a record $19 billion, the M&A heads of the big banks had no knowledge about it. It isn’t as if the technology firms don’t value or look into the financials of the firm they buy, they look at it from a much different angle compared to the bankers.

Companies like Google, Apple and Facebook have been beefing up their internal M&A or corporate development departments which consists of former bankers from Wall Street. These bankers either are those who got tired working long hours as analysts in banks or wanted to join the recent trend of working in t-shirt & jeans. Their job role is essentially the same as it was in financial services industry but they are trained to look differently at a potential target. Instead of just looking at numbers and financials, these new breed of tech-bankers look at the potential and talent that a company can bring with it. The negotiation aspect of acquiring a new firm is left to the C-level executives unlike in other industries where the M&A guys first reach out with the idea of buyout.  

The reasoning behind not using investment banks is the belief among many tech executives that banks who act as advisors on the deal lack the humane touch and their thinking don’t align with the needs of today’s tech companies. Bankers usually try to look for ways to increase the profit margin & money savings in the short term when they look for acquisition targets. But tech companies act in a different horizon, instead of profit margins they look for potential and prospective in early stage tech companies. Often investment banks only look at potential targets which are stable companies with a successful business models. Private equity firms and hedge funds usually look out after underperforming companies and use their expertise to turn around their acquisition’s’ business model. Majority of tech companies follow the ideology of private equity firms in which they make big bets on future instead of the present. The tech companies prefer to instead go to venture capitalist and entrepreneurs instead for advice and very rarely even for financing.  This gap between Wall Street & Silicon Valley is increasingly widening with the tech companies dictating their own terms when it comes to Mergers and Acquisitions.

Link to the original article: http://dealbook.nytimes.com/2014/08/17/in-silicon-valley-mergers-must-meet-the-toothbrush-test/