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ARTICLES AND THINKPIECES

INSTAGRAM'S UNORTHODOX DEAL STRATEGY

By now, everyone has heard about the Instagram purchase by Facebook for $1 billion. An overnight sensation in the mobile world. And, following in the footsteps of the dotcom craze of the '90's, in which businesses with lots of users, but no revenues, sold for 10 figures. That's somewhat interesting.

But, what really interests me is the fact that, with the $1 billion purchase announced on a Monday, the previous Friday, Instagram closed a $50 million investment round. So, if they knew they had $1 billion coming in to the company, what would they need with a $50 million cash infusion just one business day before? And, why would they essentially hand out equity that they held until just before the deal?? Kevin Systrom is reported to have made $400 million on the deal, owning 40% of Instagram. What was his ownership interest before the investment? Given that each percent is now worth $10 million, this is not a trivial issue. If the reports are true, that investment may have dropped him from 50% to 40%.

The answer, proposed by a client of our firm, might be that Facebook would not have valued Instagram as highly as it did if it didn't know it had the kind of backers that would pump $50 million into the company. That Instagram with a major war chest became a larger threat to Facebook than it would have been, driving up the purchase price. And, of course, if the deal were to have fallen through, Instagram would still be ready to rock.

It is reported that the company's valuation on the date of the $50 million investment was $500 million. Does an investment of $50 million instantly raise the value of a young company by another $500 million? Did the investment, rather than lose the current shareholders $100 million, actually increase everyone's proceeds by $500 million, less the $100 million, the latest round investors took in for their $50 million investment? (Not a bad weekend's work, by the way!) In this case, that investment appears to have done so, and everyone on the sell side is pretty happy.