Built To Be Bought (Bubble 2.0)

Over the last couple of months I've noticed an increasing sense of unease in the venture community about the trend in Web 2.0 company creation and financing events. While no one is officially willing to peg it Bubble 2.0 for fear of missing the next great opportunity, I've been having lots of conversations with venture investors about this nagging feeling that we've been here before. Which is not to say that there aren't potentially extremely interesting companies being built in the context of Web 2.0 -- after all, while Webvan and Pets.com and Excite@Home were born and died in Bubble 1.0, Yahoo and eBay and Amazon were born and thrived.

So why am I now getting this increasingly uneasy feeling? I was chatting with a veteran of Bubble 1.0 recently and I think he hit on the thing that makes those of us who've seen this movie before most nervous. He pointed out that there are a large number of "companies" being created again for the express purpose of being acquired. I certainly have seen it. I have met with companies that clearly state their intention to be acquired by Yahoo or Google or, in a pinch, Interactive Corp. I even had one company pitch me at the Web 2.0 Conference that if all went well they would be acquired by Odeo (don't get me wrong, I'm a big fan of Ev's and I certainly think that podcasting is exciting, but it strikes me as a tad premature to bet your company's future on being acquired by a pre-revenue company). These folks are unabashed about their intention to be acquired and they are developing their software and services with an eye towards compatibility with their would-be acquirers.

Acquisitions in and of themselves are certainly not a problem. The vast majority of money-making venture investments reach liquidity through acquisition. But, by and large, the most successful venture investments end in Initial Public Offerings (IPOs). It certainly isn't surprising that independent, stand-alone companies would in most cases be worth more than companies that can only survive through being consumed by larger entities. Therefore, from a venture capital perspective, startups that have the capacity to be stand-alone entities are by their very nature more appealing than companies that will ultimately require acquisition.

If companies are indeed again being built for acquisition rather than independence, venture investors are in for a rude re-awakening (that will be precipitated by a very loud popping sound). While a few companies being built for acquisition will be acquired, the vast majority will ultimately run out of money and be shut down (particularly as each new Web 2.0 idea doesn't just spawn one company but three or four). So when I hear large numbers of companies pitching themselves as excellent acquisition candidates before they've even gotten out of the gate I can't help but think to myself that we are in the heart of Bubble 2.0. Sadly, only one thing follows Bubble 2.0 and that is Bust 2.0. On the good side, there's always Web 3.0.

Comments

[okito]

Hi:

I totally agree that there are too many people trying to create "feature" companies simply hoping to be bought out. I think the saddest thing about this is that these entrepreneurs are missing the biggest opportunity of Web 2.0: the new economics.

Thanks to much lower technology costs and a willingness by consumers to pay for web-services, there are a whole new range of business models possible today that were not feasible before. If you are going to quit your job and invest your life savings into a Web 2.0 business, you should be going after a new market, not just yet another todo list or search engine.

That said, I also think we have a long way to go before we are truly in the midst of Bubble 2.0. There are not enough over-exuberant MBA's involved yet.

I wrote a more extended response to your post on my blog here:

http://www.sproutit.com/bigact/2005/10/24/more-on-web-2-0-economics

[Danny Nerezov]

David,

Nice post.

All of you guys (vcs) are getting pitched left, right and center. The temptation must be intoxicating.

What's worse than the bust is missing the bubble. Just a thought.

No....but really...all of these feature companies, which are derivatives of derivatives are not businesses. They're gambles, plain and simple and should be treated as such.

Nothing wrong with a bit of a punt...as long as you're sufficiently diversified.

[Mike]

Great comment! However, I think there is a couple of really important differences between Bubble 1.0 and Bubble 2.0. The first regarding Web 2.0 is that it takes a tiny fraction of the money to fund a web 2.0 company. In the days of WebVan we saw huge amounts of money being thrown after new concepts and ideas. So far at least, I don't think that is the case with web 2.0. What is also difference is that the noise is far louder but in a far smaller group.

We read and hear about web 2.0 every day because we follow the same blogs and feeds. However, that does not mean that web 2.0 has already become as big as the web 1.0 hype of the past.

However, if people are building companies simply to be acquired, then that is a huge cause for concern. I am also concerned to see so many people start and fund concepts with no business model.

[afelton]

What about this essay from Paul Graham
http://www.paulgraham.com/ideas.html
in which he argues:

Success for a startup approximately equals getting bought. You need some kind of exit strategy, because you can't get the smartest people to work for you without giving them options likely to be worth something. Which means you either have to get bought or go public, and the number of startups that go public is very small.

If success probably means getting bought, should you make that a conscious goal? The old answer was no: you were supposed to pretend that you wanted to create a giant, public company, and act surprised when someone made you an offer. Really, you want to buy us? Well, I suppose we'd consider it, for the right price.

I think things are changing. If 98% of the time success means getting bought, why not be open about it?

[Victor Lombardi]

If you are building a "feature company" then getting bought out is attractive because it means you can ignore many of the operational aspects that an independent entity must worry about. While not big enough to be attractive to VCs, it can be very rewarding to the small group of entreprenuers involved.

I like it because many small groups will on the whole create a lot of innovative work.

Maybe it's not Bubble 2.0, maybe it's Bootstrap 1.0.

[Jeff Clavier]

Most of these "feature" companies will supposedly not get any funding from VCs, and it is not clear to me whether angels should even touch them. But if they are 100% bootstrapped, developing a compelling and differentiated functionality on top of an established platform is OK. Note that established is an important word in the sentence.

[Jeff Clavier]

Most of these "feature" companies will supposedly not get any funding from VCs, and it is not clear to me whether angels should even touch them. But if they are 100% bootstrapped, developing a compelling and differentiated functionality on top of an established platform is OK. Note that established is an important word in the sentence.

[Dick Costolo]

If people are worried about there being a bubble before there is even the slightest public market interest, I'm wondering of Bubble 3.0 will be declared the first time somebody says "Web 3.0"... by Web 4.0 you'll only have 19 minutes to found and sell your company before the markets go cold. Bubble 5.0 will happen before Web 5.0, which will see companies founded with cash that doesn't yet exist. These organizations will be said to have "futurestrapped" the enterprise. Ray Kurzweil will write FutureStrapped! and claim that he owns a chicken that can pass the Turing test. It's all good.

[borgnamarco]

shit happens.
I think i will believe in Internet another time, BUT i will invest less time and money :D

http://treepie.sf.net

[Dave]

daveH -

Web 2.0 conf acquisition anecdotes aside, i think the "it's 1999 all over again" fear is missing the larger market trend -- namely, that (1) lots of startups are being self-funded and/or angel-funded, at least for the first few rounds, (2) lots of profitable platform companies are shopping for startups with their considerable cashflow, and (3) the audience for new web-based products & services is substantially larger & more well connected than it was 5 years ago.

given that the founder and/or angel investor are putting money into the company at pre-money valuations between $1-7M, it's not at all unreasonable to think of acquisitions by Yahoo, Google. or others at between $10-50M (or more, with performance-based bonuses and earnouts) as being decent-to-excellent returns for both entrepreneur and angel. and you still have the outlier possibility of a larger acquisition and/or IPO as a stretch goal.

the Web 2.0 "get bought instead of go IPO" logic is quite rational given these new post-2000 funding environment factors, and given the fact that many software startups can build reasonably mature feature functionality for under $10M (if not under $2M in some cases).

the concerns you express are rational for VCs (particularly a later-stage VC firm that typically jumps into B or C rounds at >$15-25M or higher), so i'm not saying *you're* being irrational, nor others who invest at the same levels. however, it's also not quite appropriate to judge the entire market behavior looking backward only thru a late-stage VC's high-powered binoculars.

furthermore, the difference in today's Web 2.0 world is not simply a shift to recognize that M&A is a more likely exit than IPO (as you note, that's always been the case) -- rather, the difference is that there are so *many* public Internet 1.0 companies (YHOO, GOOG, AOL/TWX, MSN/MSFT, ASK/IACI, EBAY, AMNZ, etc) with large cash hoards going shopping, not to mention large userbases with which to monetize the acquisitions.

this is quite different than the "car dealer i-banker/analyst" & "clueless retail investor" driven IPO market of the late 90's which blew up in everyone's faces. the liquidity exits are now being fueled -- rightly or wrongly -- by large platform company M&A that assess acquisition value based on the incremental ROI to their revenue / userbase / market caps from grabbing a new feature/startup & rolling it out to their x00 million users.

while i don't think everyone doing startups these days assumes an early exit by Y! or G, the "built-to-be-flipped" mentality is not nearly as bubblish as it is getting made out to be. on the contrary, it appears to be an extremely rational approach to the current market, and an example of learning behavior post-Web 1.0 bubble -- by entrepreneurs and angels, anyway... remains to be seen whether VCs can similarly demonstrate such learning behavior in this round ;)

- dave mcclure

(* disclaimer: the opinions above are my own, and reflect my very subjective and likely clueless take on the overall market -- they certainly do NOT reflect the philosophy of Simply Hired mgmt nor reflect upon our startup's financing specifically. while our company was initially self-funded by founders & angels, we are not planning any immediate exit via acquisition. quite the opposite; a few of our angels were previous investors in both Google and IAC, and i'm sure both they and we have our eyes on the prize :)

[Stan Sorensen]

Saw a similar story in the Seattle PI yesterday. The reality is that there's a lot of money in the market and VCs are looking to invest. One company I know is raising an A round and is typically being offered more money than they are seeking. A friend starting a new fund is being told by LPs that they think the venture segment is overfunded. When you look at that is makes sense that guys will start feature companies--VCs seem willing to fund them.

Further, if VCs are worried they shouldn't fund them. You'd hope that the bubble taught the VCs the same lessons it should have taught companies.

I'm not at all in favor of a bunch of startups based on single features being founded with the sole premise of being bought. But it's happening. I think VCs should shoulder some of the responsibility for making sure this doesn't spin out of control. As soon as funding for these business plans slows down those types of plans will diminish.

[Franco Cumpeta]

It's an industrial approach, this you write concerned by. To be bought as part of a larger system, maybe the top of the pyramidal scheme, squeezes too much brains, since it's intended as the final result of all our efforts. Get the top.

Ideas, or better, philosophies, dont care to get the top or the bottom of something; they face the world and ask themselves: what's better to do now? They should come after a some long cross-the-real probe, and should answer not much to what the marketing offices plan like answers, they should answer to what the world displays, be it planned someway or not.

"Rem tene, verba sequentur", (keep the things, words will follow) is an Aristotheles sentence. If you keep only in mind to be bought by something, yoy can't plan anything if not to be bought of some. If you keep in mind the world as a system and you keep an eye to your past, you are maybe on track to solutions. Big? Small? Who knows. Solutions are, any way, worthy more than every other resource, because solutions, bought or let free to fly by themselves, take roots. I suppose (Google docet) this may also mean lot of money, subsequently. Fund projects found on ground could be a way to keep out headache from venture capitalists. Even in this virtual world.

At last, everybody of us lives in a place, there's no virtual able to make us many, and so the most we spend, we spend right where we currently live. It's this a good business plan? Short, but smart, isn't it? Have my regards and wishes.

Thank you, David.

Franco Cumpeta
poli Inc.

email: [email protected]

[Jason M. Lemkin]

The real problem with "built to be bought" IMHO is that it ain't easy to get bought. Good companies and products don't get bought; and inferior and even poor companies do get bought, for reasons that are out of the hands of the targets. In my experience, M&A depends on a lot of factors the start-up itself can't do anything about - (1) does acquiring your start-up help someone's fiefdom at a potential acquiror; (2) is acquiror's mgmt even in a place/position to do a certain type of deal; (3) does the acquiror believe it would be better to build the product itself even if that decision is "wrong"; (4) a ton of luck in timing; (5) etc. There is a lot of serendipity in M&A, vs. an IPO at the end of the day is just about the numbers.

[jordy]

This reminds me of a funny website I saw the other day about building a business plan for Bubble 2.0:

http://odio.us/plan/

[alexsmr]

Well, looking on this interesting discussion thought stroke into my head:

Why not to build an on-line central for companies who are "built to be bought" (something like Ebay)?

Sorry for my brainfart (I'm not an investor), but it seems quite an intuitive solution to prevent new bubble burst. Or may be even build something totally new!

Think about that: the are gazillion of techies like myself who have an original ideas. To build a startup company just like that - almost impossible: this is a function of luck, timing, team, etc. (all this startup gum...). Worse of all even after many years of trying the original idea will be distorted or forgotten. Acquisition actually provide a good opportunity to exit much faster and more technology focused.

So, if you're small focused startup that have an original idea and is "built to be bought", - go to "Built to be bought" Central, create an account, follow internal Bylaws like:
1. track your project on-line
2. track your resources on-line
3. publish your sensitive company information (or required part of it)
4. publish your investment requirements for early stages.
And MAYBE you will be contacted by one of BIG BROTHERS that want to grow by acquiring small ones...

If you're a BIG BROTHER company and you feel like you want to grow by acquisitions, open account on "Built to be bought" Central to specify what technological interests you have, so "built to be bought" brothers can adjust their directions. But more important, if you're RIG BROTHER company, you can search for the right technology company, watch it growing and even pre-invest at startup stage.

If you're investor and you want to invest into "Built to be bought" company, create an account on the Central and you will be able to research for mutual interest for BIG and SMALL brothers, and pre-invest on early stages.

Everything else you may imagine yourself: the main income for Central - percent from acquisition deals.

So how is idea? Anyone interesting? :-)

[klempner.wordpress.com]

This is a very interesting opinion on the topic. Personally I can't completely agree on everything. For example IPO vs. acquisition is a much longer way for Web 2.0 companies. You need to have time and money these days to become IPO. Time is something many VCs are very sensitive about since they need to have their ROI. At the same time for entrepreneur selling the company to a much bigger company with a strong financial backing will assure growth of the business and satisfy investors.

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