Month: October 2005

A number of our portfolio companies have been fielding calls from strategic buyers expressing an interest in acquisition.  This is great news since many of the better acquisitions come when companies are bought and not sold.  For a startup, it can be quite flattering to have a large competitor or suitor express an interest in buying your company.  However, as an entrepreneur you have to be skeptical as many of these calls end up as just another fishing expedition from the strategic buyer. I have seen too many companies get overly excited about these acquisition feelers and waste time educating the potential acquirer only for the acquirer to either do nothing, build it themselves, or buy a competitor.  In fact, you have to recognize and assume that many of these initial calls are just fishing expeditions where a strategic buyer is just trying to get as much information as they can about a market and the competitive landscape.  You have to assume that they are talking to all of your competitors as well.  Before taking your first meeting, make sure you get as much information you can to gauge the real interest in your company.  Here are some questions you should be asking or thinking of during your initial conversation.

1. Who is calling you, what is their role, and what have they acquired in the past?  You need to determine whether it is just a junior person screening or if it is someone with real clout and decision making power.
2. Why do they want to enter this market and what is the decision making process by which they will make a build/buy decision?  If they are early in the process, you have to be concerned about wasting your time, educating a potential buyer about your market, and going nowhere with your conversations.
3. Have they talked to anyone else?  In many cases, an acquirer may already know who they want to buy, but will still talk to other players to fully understand the market and the competitive landscape and to use you as negotiating leverage.
4. What are they looking for in terms of an acquisition?  Revenue, product, management, both?
5. Who is responsible for making the acquisition work, and how does the acquirer intend to integrate your company into the existing infrastructure?  Will the acquisition be run as a separate, stand-alone unit or will it report to a certain group.  Knowing this will further help you understand the decision-making process of the acquirer, and who you may need to influence to get a deal done.

Before your first meeting, here are some questions you should have answered yourself:

1. What other acquisitions have they done, what multiples did they pay, and how recent were the deals?  If the buyer hasn’t done many acquisitions or if they paid low multiples do not start thinking about pie in the sky valuations for your company.
2. What is the company’s market cap and how much cash is on their balance sheet?  If your selling price is too high for the buyer based on the buyer’s market cap or cash on hand, don’t waste your time educating them about your product and the market.
3. Use your network to talk to some of the management or venture investors of companies that were recently acquired by the buyer to determine what their process was and to figure out if the opportunity is real or just a fishing expedition.
4. What is the corporate culture?  Does the acquirer have an NIH (not invented here) syndrome or is there a history of openly collaborating with partners and looking outside for new technology?

Once again, it is always nice to have a large company call you and express acquisition interest.  That being said, go into the conversations with a skeptical eye and make sure you do not waste your time as these strategic discussions can quickly lead to a dead end if not managed appropriately.  The tricky part of the dance is trying to establish early in the process a range that the acquirer will potentially pay for your company assuming everything you tell them is true.  The sooner you can get to this answer the sooner you will know if you should continue talking or just walk away.  If you manage this process appropriately you may find yourself in a great place as many of the best acquisitions happen when companies are bought and not sold.  The downside is that these discussions can suck up lots of your precious resources and be a tremendous distraction to your management team.

I had an enjoyable lunch with Jeff Jarvis today catching up on a number of things and brainstorming about value in the next generation web.  During the conversation I vented a little frustration at the use of buzz words and bubble-like mentality with terms like Web 2.0.  I am starting to get extremely tired and frustrated about every pitch that I see now where a company claims they are a Web 2.0 company and lists their principal reasons for being Web 2.0.  It reminds me of the mid-90s when everyone said they were an Internet company and sprinkled their pitch with wild growth expectations from Jupiter Communications.  Or when everyone said they were a Java company when Java was the cool buzzword.  Frankly I do not care if you are Web 2.0, Web 1.0, etc.  All I care about is what your service or product does, why it is valuable to the end user, why it is uniquely different from the competition, what the barriers to entry are, and how you plan on reaching your customers and how you will ultimately make money.  Don’t start your pitch with Web 2.0 ecochamber talk.  In fact as Jeff and I discussed several companies and ideas, we concluded that most of them were just features and not companies.  And as Jeff states, when small is the new big, then it poses problems for VCs as well.

Then Ed and I were talking about similar challenges for investors and entrepreneurs in the small-is-the-new-big age: Today, it’s much, much easier to start a new company on far, far less capital than it used to be. But this also means that it’s easier for someone else to start a competitor. So speed is more important than ever: You have to develop your business as quickly and nimbly as possible to build your product and then perfect it after it’s out so you quickly establish your value. This means that the VCs need to be able to act just as nimbly to invest as quickly as possible. The good news is that the investments are smaller and the risk is thus less. But the bad news, of course, is that it costs more effort and attention to manage many more smaller investments and it’s hard to act quickly at scale. Early bird, worm, and all that.

While getting in early and being nimble is a great way to make money, no matter how early you go, it is hard to build a sustainable VC portfolio investing in features.  As an entrepreneur, if you can get up and running for $20-30k, so can 10 other talented people.  Fred Wilson and a new VC blogger, Peter Rip, have written some thoughtful posts about a bubble mentality developing.  I have written about it before as well in an earlier post comparing and contrasting 1999 vs today.

In other words, these business models are quite capital efficient.  It is no wonder why VCs are quite excited about next generation web companies.  All that being said, I, like others, worry about believing all of our own hype, and moving ourselves to another bubble.  As you see from Tim’s map and my table above, if it costs less to build and launch a company, then the barriers to entry must be lower as well.

So if you are an entrepreneur, stop talking about Web 2.0 and start talking about how you are going to scale your business and make money.  Start talking about how you are going to create a defensible barrier to entry.  Better yet, since it is so cheap and easy to get started show me whay you are not just a feature, show me your user growth, and show me how you will maintain your competitive advantage.  Sure, as a startup, you will not have all of the answers and your business model may change, but show me that you care about these business concepts and that you have thought through these issues.  While I am a big believer in the promise of the web, I see this less as a revolution but more an evolution from where we started in the mid-90s.  We are talking about the same principles as the mid-90s, and we would not be here today were it not for the incredibly painful bursting of the last bubble.  But with every bubble bursting comes a rebirth and from the last bubble what we have is lots of cheap bandwidth, resilient entrepreneurs who scraped for crumbs to survive, and a mentality to do it cheaply (rise of open source and leveraging commodity inputs).  What we also have today versus yesterday are business models that can scale cheaply, be profitable, and throw off lots of cash.  Let’s focus more on these concepts versus being Web 2.0, as I do not want to think about what kind of rebirth will come from another bubble.