Today in DealBook, we learn about the “toothbrush test,” which large Silicon Valley tech companies use to determine whether or not to acquire a smaller start-up. The test, popularized by Google CEO Larry Page, involves asking of the start-up: “Is it something you will use once or twice a day, and does it make your life better?”
Never mind that the ADA explicitly recommends brushing twice a day (not “once or twice!”); the point of the article is that companies like Google and Facebook are doing more of their own mergers and acquisitions these days, without input or advice from the Wall Street banks they’ve traditionally turned to. And the toothbrush test, or something very much like it, has replaced more standard measures of acquirability, such as “does this company make money?”
The number of unadvised tech deals is increasing dramatically, DealBook writes:
The acquiring company did not use an investment bank in 69 percent of American technology acquisitions worth more than $100 million this year, according to Dealogic. That number was 27 percent 10 years ago.
This change isn’t necessarily a bad thing! Investment banks have very mixed track records when it comes to picking winners in the tech space, and often corporate development teams at companies like Facebook and Google are every bit as sophisticated as outside bankers. Applying old-school Wall Street valuation methods, such as the discounted cash-flow analysis, to high-growth start-ups doesn’t necessarily capture their true potential. (For example, take Snapchat, which has approximately zero dollars in revenue, yet would be worth billions to Facebook.) Using metrics like culture and vision instead of profits and loss is smart when you’re betting on the future, rather than just looking for an immediate boost to the bottom line. And cutting out bankers saves tech companies tens or hundreds of millions of dollars in fees, which they can then use for more rewarding projects.
And yet, even though the toothbrush test makes a certain amount of sense, you can’t help but wonder if it’s just a gussied-up justification for high-stakes gambling and a way for tech executives to get their board members off their backs. (“Hey, who cares if I’m bidding $4 billion for a messaging app that will never make any money whatsoever — it passes the toothbrush test!”) A hand-wave-y, vague metric like the toothbrush test is the inevitable result of an industry in which valuations and value have become detached from one another, and its rise as a qualifier will no doubt result in some bone-headed mistakes that bankers might have been able to avoid.
On another note, it’s kind of darkly funny to note that the work-life balance of a banker inside a Silicon Valley tech company isn’t much different than that of a banker on Wall Street. Emphasis mine:
At Google, Mr. Harrison has an employee looking after the deal needs of each of the company’s 12 product areas, like ads, YouTube and search. That person goes to all meetings held by the senior members of that group, staying attuned to possible acquisition needs. But the hours are not necessarily any better than on Wall Street, said Mr. Zoufonoun, who stayed up several nights in a row working to close the WhatsApp deal and fell asleep at the office the day it was announced.
Too bad for all those bankers who flocked to Silicon Valley in hopes of an easier life!