Selling your start-up to GYMA

Dare Obasanjo has an interesting post titled Flipping Your Startup 101. Dare references my earlier post Microsoft Will Acquire My Company which explains the logic the big players use when considering the acquisition of a startup. The "Flipping" post talks about the recent VC investment in Meebo and how that effects their chances of being acquired by GYMA (Google, Yahoo, Microsoft, AOL). While the subject is Meebo, the lessons and logic apply to all startups.

It is interesting to note that VCs invest in startups for the same reasons that the major companies acquire startups; 1)Great team of extraordinary people, 2)innovative technology, 3)growing user base, 4)a hot new market with huge growth potential. These are pretty much in rank order of importance.

Truly great engineering talent is hard to find. They are worth their weight in gold. Using a basketball analogy, Michael Jordan was only 1/5th of the Chicago Bulls starting lineup, but he was 100% of the reason they won so many games.

One superstar engineer/visionary like Ray Ozzie is worth 100 really great engineers. And, one really great engineer is worth another 100 good engineers. This is the normal order of things, yet few CEOs understand this. The truth is you need all levels of talent to build out a team, but without the superstar it will be tough to win.

I agree with Dare and Om Malik that Meebo is probably not now a good candidate for acquisition by the big guys, but perhaps for different reasons. The fact that they took venture capital raises the price expectations, perhaps beyond what they are worth as pure engineering talent, and their product competes with the other major players.

However, an acquisition by one of the majors is still a small possibility. It is not uncommon for big companies to acquire small companies with talented engineers and then redeploy them onto other strategic projects in the company. In other words, they are acquiring the people and their potential. The  product is of secondary importance.

It comes down to this; if the company in question has a product that is squarely in the domain of an existing Microsoft product than the valuation is a small premium over the internal development cost. If the company has market leadership in a new product space or market segment than the valuation goes up significantly.

VCs make investment decisions, and determine valuations, in the same way. Of course they want their initial investment to be successful, but if it isn't they could move the team into a different opportunity, or combine them into another investment,  and hit the jackpot. It is all about the people.

Real estate investment is all about location, location, location. Technology startup investment is all about people, people, people.

Comments

[Peter Rip]

Don:

I have to disagree with the premise that companies' and VC's decisions are based on the same process.

Pre-revenue acquistions place a much higher emphasis on people than markets or technology. This is because people are fungible and can be (and usually are) re-directed to an "integrated" version of the original vision. Public companies buy pre-revenue companies because their public stock options usually make it unattractive to entrepreneurial talent. They pay $15-30M valuations to effectively give these people cheap (unvested) stock or stock equivalents and not screw up their internal hiring guidelines. I am sure you have heard of the $1M-2M/engineer algorithm. This is just the most unabashed version of the process.

Criteria are more similar to VCs in acquisition of post-revenue companies because now earnings diluition/accretion proxies for VC ROI. Even then there is a 40-100% "control premium" which is due to the buyer's desire to potentially re-direct the people. This is part of why acquisitions usually don't work. Entrepreneurial people eschew the buyer's control.