The “Toothbrush” Test

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When deciding whether Google should spend millions or even billions of dollars in acquiring a new company, its chief executive, Larry Page, asks whether the acquisition passes the toothbrush test: Is it something you will use once or twice a day, and does it make your life better?

This criterion shuns traditional measures of valuing a company like earnings, discounted cash flow or even sales. Instead, Page is looking for usefulness above profitability, and long-term potential over near-term financial gain. Google’s toothbrush test highlights the increasing autonomy of Silicon Valley’s biggest corporate acquirers, and the marginalized role that investment banks are playing in the latest boom in technology deals.

Many of the biggest technology companies are now going at it alone when striking large mergers and acquisitions. Companies like Google, Facebook and Cisco Systems are leaning on their internal corporate development teams to identify targets, conduct due diligence and negotiate terms instead of relying on Wall Street bankers. Deals with unadvised buyers are increasing rapidly. The acquiring company did not use an investment bank in 69% of American technology acquisitions worth more than $100 million this year. That number was 27% ten years ago.

The diminished reliance on investment banks comes as technology deal making is rising rapidly. More than $100 billion in such deals have been announced in the United States this year, the most since 2000. At the center of this disconnect between technology companies and investment banks is the belief among many tech executives that some advisers simply do not know what companies like Google and Facebook are looking for.

Instead of trying to swallow already established Internet brands, Facebook uses acquisitions to make big bets on the future and plug technical holes. And in Silicon Valley’s relatively small circle of elite entrepreneurs, executives and venture capitalists, connections are easy and ample.

Tech companies emphasize that they maintain good relationships with many banks and use them on big deals when financing or fairness opinions are needed. But often, when big tech companies are looking to grow through acquisitions, it is the culture and vision, not the earnings and revenue that are of the most importance.

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