How Does Google Make Deals?

Here are some very practical insights into how large Silicon Valley firms are now valuing deals, which illustrates why too-big-to-innovate firms desparately need acquisitions to grow...until of course the earn-outs expire.

Google’s chairman, Eric E. Schmidt talked to reporters about his company’s takeover ambitions and the threat of regulatory challenges. While increased antitrust scrutiny is a “concern,” Mr. Schmidt, the former chief executive of Google, said it should not significantly impact the company’s purchasing power, since the company is largely focused on bite-size acquisitions that are too small to land on regulators’ radar screens.

“Last year, as part of our policy, we agreed to accelerate our rate of acquisition of small companies,” he said. “Because it’s the fastest way to fill out some of these broader strategies.”
In terms of acquisitions, 2010 was a banner year for the company, with a record 48 deals.

Schmidt, chief executive of Google, speaks to reporters at the Sun Valley conference.

From the hundreds of start-ups in Silicon Valley, how does Google pick its targets and assess their value?

It certainly has enough money to be liberal with its offers. Google has one of the largest cash hoards in the sector with some $36 billion in cash on hand.

But the company tries to exercise some discipline by adhering to a simple formula. For example, if Google finds a 10- person team with unique intellectual property, it will consider how long it would take for an in-house to build a similar product and at what cost, according to Mr. Schmidt.
“So what’s a year worth? We then calculate the value of the team plus the value of the year, and that’s the amount of money we’re willing to pay for the company,” he said. “These are $10 million, $20 million, $30 million kind of deals.”

He added, the acquisition model “at Google is driven pretty much bottoms-up.”

“It’s a product manager who has a problem; they can’t solve the problem,” he said, “and we have a team that goes out and does that.”

That doesn’t mean Google is turning its back on bigger deals in the nine-figure or billion-dollar realm. Last month, it agreed to acquire AdMeld, a deal he acknowledged was valued in the hundreds of millions of dollars. Meanwhile, Hulu is said to be talking to Google, among others, about a potential takeover.

On Thursday, Mr. Schmidt was coy about its intentions for Hulu, the Internet video company. He only acknowledged that it’s been “widely reported that Hulu is being discussed.” In regards to YouTube’s push into premium content, he said, “anything involving Hulu would be incremental.”