With the Dow seeing its biggest one-day drop in three years, ending about 400 points lower after plummeting more than 500 points earlier in the day on the 27th of February, one could ask: “Does anyone know where this bull market is headed?”

Something new is happening not only in the way that the internet is shaping our lives this time round, but also in how new technology innovations are getting bedded down in the industry. Briefly put, venture capital-backed start-ups [a term I use for all high-growth private companies particularly in the technology sector] are being acquired much earlier by corporate enterprises who can offer scale to these entrepreneurs and who are looking to expand the way they grow new products and services. Most larger companies through their corporate development units operate a mixed economy where they balance the greater certainty of organic growth and its longer time horizon with the benefits of inorganic growth, namely an earlier starter position, and probably a more excellent innovation.

There has been a lot written about how much value destruction can happen by acquiring businesses.   Some would argue that if you’re clear about what drives the value, then acquisitions create value when they improve long term cash flows. The time frame is important here for assessing the improvement of cash flows, but so are the additional strategic value drivers and elements above and beyond financial value.

Clearly strategic value needs to be tied to financial value. However start-ups are not bought (necessarily) for the financial value they have. That’s part of it, but there’s more.   

Entrepreneurs have the greatest insight into how a particular market is developing – if they are good – as they are in the “eye of the tornado” and are dealing with how the markets are dynamically evolving real-time. Entrepreneurs also think differently. They see things that others don’t.They feel compelled to make things happen because something doesn’t exist which should. Sometimes that’s blind faith which leads to catastrophe, but more frequently, that’s great insight which is harnessed into a step change in how an industry operates. If a company acquires that asset of the entrepreneur’s insight and innovation, then they can lead in that industry breakthrough. Time and time again, we see that the benefits of market disruption and dislocation accrue to the number one and two players who embrace it. Said another way, the disrupter will be acquired by the entity they most disrupt, and embracing the disruption can be very value-enhancing.

It is common to refer to Google as a media firm today. The company entered a crowded market with better technology. Its unfair advantage was applying that better technology, specifically search algorithms, to the aggregration of audiences, which is what media firms do. Google figured its business model out later. Since going public in August 2004, it has become one of the largest media companies on earth. That game change occurred by a different approach – different thinking – and adding different technology to media.

Part of why corporates buy start-ups is to add new DNA to the corporate gene pool and introduce that new way of thinking into how they operate. Sometimes there is massive organ rejection by the body, but there have been hugely successful acquisitions. In the best of these, the startup culture has positively affected the corporate culture as well. The EMAP acquisition of WGSN has worked exceptionally well. WGSN is a Bloomberg service for the fashion and style business which was acquired by EMAP in October 2004 for £140m. WGSN’s business has doubled since then.

So is the buyer typically disadvantaged in an M&A process? Pretty much - one has to conclude as the information asymmetry is such that there is a fundamental disequilibrium. The best way to offset this is to ‘date before getting married.’  Not surprisingly, some of the healthiest acquisitions have stemmed from successful business development leading to the larger company wanting to own the startup. The longer and better you understand the asset, the better you can assess the value.      

There are more ways to get some of the right and new DNA in your firm if you are running an established enterprise. Acquiring firms will always carry the risk of information asymmetry.      Google apparently acquired YouTube in five days. It’s easy to look at the price and the time frame and see how that worked in the founders of YouTube’s favour. Increasingly, smart corporates like Skype and Google are investing  directly into startups in order to continue to learn about markets.    Recently they both co-invested in FON, a European Wi-Fi network.

In summary, it’s important to stay radically open to small change which indicates that major disruptions are happening in the market. You can become obsolete faster than you know.  Partnering, investing and acquiring have always been part of the corporate toolkit, but derivatives of each, and blended models, and an overall speed in the market mean that a corporate executive can never take anything for granted – neither his current market position, nor his next year’s forecasts.

Julie Meyer