Reid Hoffman | M&A or IPO?

Hello, I'm Chris Yeh, the co author of Blitzscaling and I'm here with my co author and old friend Reid Hoffman, the co founder of LinkedIn and investor at Greylock Partners. What I'd like to talk about today, Reid, is the question of whether or not founders should be seeking acquisition or ipo. This is a big topic right now because after all, we're in a market where the NASDAQ is at near all time highs. There are a lot of big tech companies with money to make acquisitions. And so this is a question that a lot of founders are actually considering. So let's start with the do all companies start with a goal of an ipo? And should companies ever be built to sell?

The short answer is it's about as much risk and blood and sweat and tears to start a company with an IPO target as it is with a sale target. And because even though only a small set of companies succeed in ultimately going public, that's where when you add up the percentages and the values, you have the same cost line, the same stress line, the same effort line, and then the outcome line is mammothly higher when you include the IPO set. So the short answer strategically is it almost never makes sense to start a company with the intent to sell. Now let me give two asterisks to that. So one asterisk, which is really the least relevant one is you go, look, I got a couple of my friends, we know that there's like this really important need that's going to happen across preferably more than one of the tech giants, that we're going to go out and we're just going to build a piece of technology and that piece of technology they're probably going to buy and we're not going to take much in the way of capital. We don't really have to go through all the right motion because we're taking this bet on a very high level that they're just going to need our piece of technology. And a couple things have happened in arena. The ones most top of mind for me I think is a company called FrontPage, which was an HTML company that Microsoft bought years back. That can happen. But the problem is there's so many different things that you're betting on your actual certainty that the market and the technology companies, everyone else, will go across this arena and that they won't already have their own internal factions doing it and that you will have gotten out there and really built this amazing piece of technology first. And it could just be a total Waste of time. Now, so that asterisk is tiny, but like, rounds to zero in the universe. Tiny but present, but tiny. Now, the other one that people frequently mistake is that frequently your idea in a company may have a lot to do with generating a ton of strategic value where you have potential uncertainty about economic value. Because in order to go public, now that people are really trading in your shares, you have to have at least a very clear economic value story. Sometimes a company's not profitable, although more often than not a really clear path to profitability or clearly being profitable is important. But sometimes you go, okay, I'm going to acquire a whole bunch of users really quickly. And in that acquisition of users, it could be tied to another economic model or strategically really valuable.

It be, could.

It could be customer engagement, could be data set, could be technology, could be some combination of any of these things, and then someone else will buy us. And actually, in the very earliest days of PayPal, one of the things that was like, okay, we've got this mechanism for making payments happen, but we have no business model because we didn't think we could charge a master merchant thing. That came much later. And that was a, oh, my God, if we don't do this, we're going to die kind of pivot, which is frequently how these big innovation pivots jump. And part of the reason why startups do them, we don't have an economic model, so we think maybe we could build a bank. But building a bank is really painful. So maybe a bank or someone like it who wants to be in this will buy us for strategic value. So very early, it very quickly got to, well, maybe we're going to be doing strategic value. And by the way, acquiring a bunch of customers and acquiring a bunch of customers on ebay and having a product that a lot of buyers and sellers on ebay loved creates a lot of strategic value. And actually so much so that one of my jobs for like, six months was Peter sent me out on a mission to sell the company for $600 million. And I could only get to 550. And that was from VeriSign. Right. So we said, okay, well, we're not going to sell the company. We're going to go to IPO. And part of the reason why PayPal was worried about an IPO is the risk factors were significant. But by the way, people will trade in public companies where there are significant risk factors. And so that was just a, okay, we'll. We'll have to figure out how to get out there and how to do that and make that happen. And we were young and naive. We'd never taken a company public before. We didn't really realize, you know, that this was. And part of the reason I illustrate this as an example is we really actually should have kept the going public as the primary thing the whole way along. Because to close off this element, the last kind of thing about why you never really should start with selling as your plan A and you should only be shifted to selling in a certain set of circumstances, which undoubtedly we'll get into. But one of the truisms, one of the kind of aphorisms about business that's really important to remember in this circumstance is that companies are bought, not sold. And what that means is, you know, there isn't really that kind of like a marketplace, like there's a marketplace for computers or a marketplace for, you know, a number of other things. You can't just roll up and say, well, I got one of X. Would you like to buy one of X? It's the market clearing price of Y. Because when a company is making an acquisition of another company, they do so with a strategic goal that aligns the internals of that company. That's why it's bought, not sold. And so, yes, you try to get the recognition of the larger company to realize that you're really important. A strategy either has or should have and so forth. But ultimately that comes around to the larger company going, this is key to one of my strategies. And because it's key to one of my strategies, now I'll buy you versus oh, look, what's for sale is never the way that it actually in fact starts.

You know what's fascinating about that is the fact that it seems like in some ways it's harder to build your company to sell than it is to build it to take it to ipo. Because if you want to take it to ipo, you know what people are looking for? They're looking for business momentum, revenue acceleration, they're looking for market share, all these different things. Whereas for the buyers, they may have strategic considerations that you don't even know about.

I think that's exactly right. And that's one of the reasons why that, that second asterisk is important. Because one of the things that sometimes get Silicon Valley, it's kind of crazy reputation where east coast people think, oh, are you building companies to sell? Is because they expect every company to start at the very beginning in this kind of shape where you say, well, what's your cost of customer acquisition? What's your Long term value, what's your cost, your cogs, you know, your cost of goods sold, you know, what's your, what's your, what's your contribution margin and operating margins, everything else. And they look at all these companies that are growing really fast and they say, well, even maybe what, you know, all of Blitzscaling, what's your business model? And they go, well we're not really sure we're going to work it out. And they go, oh, you must be building in order to sell. And actually, in fact that's wrong. What it is, is, well, we know that if we build something of massive strategic value here, we have the chance to build in real economic value. Like for example, let's take Google. Like Google started with saying, hey, no one ever pays for search, search is low value. So we're going to sell enterprise boxes. Even though selling enterprise search has not really worked and didn't work for Google. But as they're doing it, they're building out this amazing strategic thing. And then they started working on AdWords. Took them two years. Susan Wojcicki Masters of Scale episode will be sometime in the next few months. She was one of the key people along with Salar and some others in building the Google AdWords business. But there was like, okay, once we got this strategic position, we can work on the economic position. And that's part of like for example, one of the things we say this is part of the inside of Blitzscaling is actually in fact you can blitzcale for that strategic value. You can have a bunch of unknowns and uncertainties around revenue model and around how good is the business model and how much is it an economic value and how much is that is the value of the share in the economic model versus the strategic value. But that doesn't mean you're building the sale, right? It may mean you pivot to sale when you can't make the economic model work. Or if a acquisition companies are bought, not sold, rolls in at such a high value, you go, well, on a risk adjusted basis for me to go and build the economic value, this is a better proposition, right? So I'll take this proposition. But that building of strategic value first isn't actually in fact building it to sell. That's actually a strategic decision about how you can build to a place. Because among other things, when you have a lot of strategic value, the capital markets are much more like, well, okay, we'll invest at you at these higher valuations, give you a bunch of capital in order to take the next set of risks in terms of building out a business, because we actually evaluate that if you succeed at that, we'll make a lot of money. If you don't succeed at that, you'll sell and we'll get back our money or make a little bit of money. And that's a good trade on a business. Like if you have a very low probability of losing money. The necessary economics for making money for a blended portfolio don't need the high ceilings AS Classic Tier 1 Series A venture capital needs.

And if you think about that, as you're going through, you're trying to win one of these valuable markets. If you win that valuable market, you're going to be very valuable as acquisition. You're also gonna be very valuable and attractive as an ipo. So the goal is to win the market, not necessarily to sell. And even if you don't know how you're going to make your money, as long as you're still building that value, you're still building towards that ipo.

Exactly. That was the reason I did that asterisk. Cause it's not like you try to look like an IPO company day one. That's a catastrophic mistake. Right. The fact that you're building to it and that you may have some parts that you're like, ah, I don't know. I don't know. Like, I'm pretty sure that once we get there, we can figure it out, but I don't know now, like, you have multiple iconic companies of which Google is like, you know, Alphabet is like one of the super obvious ones that saying, oh my God, like, it had a thought about how it would make a business model work, but, you know, it never really got any traction on that thought and then had to pivot and had to work hard at the pivot where years that plan wasn't working.

And one of the things I love about doing these podcasts is I learn things that even I do not know. Like, for example, I didn't know that Peter Thiel sent you out to sell PayPal for $600 million. But what's remarkable about that story is that you got a $550 million offer, but you guys still had the principal and the. Whatever you want to call it, the boldness to say, no, you know What? We said 600. That's our number. We're walking away.

Yeah, well, it's one of the things that's actually pretty helpful in a lot of negotiation circumstances as people realize that when you actually, in fact draw a line, you're really drawing a Line. There was a later version of this when we were negotiating to sell PayPal to eBay because there were four different efforts. And one of them was because very frequently right before an IPO is when these happen, is I walked in the door and I said, well, I have a mandate to sell the company for a billion dollars. And as we negotiated and as the weeks went by, the price of the ebay side kept going up and finally got this call saying, we don't think you're negotiating in good faith. And I said, well, why not? And they said, well, you know, we've been increasing our price. You have not been reducing your price. And this is one of those classically, I think, dumb MBA things, which is. Well, the only model for negotiation is a haggle where I shift my position and you shift your position. And of course, this starts with people articulating the most extreme position they can because they want the most room for this tug of war on a rope to kind of move to the center. And everyone kind of knows this and plays this standard game. And I said, look, no, no, I've been extremely clear with you. I have a mandate to sell the company for a billion dollars. If you give me a billion dollars right on clean terms, you will get the company. Anything else? I'll have to go back and see if people are interested relative to the ipo. Are you telling me that this price, which was, I think $850 million, is your last and best price, and that if we don't take it, we should go public? That's what you're telling me? Because we're pretty sure we can go public over a billion dollars. And they said, yep, we don't have the same confidence you do. 850 is our price. I said, okay. And then I called them back, you know, four days later, and I said, okay, we're going out in two days, right? And we went out, we were 1.2 billion. And then I called them back about a month later and I said, look, now the price is clearly higher because we now have a public market. Would you be interested? And they said, yep. And we got to the 1.5 billion price, although there's a bunch of things in that too. Now, the reason that we were doing this and the IPO and so forth, we'd learn it. We were first time entrepreneurs. We hadn't learned the lessons as strongly as I'm articulating them here, which is go long, go long, go long. If you have the shot at it and keep doing that as a North Star versus kind of an economic maximization portfolio value. But, but we also had a bunch of different risks. Ebay was our primary profitable business. They were opposing us in very strong ways. They felt that us being independent was a real risk factor to their business. And so it isn't clear that PayPal could have gotten to where it is today without being essentially nurtured within the ebay framework, which was like, let's have all eBay transactions versus like about a quarter of them go through and let's have it all very supported. And this is one of the reasons why the PayPal acquisition by eBay, now this was after PayPal was a company, was accretive revenue per share in the first quarter because all ebay did was stopped trying to discourage people from using us and said, hey, you can use PayPal. That was it, that was it. And then it was accretive revenue per share. That was how much. That was a gale force wind against PayPal in order to make it work. And that was important for what PayPal became.

And ironically, as you just pointed out, the unwillingness to meet the earlier price cost eBay about $500 million over a very short period of time.

Yes, it's kind of don't get diluted. Like, for example, I would say the general lesson for all corp dev and acquirers is to say, does the real economic difference for you the difference of $150 million in this scenario? Now, I think it was ego. I think they were irritated that I was not moving down. But like one of the super important things and all in business all over, right? Is don't get driven by your ego, right? Like really evaluate it and think about it like, is that worth doing? Right? And you know, I think PayPal turned into one of the hugely successful acquisitions because as of course now PayPal as a public company, it's worth more than ebay, where it spun out of ebay and so was a very successful thing to do. And you know, people have argued with me, it's like, oh, you should have never sold. And it's hard to a little bit know that ex ante. But the fact that I mentioned, which is it's unclear that PayPal could have gotten to where it is now without a multi year incubation period, right? That was all like, grow, grow, grow, grow, grow. Now perhaps if you look back at it, as opposed to deeply integrating PayPal, the strategy for me may have been for their hangers, like, okay, we're going to incubate you and we're going to spin you out. But we're going to take all the advantage of pushing deeply behind you and maybe that could have been done as a look, we'll take a 50% pipe in the company in some way or something and still do that all as an independent company because they had to refactor a whole lot because the entire exec team left within three to six months. A bunch of us left in the first couple weeks anyway. There may have been different things there. Always very hard, hugely successful, very lucky, serendipitous, like second guessing the past. But I think that the general principle that all of us learned there was go long, have a theory for going big and only shift to selling as a serious, like a serious shift to a plan B, not as a how do I kind of do the math and try to get the highest economic point, visa risk factor to decide which things to do right versus do I have a chance going along? Do I have a plan, Do I have confidence in some of the things that I can do?

And the other thing that's interesting is, and again, you are not necessarily the average venture capitalist, but we've both sat in that entrepreneur's chair pitching to venture capitalists. How many times have you heard a venture capitalist ask someone so what's your exit strategy? And they're expecting to see a slide saying here are the different people who can acquire us. And yet at the same time we just had this long discussion about why that's the wrong approach. So how do you square that circle?

Well, one part of it's quality VC. Although that's not saying that the quality VCs go oh, acquisition irrelevant. Because it's the VC's job to say, okay, what's the range of possible outcomes? Because it's very risky investing. And part of when you become a professional vc, it's like one of the things that you learn being a VC versus an angel investor and so forth is you realize that you kind of think through what a potential tree of exits look like. Where, you know, like for example, you know, in 10 plus years of being around the table at Greylock, we have never invested in a company where it wasn't. We're really going for going public, right? That's the thing we're going for. We have a thought, we have a plan. You know, we think this is the way that there's a market opportunity that in x years, usually 10 plus, we can transform an industry. It can be one more of those iconic companies that's super important. Nevertheless, in every investment we say, well say that doesn't work. What are the other possible economic outcomes which frequently is a sale like okay, who would buy it, why would they buy it? And so forth. And that partially gives you a sense of like, what is your risk profile on the capital? What are your different possible returns? Because if you said look, if I put a dollar in and what I have is I have a, you know, a 10% chance of making $100, great. But if I have a 10% chance of making $100 or call it a 10% chance of making $80 and a 50% chance of making $3, right. Or maybe that's not quite the right math but you know, like you could.

You, you could get an expected value.

Calculation, you're going to accept the value calculations. And by the way, you know, one of the things is even though part of the reason why the early stage venture investment is highly risky, because a lot of things go to zero, each thing that goes to zero is a big hole in the portfolio which overall reduces the multiple of your entire portfolio. So if actually in fact like you could wave a wand and said nothing goes to zero, everything's minimum is 2x, all of a sudden your whole portfolio looks a whole lot better right now. That's not to say you play for the upside, not for the downside, not only as the overall portfolio but also each individual investment. But part of the reason you asked that question now when you get to kind of the higher level game, think of it as the VC201 is you're trying to test a little bit about the kind of, call it the pivoting rationality of the founders. Because if a founder says no, there's no chance, this is just going to be huge. I'm not going to think about anything else. And it's totally fucking impossible. And you're like, wow, you're either lying to yourself or lying to me. Because nothing has that certainty characteristic. And both of those are a little nerve wracking are risk factors in an investment for sure. But if you say look, we really think we have a really strong chance at ipo, but by the way, say we only succeed at building the following parts of strategic value, then these folks would be really interested and this is why we'd be a premium for those folks and the fact there's more than one, there's three or four who are actually in fact will pay good prices for a company like this, then you go, okay, great, now we'll push really hard, we'll raise as much capital as we can and, and hire this Stunning talent tour then, by the way, you know, talent and further capital that becomes even more important the more capital comes in is like, well, actually, in fact, the chances of losing capital goes down.

Now, when you were working on PayPal, what you described is a situation where you were taking the company public, but you were also considering selling the company at the same time. So when should founders consider selling? When should they decide to then focus on it? Because again, Peter sent you out there with a specific focus on selling the company. Maybe it was wise, maybe it was unwise, but what are the circumstances under which it makes sense for someone to do that?

So I think with the experience that people Peter and I have now, I think I probably wouldn't have been given that mission. Both of us were young entrepreneurs, hadn't done a whole lot of investing, hadn't participated in other companies going public. And so to us, that kind of looked like Mount Everest, right? And so we're like, well, we don't know if we're going to look like one of these really huge, iconic companies, and we've got these problems that we don't know that we have solutions to in the business that we're working on. And we have an intense amount of strategic value. And possibly, you know, in this kind of economic, rational way, transacting right now is the right thing to do. And generally speaking, that once you kind of learn that companies are bought, not sold, you kind of realize that going out and generating sale is hard, rarely happens, like much higher risk factors than you think. And you really don't begin to have something of real strategic value until people start knocking at the door, going, so, right, you know, have you thought about selling? And then you actually have something of strategic value. And then, by the way, you can possibly get more people at table and make that happen. But generally speaking, if you have something that people want to buy, generally someone's going to knock at the door. There are exceptions, but that's the general rule. And so we went out, and of course, since we were going out and knocking the doors, people were like, well, shoot, maybe you lack confidence. Maybe the risk factors are much bigger than we think, and we're willing to take that risk for a certain price because you have this great strategic asset. But part of the reason why they don't think they got to the price was because they're like, by coming to us and talking to us about it, you're signaling that you, as knowledgeable insiders, are fundamentally very worried about this company's ability to go the distance. And so Therefore, we're super worried about it, too, because you're more insiders, you've built a great strategy asset, but you're more insiders than we are. And so I think that today, or today's experience, we would have just been going, how do you just keep building as much spectacular strategic value? We would have had nervousness about how do we convert it to economic value. We would have said, look, we don't really know how the business model is going to come together, and all the rest, we're going to need to work on that. But we would have been going, look, as long as our strategic value is going way up, and as long as we can continue to either raise money at good prices or make enough revenue to make it work, then we continue to play in the game as we go. And we wouldn't have necessarily made that effort. And I think that was partially because the whole management team, not just Peter and I, but this is all kind of like our first major gig. We'd done small companies before, but it was like, oh, wow, this is a strategically significant company. Okay, how do the rules change here? And part of the reason I do podcasts like this and so forth is to share those lessons so that other people can come up that learning curve faster than we did.

Yes, if only you could have had a time machine to get a copy of Blitzscaling while you were building PayPal. Though, admittedly, if you did have a time machine, I think there are more important uses for it than that.

Yes, there are some great uses of a time machine that don't involve sending a business book, however interesting and useful, back in time.

So let's then talk about the IPO option. So the public markets right now are going along pretty well, and yet at the same time, we have an economy where there are millions, tens of millions of people out of work. How much are the markets actually reflecting the economy right now? And given where the markets and the economy are right now, is this a good time to try to take a company public?

So it can definitely be a good time to take a company public. First, I'll make a small set of reflections on the public market. I think the public market is basically saying that the major governments of the world are so committed to avoiding a Great Depression that the stimulus will keep flowing into the business side as long as it takes in order to offset a Great Depression. And I don't think that commitment and intent is an incorrect assumption. However, it's insufficiently blending in the catastrophically stupid pandemic response that a number of governments, most notably the US Government and most notably the Trump administration, are doing, which if you were trying to destroy value, you're trying to destroy companies, jobs, lives, et cetera, et cetera, you'd have to work to do it worse than they're doing. I mean, like, for example, we're talking to a whole bunch of entrepreneurial business people and they say, hey, what's the way that we help solve the COVID thing? Let's hide all of the data. So, oh, what's the way that you should make strategic decisions about your business? Let's take away all your dashboards and you just make it without it. I mean, just literally amazing. Amazing. Like, it almost looks like it kind of looks like deliberate sabotage. That's how badly mishandled it is. But that's obviously crazy. So it just. You presume incredible incompetence versus a intent to have a terrible pandemic response. And so with that, that means the underlying thing, no matter what the commitment of the government will be to saying, hey, we'll be doing business. And economic stimulus to keep these things going will actually, in fact still be the drop of tons of small businesses, which will mean stuff for real estate, mean stuff for supply chain, mean stuff for consumers, mean stuff for like all these things. And, you know, there's a huge amount of work that needs to go back to rebuilding that. There is the uncertainty factors in business would make them tighten up their investing decisions and be more careful about hiring and more careful about investing and expanding their lines of business. There's all of this stuff. So the market seems broadly, well over enthusiastic, right. Responding to what they think is going to be happening because of all the, like, you know, massive stimulus for businesses. Now, that being said, then you say, well, if the market's that crazy, should a business not go out now? Well, the actual kind of timing is you, generally speaking, want to choose a timing window that fits within the strategy of your company. And frequently part of the strategy of your company needs to be as you're going public is you're going to go public at some point because that's the better way of having liquidity. It's a better way of being benefiting employees and investors, of getting public stock as part of acquisitions, for example, and growing a business and whatnot. It has a bunch of utility in that once you've established a pretty reliable business kind of building into the economic value, not the strategic value, that then the discipline of being a public company is actually very helpful for that. And there's a whole Bunch of work that's gone into making that really work. And so you want to do it. Now. Take, for example, the LinkedIn case, or when we chose to go public is we were looking at our business and going, look, we got this really interesting thing. We're really helping hundreds of millions of professionals do things with their careers and do things with whatever their business task is, whether it's working as an employee, whether it's being an entrepreneur or startup person, or whether it's being a service person. LinkedIn helps all these things, but people don't really know it. We haven't really had a chance to tell our story, and once we get to investors, they'll go, oh, my God, this is much more interesting than we had previously paid attention to. So we really wanted a time that when because the kind of market windows open and close, and it's roughly speaking, do the investors who take money out feel like betting on the future, or do they feel like kind of managing their current portfolio? And it doesn't mean you can't ever go out. PayPal was one of the two tech IPOs in 2002. And so, you know, generally speaking, no one is going out. You can still do it, but it means that it becomes much harder. The valuations are lower. You, you know, et cetera, et cetera is part of how that when market closed means and market open means there's more companies going out and so forth. So we wanted at LinkedIn to be like one of the first companies at the opening of the window. So we got ready and got prepped and everything else. And the reason we want to do it is our strategy. And the strategy is different in different companies, but our strategy was a major chunk of our professional base, both as company customers and as professionals pay attention to the kind of business press, and the business press pays attention to IPOs. So if you go and you're one of the first ones out there and you're telling your story about how it works and all the things that happen and what your metrics look like, then all of a sudden, people are paying attention to you. And that was part of our strategy for going public. Now, there are interesting similar strategies that you could say going out right now because the market, I think, has enough capital that it's open, will accept IPOs and so forth. So it's not closed. Now you could say, well, I think we're gonna have a lot of turbulence in the next couple years. We may be coming up to because of Trump's mishandling of the pandemic to something that resembles a Great Depression and trying to pull out of it. But you're gonna go, okay, but it may still be better to be public. One thing is maybe you could tell your story, your differential story. Maybe the fact that you can get out, you have then public equity value. And that public equity value allows you to differentiate going into the next strong window. I mean, remember when Facebook went out, it dropped right to its IPO value in one part because people had such uncertainty around it. And look where it is now. Or Netflix. There's a stack of these companies that go from the market being uncertain or having turbulent times to being spectacular. So that shouldn't be the we're waiting for the market to just be clean sailing forever. It should be, how does your company meet this? For example, if your company is part of an ongoing trend that's the right trend to be in, then being public is helpful. If your company looks so much better than all other companies in its category or industry, that could be a good reason to go out. I mean, there's a number of different things that could lead to a choice to say, hey, I'm going to go out and month x, August, September, October, November. And that could be the right call. You just have to factor in the, well, let's presume volatility for the next couple years. And is that still the right call for what we're doing?

And what's really interesting, besides the fact that this could be a good time for people to go out, is the fact that I really get this sense from you and you can correct me if I'm wrong, but there's this feeling that entrepreneurs often have where they view the IPO as the end. And what you're saying is it's really just a means. It's just one more tool, whether it's to help with the marketing, whether it's to help with the M and A strategy, whether it is a way to reward employees. But it's not about raising money. It's not about the IPO as this goal. The IPO is the means to an end.

Yeah. And by the way, it's very similar to are we a million dollar revenue company, $10 million revenue company, $100 million revenue company? You don't go, we got to 100 million, we're done. It's like, no, no, no. It's a lot of work to go to each of these things. And that will play out, as we wrote in Blitzscaling, into different organizational dynamics and strength. And usually as you're growing These companies that have great numbers of customers, great amount of revenue, they then become multi threaded, they become larger organizations. The way you organize your company will change in terms of the kinds of executives and executive behavior and strategic decisioning and internal company communication. But each of those milestones, each of those new levels of scale doesn't say over. It just says new tools and the game has evolved and changed. And that's exactly what the IPO is. And so part of what people usually say when they're saying I want to create an IPO company is they say, generally speaking, the target of an IPO company is something that theoretically lives forever. Like, you go out, you're public, you're a going concern, and as part of the going concern, you're a force in the world. Hopefully your mission is adding a whole bunch of real positive value, not just jobs and products and services, which are really important as they are. And that, that's part of it. Now, that being said, the so called topple rate of The S&P 500, you know, you and I wrote about this in Blitzscaling. You know, a lot of public companies get bought, you know, some go out of business. And so, so it isn't actually in fact going public is the, like, I live forever. But that's the proxy. But by the way, live forever. These are organic, these are living. That means that you go public. Well, now you've climbed the, you know, the mountains, the foot mountains of the Himalayas. Now you're going into the Himalayas.

And when you go public and you've done this directly at PayPal and at LinkedIn, one of the things that really is a big part of it is this S1, which is this document. It's filed with the SEC. People spend all this time working on it, lawyers, the founders. It's a make or break document and you can see that sometimes it's a break document. As what happened with WeWork when their S1 came out, people finally got a look at their financials and said, oh my gosh, what is going on here? Including some of the more over the top assertions in the S1 as well. So what are some of the smart ways or alternately some of the particularly dumb ways you've seen Companies use their S1 to tell their story or gone on the road to tell their story.

Well, part of that making you into a good institution is the S1 is a good process for how do you encapsulate the story in a way that a bunch of the leading figures of in public market investing would be willing to buy in or not, and why it is you think you have this company that's going to go the distance? What does its business model work? Like, how does it work? What are your risk factors? Because a central part of telling an S1 story is accurately identifying your risk factors and sharing them with the investors who are paying a lot of attention, and then derivatively press and everyone else who's also paying attention to that. And so that's part of the reason why I think going through the S1 process is a good process for those companies that say, we want to get a scale potential. And so, generally speaking, all of the companies that have gone out and succeeded, I mean, literally all of them have had at least reasonably good S1 experiences because they went out, they got public successfully, and actually relatively few fail on the going public side. Usually that's kind of a sign of the market overall has had too much exuberance. People are like, well, maybe they'll just buy a sexy story that looks like it has a lot of momentum. And part of that was like, for example, the Internet boom, that was a lot of that. Like, hey, I know we have negative margins, but as our volume gets bigger, it'll get better. And you're like, well, why will it get better? Why won't higher amounts of volume with negative margins be worse? Right? And everyone kind of learned. They said, oh, well, there's certain kinds of strategic value that may not be profitable, that are going public that could still convert to being strategic and profitable. And that's some combination of, where do you think prices can go? Or margin or cost structure, what does competition look like? And a set of things. And they say, no, no, that's okay. We can buy this thing when it's not yet profitable because we think it'll become. The presumption is with that risk, you're going to have a multiple. It's kind of like venture investing, but you can still do that. And so I'd say, generally speaking, the successful companies now, you know, we work as an example or things where you go, well, actually, in fact, once you actually kind of cross the T's and do the analysis, you go, this is using a huge capital expenditure to cause growth and mask the fact that the fundamentals don't really work very well. Or if there are fundamentals that work well here, they're not being presented clearly, right? In a way that an investor can understand them. And by the way, not being presented clearly means that the likelihood the business will get there is relatively low. And so I think that the S1 process is a very good part of the process and is part of what is the reason why people tend to say they'll take assertions from public companies in a much different light than they'll take assertions from a private company. Because a private company can kind of play it quick and loose and say, oh, we got this amazing growth and we're the best thing ever. And it's like, okay, public companies aren't allowed to say anything like that without like being able to say, and here's our audited data that we go to jail if we're wrong about. Right. That's backing up our assertion.

It's like the difference between going on TV news and providing information during a deposition. One of them actually counts.

Yes, exactly.

So let's consider the founder who has gotten to the point where they've built something of strategic, strategic value, and people start to knock on the door and say, hey, you got something interesting there. We might be interested in finding out a little bit more what happens once you enter that selling phase. Does that shift the product roadmap, the internal management, the recruiting? Does how you run your company differ once you're actively into that selling phase?

Well, there's an intermediate question. So the first one is to think a little bit about when should you take selling seriously? So generally speaking, if you go, oh God, like we have some stuff of real strategic value, but we may not be able to really pull together the economic value and our time clock may run out. We may not be able to fundraise the right way. Part of the way that I advise entrepreneurs to do pivots is that if you have a plan which is essentially reflected by an investment thesis, if you're confident your investment thesis is going down and down and down and you can't figure out how to shift the plan or market such that your investment, these go up, it's time to pivot. One kind of pivot may be, well, maybe we just can't build an economic model here and maybe we should sell. And then do you have people knocking at the door or do you need to try to generate people knocking at the door, which is hard but not impossible. And then once they knock at the door, then your question is, well, you may be in a number of different places. So frequently you're in a place where you go, well, actually I'm on path to building a high value, industry transforming company and I'm not that interested in selling. In which case it may be a very, very quick decision where you kind of go, no no, thanks. Look, we want to be friends, but no thanks. Sometimes you'll go, well, we'd only sell if you're going to buy us out of like five years of growth. Like, we think we got five years or enough of a high probability on the five years that we'd want to take it. And so we're not really willing to take a big discount. And then is our strategic value that to you or, you know, something kind of equivalent? And you definitely want to be active about this because exploring the option is expensive in a lot of ways. It's defocusing. The company gets uncertain. There's a lot of things that can go wrong with an acquisition just by being in the process, right? And then say, you do decide to say, look, actually, in fact, we should take this seriously because we think that our strategic value to one or more acquirers is going to be worth a lot more than our ability to convert into economic value. And then it's like, okay, well, what's the right way of doing this? Is the right way to be very cozy with one, the right way to do a small number, the right way to kind of run some equivalent of an auction. And obviously, because you care about the mission of the company and you care about where the employees land and what the longevity of the impact entity is, there's a set of things which a pure auction may not be the right outcome to, but you know, it's kind of, this is a blend. This is like a bit of a slider. And then based on that, you may say to, hey, we're investigating selling as a serious plan B or may switch to a plan A. And then when you do that, by the way, even if you switch to a plan A, like, basically when you're getting to the point where you're signing the documents, then you aren't even across the line until the documents are signed. And so part of what you usually are doing is being very careful is say, even if selling goes to plan A, you've got to have plans B and C. Now, if you're truly like, look, we're just not going to make it, we're not going to be able to get public, then plan B may be to sell to somebody else, you know, et cetera, you know, as a, as a way of doing it and restarting that process. But you, generally speaking, you know, always want to have the, look, if we, if we're going long, this is what we need to do in order to do it. And sometimes you say, that's what we're going to do, even if it's like lay off 2/3 of the company, try a different business, etc. Sometimes that's the rational choice.

Now, if you're going down that rational choice and you're selling the company, how much do the CEO, the senior team, really factor into that acquisition Discussion? I ask because you've been through acquisition at both PayPal and LinkedIn, and those look very different, at least to someone on the outside. With PayPal, as you described it, most of the executives are gone within six months and some of them are gone almost right away. Whereas with LinkedIn, after the Microsoft acquisition, obviously the team was a huge part of it. You joined the Microsoft board. Jeff stayed on. He only recently transitioned over to Ryan Ruslansky, and Ryan Ruslansky obviously a very longtime employee of LinkedIn as well. So there's been continuity. How does this work? Why were those two situations so different?

Well, so in the PayPal case, I think, and look, I wasn't on the inside on the ebay, glad I was on the PayPal side, but I think ebay was like, look, this is both a huge opportunity for ebay and a risk. Like, because, example, if you were going to try to build an alternative auction site and compete with ebay, you should buy PayPal in order to do that. It has certain risk to it. But like, so it was both an opportunity risk. And so I think they were less focused on retaining the management. They felt they could run it themselves, you know, perfectly well, and it was more the pure version of the asset. So they weren't really as focused on the management side. And I think to some degree, I think they'd hoped that the management side would stick around longer than they did. But that's one of the reasons why, I think, generally speaking, on both sides, this is a form of marriage. And it's good to be pretty upfront and explicit about what's going on now on the LinkedIn side. And many, many points of kudos to Satya in this process. Satya Nadella they were like, look, this is the kind of thing that Microsoft should be doing on the Internet and it's really important to us, but there's a reason we didn't build it. We don't have the kind of internal culture and the way of thinking about this. And so it's really important to us that we succeed in this acquisition of making kind of, as it were, the best of both worlds between LinkedIn and Microsoft and not the worst, because one cross check you should always do whenever you think, oh, this could be the best of both worlds. Is, is if the best of both worlds is a possibility, so is the worst of both worlds. So you have to really work at how do you make it the best. And so part of the discussions that we had in depth and over time with Satya was like, look, these are the key things that would really, actually in fact really benefit and help LinkedIn and LinkedIn grow by being part of Microsoft. And these are the things that would help Microsoft grow by having LinkedIn be part of it. And these are the things that are important to keep independent and allow happen organically. And one of the kind of key things was to say, look, LinkedIn's whole focus is its individual unpaid customer is its top customer, even though it makes money from companies and subscribers and everything else. It's that focus on being great for the free account, like to some degree, LinkedIn's paid services, its top competitor is free services, right? And so that's like really important to the health and vibrancy of the network and that's that individual focus. Even though we also have organizations within what's going on LinkedIn and said, look, it's really important we keep this as a culture. You know, Microsoft is the best company in the world at dealing with enterprises and being enterprise focused and having all the requirements for enterprises. And it's important we add that to some of the stuff we're doing at LinkedIn because we're not slouches at it. But there's a, you know, Microsoft's the best in the world, so things we can learn. But it's very important that, that focus on the individual, professional, that individual, you know, career person, et cetera, is still top and paramount. And so we really have to preserve that culture. There's things that Jeff has built here and the team has built here that are really great culture that could add to the things that Satya was trying to do with the Carol Dweck growth psychology and other kinds of things and fit very naturally with how Satya was trying to evolve the Microsoft culture. And so we had a bunch of conversations and to give you an example, so we, we came to it and said, okay, we trust and believe Satya on this stuff. So great. And so we did the deal. And then he, I think it was a couple months before the deal closed, Satya called me and said, called Jeff too and said, I got this idea, why don't we make Jeff in charge of the acquisition? And this is, I don't know of anything that's happening at scale at all in history. I'm not a business historian, but typically the huge company appoints one of its people who is a senior leader, maybe an executive, somebody else who's in charge of the acquisition. Because it's like, well, these are all the things that we know that we can reflect all of the larger companies, in this case, Microsoft's interest and can navigate things and make the hard calls. And there's always a variety of opinions on how things should work, like how independent should LinkedIn be or not, or how do these things play? And so you say, well, we're going to have Jeff do that. Now, I'm certain that there were people in the Microsoft side who thought Satya was an idiot for having this idea, but it was brilliant. Because what Satya realized is that, look, Jeff really cares about doing the right thing. Not just by the LinkedIn individual, the LinkedIn customer, the LinkedIn employee, the LinkedIn Corporation mission, but also by Microsoft. Because we already know what kind of guy Jeff is, and we want Jeff to play in our overall system as the head of LinkedIn. And so this is the clearest way to show that to Jeff and the clearest way to have Jeff sort out. And obviously, Jeff's super collaborative. So it's like, okay, well, what do we need to do here and how do I need to respond here and what do I need to do? So he said, oh, that's a good idea. Let me figure out how to operationalize it. So it really works for Microsoft as well. And so, like, just genius idea. And that was part of the. The thing of that when you're doing this, you want to be. You've got to think about the fact that you are going into this kind of marriage and you've got to be building those mutual ties of trust and respect and coordination and collaboration. And that was like a genius move that hadn't even occurred to me or to Jeff or anyone else on our side because, like, it's not never the way it happens, but it was like Satya was going, let's see, how do we make this work in a really great way for Microsoft? Well, this would be a really great way to make this work for Microsoft. And so the years intervening have shown how smart that was.

So let's take a step back and think about the M and A market as a whole. What are your predictions for what you see happening over the next 12 to 18 months? Which companies are going to be looking to make acquisitions? In what areas? Which technologies or markets are going to be hot?

Look, there's one part of this answer which is enormously straightforward and simplistic, which is there's obviously a set of strategic games afoot which go on with platform changes in the cloud, in mobile, in artificial intelligence, in market changes. In terms of what's going on with the pandemic and what's happening of course with things like video conferencing and all of those make kind of a standard list that you'll get from various people saying oh, these kind of companies are going to be hot in the M and A market and these other ones aren't. And a little bit because as we've been talking about, I don't recommend entrepreneurs that they take the M and A target almost ever to be their top goal. Barring like lacuna by which you get into that, I don't think it's overly worth focusing on now. It is worth focusing on kind of what these trends are and how you can leverage these trends to build a strategically super important and possibly industry transforming economically valuable company. If you were to list all the things that's going on with these big tech companies, everything else, the amount of raw things and market development that is going on is just kind of stunning because it goes across this whole thing. There's efforts in health, there's efforts in automobiles, there's efforts and changes in product software, there's changes in communications, there's changes in kind of hardware and devices. Just like all the stuff going on. And that's part of what I think is good and what's happening with modern vibrant industries that are part of inventing the future. And then what you want to be figuring out is what are the places where you create something really unique and special and differentiated and has ideally one of the things is I think we're moving towards more giant tech companies, not fewer. And ideally you want to become one more of those or at least even a kind of like a, like one of those hitter companies. Like you may not have been one of the trillion dollar companies, but look, if you're a $100 billion company, that's a super rare achievement and there's very important things you're doing in the world.

Well, that's excellent advice and we've got to thank you for providing it. A couple of other questions just around some of the things you've been through. We talked a lot about your experiences at PayPal and LinkedIn where you were an entrepreneur and operator, but you've also now been an investor at Greylock Partners for quite some time now and have been involved and sitting around the table for some pretty interesting things that happen. So, for example, there were companies that very rapidly shifted from one strategy to another. Like AppDynamics was acquired days before the IPO, or Instagram was acquired. I think you were telling me before we started recording, you wired the funds in for your investment on a Friday and the acquisition by Facebook was announced on a Monday. So what lessons can we draw from some of these things and how did the decision making go to cause such a rapid shift?

Well, so it's a common thing that happens during an IPO process that not only are public market investors looking at you, but a lot of other companies are looking at you because they kind of feel that this is a frequently that this may be the time where they feel that they might be able to get you for a coherent amount of value, where it doesn't have that uncapped upside of what goes in terms of going public. Now, of course, one of the challenges is that usually you have to pay an interesting premium to really put forward a compelling case in order to buy it. Because we've gone through all the work and if we're fortunate and the market totally loves us and the business works out, we have a really big upside. So the AppDynamics one is one of those classic which was super great company. The CEO David Wadhwani works with us now at Greylock. Been delightful to have moved from kind of like light familiarity with him, was part of a portfolio company to being a clearly like fits with that kind of culture where we try to be really great, you know, kind of colleagues and company builders, you know, helping build companies in the future. And David has fit in, you know, just 11 out of 10. It's been great. And so I think it was kind of like, well, actually, in fact, strategically, what's good for the shareholders on a risk adjusted basis, that is a great result for them. Part of the what's great for the employees, what's great for the customers, what's great to develop it. Let's take the acquisition that happens and it happens in some number. And by the way, that's as you know, it usually has to be a pretty good deal, which it was. So that plays out. You always have people who are on the other side because you don't know like you're making a risk decision. But you know, David's smart, so I 100% trust his decisioning. And then on Instagram, that was probably a bit more of a surprise. You were like, oh, okay. Well, you know, they got this small number of employees and millions and this really fast growth. And we don't really know what the business is going to work out, but we're going to do a blitz capital like, you know, high valuation investment in order to make this play. And then we're going, he's going, okay, he wants us to close quickly so it can move fast. Okay, we'll close quickly. And actually it was because, you know, Kevin and Mikey, they weren't planning on selling, but they knew there was a possibility that the conversation was afoot. And so they just said, look, we did this deal. It's an honorable, high integrity thing to do. It's part of where, you know, Kevin and Mikey and you know, are just, you know, in addition to being amazing product innovators and creators, are also super high principled, high integrity partners. And so we did the deal. And you know, normally after you do the deal, you expect the usual pattern in venture capital is you walk into the next board meeting after you've done the deal and oh shit, this is going to be a lot harder than I thought. That's, that's like the 80% post investment experience. And it's like, oh no, we're not going to even have a board meeting because we sold. And here's your 2x investment over the weekend and you're like, well, on IRR basis. That's great. And look, you always back the entrepreneurs and the things they really want to do. We were obviously bullish on going long, but Kevin and Mikey are awesome and we still look for opportunities to be in business with them. So two different, very different stories. And it was, by the way, one of the many talents that Mark Zuckerberg has because in others this whole. Did he buy out the competition? Instagram was tiny and it got grown to much, much larger by, by integration with the Facebook infrastructure. And it didn't have to solve a bunch of problems that would have caused, you know, both innovation and risk and everything else going along lines. And so it's part of Mark's genius to go, I'm going to go get this deal done. I'm personally not send my corp dev person, I'm personally going to go spend the whole weekend with them, talking with it, building confidence, et cetera, et cetera. And so it's easy in the current market to say, wow, that was really obvious. And by the way, was it obvious it was a really great asset. Was it obvious that a couple of different players would have loved to have bought the asset? Sure. Would those players have put enough money on the table to have really motivated Kevin and Mikey to say, this is the right risk adjusted, but for building the thing we want to build. Unclear. And like I said, it was tiny then. So it wasn't like the, oh, we know we're buying out competition. It was part of the genius of, in addition to the mechanics of how Facebook runs, but also the genius of Mark and saying, ah, Kevin, Mikey, this thing, this is great. We can build this into something really important as part of one of the key pillars of the Facebook ecosystem.

And this is a great illustration of the point that hindsight is 20 20. If you were to go back and look up the headlines the day after the Instagram acquisition, there would be a lot of people saying, oh, my goodness, Facebook just paid a billion dollars for a company that's 18 months old and has zero revenues. It has 13 employees, and by the way, only six of them had really been around for longer than a week. And there was a lot of skepticism. And by the way, this is not the only time that people express skepticism. I remember when YouTube was acquired, people like, oh, my God, this thing doesn't make any money. It could be sued out of existence at any time. And I'm sure you'll agree with me, you were probably thinking the same thing I was, which is, oh, my God, Google just got an enormous bargain, and everyone who didn't buy YouTube is going to regret it. Just like they regret not buying Instagram.

Yep, exactly. And that is kind of the genius strategic moves. Now, genius and madness frequently are closer to each other, so you have to really be very active and play out the risk on the genius moves. But YouTube is another example of a genius move.

And for those people who are listening in, who are curious about and want to learn more about the Instagram story, they can in fact find a Masters of Scale episode featuring Kevin Systrom of Instagram. And they should look it up. Just look up Masters of Kevin Systrom and you'll be able to hear the entire story, including why Kevin now has post traumatic stress disorder around the sound of the ringtone on his phone.

Exactly.

So, Reid, thank you so much for taking the time out of your busy schedule. What we've heard today is that when it comes to M and A and ipo, it's really important always to focus on building the strategic value and to focus on building towards that ipo. Yes, there will be times when selling becomes your plan A. Usually it's because you feel like your thesis has gotten to the point where you think you can get better economic value that way. Or because people have started to knock on your door. But in the end, whether you sell or go ipo, that is a tool. It is the means, not the end. It's the means towards your bigger vision of transforming an industry and of creating something that is going to endure for decades.

Well said.

Well, that concludes this episode of Gray Matter. You can subscribe to gray matter on soundcloud.com greylock partners. You can also find new episodes and blog posts on greylock.com you can follow Greylock on Twitter reylockvc. I'm Chris Yeh and thanks for listening.