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» Hornik's Deal or No Deal: There is always a price from Jeff Clavier's Software Only
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Jason M. Lemkin

An interesting corollary of these relatively small and relatively quick acquisitions that I've seen is VCs trying to include terms that specifically discourage it. The comment I've heard repeatedly is "oh, well this would be a great deal for Google/Yahoo/Whoever to buy for $Xm but where would that leave us?" It actually creates a tension point around a venture investment because the Flickr/Writely/etc. deals get a lot of press and attention don't really move the needle for VCs in terms of return. No problem if you haven't taken the VC money. But if you do take VC $$$ or are thinking about it, it's an issue . . .

Simon  Olson

As you mention, there has been a lot of discussion recently about the "threat" to venture capital firms posed by the latest trend of large companies buying early-stage start-ups.

The argument is that: (1) the comparatively low cost of starting Web 2.0 companies coupled with (2) the relatively early-stage at which companies like Google and Yahoo are willing to buy, threatens to disrupt the traditional venture capital model.

In my opinion, both arguments are flawed.

The first argument, which essentially says that Web 2.0 start-ups won't work with venture capital firms because they don't need the money, ignores the fact that capital is just one of about a dozen reasons why a start-up chooses to work with a venture capital firm.

So, even if a start-up does not need the money, they may still want to work with a venture capital firm in order to get assistance with recruiting, customer introductions, etc.

The second argument, that the traditional VC model is obsolete due to the fact that venture capitalists are being squeezed out of some Web 2.0 investments by large acquirers is, in some ways, even more ridiculous.

First, as you correctly imply, the flow of mergers and acquisitions is cyclical.

Google and Yahoo may be swallowing lots of smaller companies now, but what about a year from now?

If the pace slows, you are going to see a lot of companies requiring the assistance of venture capitalists, particularly since most of these Web 2.0 companies are not really stand-alone businesses.

There was a great quote from Brad Schell, the founder of @Last Software, which was acquired by Google last week, which said, ""3D for Everyone" is becoming a reality; we're bringing the '3D' part; Google's contributing the 'Everyone.'"

Whether you are talking about 3D, tagging, maps, or another technology, most of these Web 2.0 start-ups can eek out a subsistence level existence on their own but they only begin to take on real value when integrated into a larger company.

Finally, assuming that everything the critics say is true and that venture capitalists are not needed in a Web 2.0 world, big deal!

Though they may currently be in vogue, Web 2.0 companies comprise just one small part of a much larger universe of potential venture capital investments.

There are, and will always be, many other promising areas to invest in, clean energy and synthetic biology being the most recent additions.

Simon  Olson

As you mention, there has been a lot of discussion recently about the "threat" to venture capital firms posed by the latest trend of large companies buying early-stage start-ups.

The argument is that: (1) the comparatively low cost of starting Web 2.0 companies coupled with (2) the relatively early-stage at which companies like Google and Yahoo are willing to buy, threatens to disrupt the traditional venture capital model.

In my opinion, both arguments are flawed.

The first argument, which essentially says that Web 2.0 start-ups won't work with venture capital firms because they don't need the money, ignores the fact that capital is just one of about a dozen reasons why a start-up chooses to work with a venture capital firm.

So, even if a start-up does not need the money, they may still want to work with a venture capital firm in order to get assistance with recruiting, customer introductions, etc.

The second argument, that the traditional VC model is obsolete due to the fact that venture capitalists are being squeezed out of some Web 2.0 investments by large acquirers is, in some ways, even more ridiculous.

First, as you correctly imply, the flow of mergers and acquisitions is cyclical.

Google and Yahoo may be swallowing lots of smaller companies now, but what about a year from now?

If the pace slows, you are going to see a lot of companies requiring the assistance of venture capitalists, particularly since most of these Web 2.0 companies are not really stand-alone businesses.

There was a great quote from Brad Schell, the founder of @Last Software, which was acquired by Google last week, which said, ""3D for Everyone" is becoming a reality; we're bringing the '3D' part; Google's contributing the 'Everyone.'"

Whether you are talking about 3D, tagging, maps, or another technology, most of these Web 2.0 start-ups can eek out a subsistence level existence on their own but they only begin to take on real value when integrated into a larger company.

Finally, assuming that everything the critics say is true and that venture capitalists are not needed in a Web 2.0 world, big deal!

Though they may currently be in vogue, Web 2.0 companies comprise just one small part of a much larger universe of potential venture capital investments.

There are, and will always be, many other promising areas to invest in, clean energy and synthetic biology being the most recent additions.

Dave

Mistah Hornik -

great piece & interesting reading... but i think the analogy with 'deal or no deal' is a bit off, for at least 2 reasons:

1) the example 'deal or no deal' appears to have a fixed price, whereas most acquisitions have at least some upside / earnout potential based on post-acquisition performance (could be individual and/or company based). options on upside performance would likely reduce some of the fear of a big 'missed opportunity' that might come from selling at too low a value.

2) in the 'deal or no deal' scenario, there isn't really any structure that mirrors previous startup valuation / investment structure, and/or the investor's IRR targets or expectations. i mention this because whether or not a venture investor has been involved in a startup may limit the exit options / set a higher bar for sale.

while no analogy is ever perfect, your example appears to state the acquisition scenario as a bit more random & apparently negative than might really be the case.

in reality, i think the VC investor perspective / belief is that maximal returns are best achieved when portfolio companies swing for the fences. however, that strategy only works well for the VC, their LPs, and for the folks employed by the 1 of 10 companies that hit it big in the VC's portfolio... on the other hand, the asset allocation benefits of an "only swing to hit home runs" strategy don't work so well for people at the remaining 9 of 10 companies that don't hit it out of the park.

whether or not playing "small ball" (aka, taking an early acquisition offer) benefits the entrepreneur better than "home run hitting" may be up for discussion, but i don't believe it's quite the equivalent of the random value you are associating with a TV game show.

my .02,

- dave mcclure

(note: the opinions expressed are my own, and do not necessarily reflect the perspective of my employer... who most certainly *is* VC-funded ;)

David Hornik

My point wasn't to suggest for a second that valuation is random. Nor to suggest that taking an early deal is a bad decision because of all the missed opportunity. I was simply suggesting that at any given point in time when an offer is made to buy your company there is a limited set of data that a company needs to assess to determine if now is the time to sell. There will never be perfect data. So a company needs to assess what they know and what they don't know and decide Deal or No Deal.

While it is true that some acquisitions include earn outs that could potentially increase the upside, as a general matter those earn outs take two forms. They are either earn outs that are designed to be assuredly met and therefor are the equivalent of deferred revenue. And there are those earn outs that will likely never be met, and they are frankly in there just to make entrepreneurs and VCs feel better about the lower price they are actually agreeing to. Because so much of what happens in a company once it is acquired is determined by the the acquiring company (marketing budgets, placement, support, hiring, etc.), it is hard to assure that the "necessary" resources are afforded a startup once it has been bought to meet many earn out criteria. So I personally assess the realistic likelihood of achieving an earn out and factor that into the offered price when considering acquisition offers.

As for the "swing for the fences" attitude of VCs, it is certainly the case that a $30M acquisition can been a fantastic outcome for an entrepreneur while not a particularly exciting outcome for a venture capital firm. That is why I don't think all companies should be venture funded. When I fund companies, I don't perceive it as hitting for the fences. I fund companies because I believe that if they hit solid singles in the business that they are pursuing that there will be a huge market and the outcome will be large. Before any entrepreneurs and I decide to work together, everyone is very clear about the economics of taking venture capital. Which is not to say that we never accept early acquisition offers. But I perceive the companies that I fund to have very big upside at the time I fund them, so the key question with any early acquisition offer is whether it is large enough given my perception of the big upside discounted by the risk of executing on the business. In some instances, the price is big enough or there is new information since the company was funded to suggest that an early exit makes sense. All you can do is look at the briefcases you've opened, consider what may be in the briefcases that are still closed, assess the likely outcomes at hand and decide Deal or No Deal.

CliffBoro

David: This is a great post and certainly an apt comparison for our times. Interestingly, the "Hornik TV Game Show Test" also works for entrepreneurial ages of the not-too-distant past. "Who Wants to Be a Millionaire" conjures up memories of lots of companies calling their VCs during the internet rage for another lifeline -- and sadly, "Survivor" sums up the whole post-boom period! Fortunately, I'm far too young to make judgments about the "Gong Show" or "25,000 Pyramid". However, when it's all said and done -- I think that the only rule for when to sell a company must be that venerable-standard, "The Price is Right".

john

Hey great job!!

You have really undertaken lots of efforts to write this wonderful piece.

Keep the great work going!!

joystick

I reckon this early acquisition phenomenon is more than a temporal fluke but a reasonable trend- a modern form of "going public". Particularly in the class of firms and technologies dubbed ad-hocly as "Web 2.0." With development costs lower, a widespread awareness of the value of openness and the big gorillas in the room, a larger proportion of firms would seem to not be able to scale to traditional VC-level exits. In the basest of terms, there is frenetic competition.

I am excited to see a few new "angel" funds. Personally, I think larger VC funds, and even big corporate players, should consider entering the angel stage via new partnerships and even membership agreements. There are a few too many big piles of money chasing the few ideas that truly have massive upside. And perhaps too few smaller piles of money, particularly outside Silicon Valley, chasing smaller but fast-growing and feasible ideas.

In line with the ecosystem perspective folks like David H promote, we need to be aware of the necessity to fund ideas and teams as early as possible in order to boost the vitality of the overall ecology. Too many ideas either cannot be pursued, or are pursued after very aggregious angel terms (e.g., first rounds that take 50%). That's not good for the environment.

joystick

I reckon this early acquisition phenomenon is more than a temporal fluke but a reasonable trend- a modern form of "going public". Particularly in the class of firms and technologies dubbed ad-hocly as "Web 2.0." With development costs lower, a widespread awareness of the value of openness and the big gorillas in the room, a larger proportion of firms would seem to not be able to scale to traditional VC-level exits. In the basest of terms, there is frenetic competition.

I am excited to see a few new "angel" funds. Personally, I think larger VC funds, and even big corporate players, should consider entering the angel stage via new partnerships and even membership agreements. There are a few too many big piles of money chasing the few ideas that truly have massive upside. And perhaps too few smaller piles of money, particularly outside Silicon Valley, chasing smaller but fast-growing and feasible ideas.

In line with the ecosystem perspective folks like David H promote, we need to be aware of the necessity to fund ideas and teams as early as possible in order to boost the vitality of the overall ecology. Too many ideas either cannot be pursued, or are pursued after very aggregious angel terms (e.g., first rounds that take 50%). That's not good for the environment.

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