Debate is already starting around Instagram's recently-announced acquisition by Facebook. e.g., Why the heck would Instagram sell a stake of its soon-to-be-acquired company to Sequoia (and Thrive, and Greylock, and Benchmark?) The reason is simple: playing chicken with a potential acquirer can drive a much higher valuation. And more importantly, the acquistion is more likely to close quickly and successfully if the target company has a war chest of cash and a strong, fresh investor group.
"I’m as shocked as you are, namely because I was working on this as a funding story all morning. Anyways, right before its billion dollar acquisition from Facebook, Instagram closed a $50 million Series B round from Sequoia, Josh Kushner’s Thrive Capital, Greylock and Benchmark at a $500 million valuation. The round was led by Sequoia, as first reported by AllThingsD’s Liz Gannes.
"Investors, many of whom didn’t know about the Facebook acquisition, literally doubled their money (which was wired to Instagram last Thursday) overnight.
As noted, it's smart to use an impending investment valuation to drive a higher acquisition valuation. Strategic/acquisition values are typically much higher than investment values. eg, as of today, Instagram is worth more to Facebook than it is to Sequoia, because Facebook gets strategic value in addition to market value. If the company was able to use the Sequoia deal to drive its Facebook acquisition value higher, then in theory the founding team's smaller share of a larger $ pie is greater than the larger share of a smaller $ pie. A nice play if you can make it.
What about Sequoia and the investor syndicate? Investors with a signed term sheet would be fully aware that acquisition discussions were taking place, as well as what valuation range they were in. I would be surprised if Instagram's investment group did not go into this with eyes wide open. Investors win either way - an instant 2X multiple on investment (and a crazy high IRR), or a highly desirable company that they believe has growth potential.
I'm even more green-eyed than usual today. Call me jealous impressed.
NOTE: To be clear, I am not privy to the boardroom conversations around this deal. I'm simply opining on why it could make sense, based upon experience with my own investments.