Posts from January 2011

For the past month we've been doing M&A Case Studies on MBA Mondays. It's time to go back to the basics of M&A. I laid them out in this post. For the next few weeks, I am going to discuss each of the key issues in detail. First up is the integration plan.

The integration plan is the way the buyer plans to operate your business post acquisition. You should get this figured out before you sign the Purchase Agreement. You are going to have to live with the results of the integration and you had better buy into it before you sign your company away to someone else.

There are two primary ways a buyer can "integrate" an acquisition. The first way is they mostly leave your company alone. Examples of this are Google's acquisition of YouTube, eBay's acquisition of Skype, and The Washington Post Company's acquisition of Kaplan (one of my favorite M&A cases). The second way is they totally integrate the company into their organization so you cannot see the former company anymore. Examples of this are Google's acquisition of Applied Semantics, Yahoo's acquisition of Rocketmail, and AOL's acquisition of our former portfolio company TACODA.

And, of course, there are many variations along the spectrum between "leave it alone" and "totally subsume it." In my opinion, consumer facing web services should largely be left alone in an integration. On the other hand, infrastructure, like Doubclick's ad serving platform, is best tightly integrated.

The other critical piece of an integration plan is what happens to the key people. Do they stay with the business? Do they stay with the buyer but focus on something new? Do they parachute out at the signing of the transaction?

I believe the buyer needs to keep the key people in an acquisition. Otherwise, why are you buying the company? So letting the key people parachute out at the signing seems like a really bad idea. That said, the buyer also needs to recognize that great entrepreneurs will not be happy in a big company for long. So most M&A deals include a one or two year stay package for the founder/founding team. That makes sense. That gives the buyer time to put a new team in place before the founding team leaves.

Generally speaking, I think it is a good idea for the key people to stay with the business post acquisition. This provides continuity and comfort in a tumultuous time for the company. However, I have seen situations where the key people went to other parts of the organization and provided value. Dick Costolo left Feedburner post acquisition by Google and focused on other key issues inside Google. Dave Morgan left TACODA and focused on strategic issues for AOL post the TACODA acquisition. This can work if there is a strong management team left in the acquired business post transaction.

Another key issue is how to manage conflicts between the acquired company and existing efforts inside the buyer's organization. This happened in Yahoo's acquisition of Delcious. Yahoo had a competing effort underway and they left it in place after acquiring Delicious. This resulted in a number of difficult product decisions and competing resources and a host of other issues. I think it was one of many reasons Delicious did not fare well under Yahoo's ownership. You have the most leverage before you sign the Purchase Agreement so if you want the buyer to kill off competing projects, get that agreeed to before you sell. You may not be able to get it done after you sell.

These are some of the big issues you will face in an integration. There are plenty more. But this is a blog post and I like to keep them reasonably short. Take this part of the deal negotiation very seriously. Many entrepreneurs focus on the price and terms and don't worry too much about what happens post closing. But then they regret it because they have to work in a bad situation for two years and worse they witness the company and team they built withering away inside the buyer's organization and are powerless to do anything about it. It is a faustian bargain in many ways. But you don't have to let it be that way. Get the integration plan right and you can have your cake and eat it too.

When something you have come to rely on is taken away from you, it is frightening.

This week, when I read that Egypt's government was able to completely turn off the Internet in country, it stunned me. The Internet was designed to be immune to such things.

I have come to accept the idea that I can skype with anyone anywhere in the world at any time as "the way it is." I have come to accept the idea that I can text message anyone with a cell phone anywhere in the world at any time as "the way it is." I have come to accept that I can check twitter and find out what is happening all over the world in real time as "the way it is."

Well it isn't exactly the way it is. And that is frightening to me.

My business interests are based on the availability of the wired and wireless Internet to everyone all over the world. Our firm has been active in working with the US government to make sure that continues to be the case in our country. We support net neutrality rules and oppose legislation such as COICA and the Internet Kill Switch.

But my business interests pale in comparison to my interests as a citizen of this world. When I think about being in a country that has no internet, no mobile phone service, and no international news on TV, it scares me. 

I suppose I am a "cyberutopian" at heart as Evgeny Morozov calls us. I believe in the power of technology, particularly communications technology powered by the internet, to make the world better, safer, and more open and free.

This past week has shown that the cyberutopian view is naive and that those who are not interested in a better, safer, more open and free world will use technology to further their interests too. 

So this has been a frightening week and one that shows that the fight for human rights all over the world will not be delivered a decisive win via the internet.

I'm going to be spending today at the Women Entrepreneurs Festival at NYU's ITP school.

I'll be tweeting out the things that are most interesting to me, and will post all of them to the #wefestival hashtag where there are already some great conversations happening.

I love the idea of an event that celebrates women entrepreneurs. We need more role models, more success stories, and more doing.

As I finally migrate my entire contact database (after some serious cleaning up) from Outlook and into Google Contacts, I am sitting here thinking that Microsoft may be getting its mojo back.

I'm done with their productivity suite. I left Outlook mail for gmail a few years ago. Left Outlook calendar for google calendar shortly thereafter. I've left Excel and Word for Google Docs (mostly) and now my contacts are headed to Google too. Then I will be once and for all done with the twin beasts called Outlook and Exchange.

But I am starting to consider other Microsoft products. We've got two xboxes in our home and a Kinnect is coming soon. I've been using Bing more and more. And now I am about to get a Windows Phone 7 device. It was a comment on this blog that got me to do that (I also love their ads).

I'm totally into my Samsung built Nexus S so I just found an unlocked Samsung Focus on eBay and it is coming my way. I'll use it for the next few weeks and then pass it around our office for others to try out.

I'll be curious to see how well Windows Phone 7 supports the google productivity suite. If Microsoft really wants to be a player in mobile, they have to ditcch the idea that everything revovles around their productivity suite which more and more people are leaving for the google apps.

But I am totally taken with the idea that the contact book on your mobile device should be the central organizing principal and all the social apps/nets you have should plug into that. So I'm going to give Windows Phone 7 a spin. I'll let you know how it goes.

Given the amount of startup activity we've been witnessing the past couple years in the web space, we are in for a bunch of strikeouts this year. We should not avoid talking about failure. Words like roadkill and deadpool should be avoided at all costs. But I sure hope that the lessons that were learned will be shared with respect and restraint.

My friend Roger Ehrenberg has a great post on this today. Please go give it a read.

I'll end with the comment I left on Roger's post:

in the VC business, if you hit .300, you are doing well. if you hit .400, you are going to the hall of fame. but it is how you behave when you strike out that defines your reputation. 

no throwing bats 🙂

This is going to feel like a continuation of yesterday's post which was a continuation of last week's post. But it is what I am thinking about so it is what I am posting about.

I love what @Bryce wrote about mobile on his blog yesterday:

By their nature, these phones were born social. They were built from the ground up to connect us. First with voice, then with text. Now, they’re packed capabilities like photos, videos and a wave of native and web applications. We’re just beginning to catch a glimpse of what a powerful and disruptive force they can be. Not just to incubent handset manufactures and telcos but to social movements and government regimes. 

I’ve made clear my belief that we’re in the midst of a massive global reinvention. Not just a shift from analog to digital, but a shift from centralized control to distributed systems. From isolated single user experiences to a global social fabric. These mobile devices are the of Gutenberg presses of our generation. This is not a bubble, this is a revolution.

Social web services were also "born from the ground up to connect us" but it sure seems like phones are more natural, more fundamental, and more important.

I've been thinking for a while now that there will not be one social graph to rule them all (Facebook) but that we will eventually have a multitude of web/mobile services in our lives, each with a social graph we curate specifically for that service. That's been my gut instinct as I do not believe the Facebook social graph is the right graph for Twitter, Foursquare, Tumblr, Etsy, Svpply, Boxee, etc, etc, etc.

But what has been less clear to me is how we will make it easy for people to do this curation. I posted some thoughts on this subject last week. And I've continued to puzzle on this topic since.

Yesterday, in a series of chats with my colleagues at USV, it started to become clear to me that the mobile phone address book may well be the answer.

I have been using a bunch of mobile messaging apps with social graphs in them. Examples are Kik and Beluga. When you download and startup these apps, they do a query of their user base against your contacts and allow you to easily and quickly add all the people who are in your contacts to your network in these services.

Of course, you could do the same thing with Facebook's API (unless you are Twitter who they continue to block from doing this). But the truth is that most people have very large social graphs on Facebook and probably don't want 1000+ people being added to their mobile messaging app. Those same people might have 100 or so people in their mobile phone contacts and these people are certainly exactly the kind of people you would want to add to a mobile messaging app.

Mobile messaging is clearly a perfect match for a contact book on a mobile phone. But all web/mobile services can and should use this move to quickly build application specific social graphs. The people in our phone contacts are our "strong ties" and we should want them in most any social graph we curate.

Every big powerful technology company has met a new technology that has undone their dominance. For Microsoft it was open source and the Internet. For Google, it appears that it may be social. For Facebook, it appears that it may be mobile.

This MBA Mondays M&A case study is about the effect that stock option acceleration provisions have on M&A transactions. I am reblogging a blog post that Feedburner founder/CEO Dick Costolo (now Twitter CEO) wrote in the wake of the acquisition of Feedburner by Google. This post is still live on the web at its original location. While the names are fictional, the situations are not. It's a really good read and addresses a whole host of issues that you will face as you think about stock option acceleration for your team.

——————

Question number 1 comes from an invisible Irish gentleman named Bernie in Wichita. Bernie writes, “Can you explain options acceleration? And when would I want to use it? And when wouldn’t I? And what’s single trigger vs. double trigger acceleration and how do you feel about those kinds of things?”

Those are great questions Bernie! Hopefully, I can at least get you to realize there's a lot to think about here. Let’s dive right in.

Most options plans for your employees have a vesting schedule the defines how the options vest (ie, when the employee can exercise them). Vesting schedules for tech startups all generally look like a four year vesting period, with 25% of the total options grant vesting on a one year cliff (ie, nothing vests for a year and then 25% of the options vest on the 1 year anniversary), and then the rest of the options vest at 1/48th of the total options every month for the next 36 months.

Now let’s say you’ve got this classic vesting schedule and you hire somebody named Bobby Joe after you’ve been in business for one month, and he gets an options grant equal to 1% of the total outstanding shares. He works hard at your company for 11 months, after which your company is acquired for an ungodly sum of money. The acquirer decides that they were buying your company because of it’s cool logo and they don’t need any actual employees so they are all terminated effective immediately.

Bobby Joe’s options are worth how much? If you answered “Bubkas”, “Zero”, “nothing” or laughed at the question, you are correct. Although Bobby Joe has worked at the company for almost the entire life of the company, he gets nothing and the person that started 30 days before him gets 25% of their total options value. Doesn’t seem fair. Or as Bobby Joe would undoubtedly say “I’m upset, and I will exact my revenge on you at some later date in a compelling and thorough fashion”

Enter acceleration. Acceleration in an options plan can cause vesting to accelerate based on some event, such as an acquisition. For example, you might have a clause in your plan that states that 25% of all unvested options accelerate in the event the company is acquired.

If Bobby Joe had acceleration like this, he’s happier. He may still not be as happy as the person hired a month before him who also accelerates and now has 50% vested (the first year cliff and the extra 25% acceleration), but it sure feels a lot better to be Bobby Joe in this scenario.

That brings us to single trigger, double trigger, full acceleration, partial acceleration, etc.

We’ll start with full vs. partial acceleration. Full acceleration means that if the accelerating event happens, 100% of unvested options are vested and the employee is fully vested. If you started your job last Wednesday, the board approved your options grant on Thursday with full acceleration, and the company was acquired on Friday, congratulations, you just vested 100% of your options….you are just as vested as Schmucky in Biz Dev who was employee number 2 and started 3 years and 10 months ago (although shmucky may of course have a larger total number of options than you).

Partial acceleration we already referred to; this is how we refer to vesting some remaining portion of unvested options, such as 25% of the remaining unvested options.

Ok so far? Good, we are coming to the fun part. Let’s say you bootstrap your startup that’s selling bootstraps on bootstrap.com for two years and then let’s say you have a 20% options pool that was created as part of an A round financing. Over the next 6 months you hire a whole bunch of people, you allocate 15 percent of the options pool, and an acquirer comes along. Do you think the shareholders (common and preferred) are going to be more excited about full acceleration or partial acceleration? Full acceleration dilutes the shareholders 15%, whereas partial acceleration only dilutes the shareholders…well, partially. As a variation on this example, let’s say you hired employee number 1 when you started bootstrapping and you allocate the same number of options to everybody. The guy who started last Tuesday is going to make just as much as employee number 1.

For these kinds of reasons, you will frequently see investors and others argue for partial acceleration. Options holders and those negotiating their employment of course prefer full acceleration. This can be the cause of lots of board arguments in the early going as you and your investors decide how acceleration will work in your company options plan (or with employees who want to negotiate additional acceleration on top of the existing plan). Hold this thought for a moment while we hop across town to learn about single trigger, double trigger, etc.

Single trigger acceleration simply means that there is one kind of event in the options agreement that triggers the acceleration of some or all options. Single trigger usually refers to an acquisition. Double trigger (and I suppose triple and quadruple trigger) acceleration means that there are multiple kinds of events that can trigger the vesting of options. Double trigger acceleration usually refers to a situation in which the options plan grants partial acceleration on an acquisition, and then further acceleration (perhaps full, perhaps additional partial) if the employee is terminated (eg, our first example where they’re buying the company for its logo and don’t need employees).

Now for the important piece of the conversation: What’s the best way to set up an options plan vis-à-vis acceleration? The idea behind double trigger acceleration is that as we saw in our bootstrap example, there are lots of interested parties that don’t particularly care for full single trigger acceleration. It is very employee friendly BUT not necessarily equitable and your investors will very likely raise their hands at every board meeting and ask if you’ve come to your senses yet if you’ve started your plan with full single trigger acceleration. We’ll see another reason to dislike it in a minute. So, along comes double trigger acceleration in which we seem to be creating a more ‘fair’ plan because partial acceleration makes the shareholders happy and the employees who’ve worked there for a couple years get a bigger piece than the guy who started Tuesday, while also providing additional consideration to any and all employees who aren’t offered jobs after the acquisition.

Here’s how I feel about all this, from number of options granted to acceleration: I’m for partial single trigger acceleration on acquisition (with no special exemptions for employees with super powers) AND an options grant program that objectively matches role and title to size of grant consistently across the organization. (eg, all senior engineers get 4 options, all executive team hires get eleventy-eleven options, you get the picture).

Why? Because any other approach misaligns interests and motivations. I know of one company (not one I started or worked for) that had full single trigger acceleration and the people at this company STILL hate the head of sales that got hired one month before an acquisition and made more than the hundreds of people who’d worked there for three years. Double trigger? Now you’ve got people who might WANT to get terminated if there’s an acquisition. Subjectively granting options quantities based on whatever the criteria of the day is? Always a bad idea and bound to end in tragedy and you regretting your whimsical approach to options grants.

So, at this point the astute reader thinks “this is all well and good, but you can just as easily have some employees who really take a bath if they’ve just left a very nice and respectable job to come work for you, then get terminated on acquisition a month later, and only get partial single trigger acceleration”. This is true. The answer is hey, they get partially accelerated, and I’d rather have generally equitable distribution of the deal. If you’ve got a reasonable Board of Directors, you can accommodate anomalies with performance bonuses or severance or whatnot instead of being locked into a plan with misaligned interests.

There’s another hidden issue with full single trigger acceleration that I mentioned earlier, and we can call this the “acquirer’s not stupid” rule. If your employees all fully vest on acquisition, how do you think the acquirer is feeling about your team’s general motivation level post-acquisition? They are not feeling good about it. No they are not. They are thinking “gee, we are going to have to re-incent all these folks and that’s going to cost a bunch of money, and you know where that money’s going to come from? I think we will just subtract it from the purchase price, that’s what we will do!”….so the shareholders get doubly-whacked…they get fully diluted to the total allocated options pool AND they likely take a hit on total consideration as the acquirer has to allocate value to re-upping the team.

My FeedBurner cofounders and I have done our options plans a bunch of different ways across a few different companies, even changing midstream once, and I think partial single trigger acceleration causes the least headaches for everybody involved in the equation (although it obviously provides less potential windfall for more recent hires).

NB: you should be very very clear when you hire people about how this works. Most employees, to say nothing of most founders, don’t really understand all the nuances in an options plan, and it’s always best to minimize surprises later on.

You want to sort as much of this out up front with your attorneys before you start hiring people. You want to avoid having “the old plan with X and the new plan with Y” and that sort of thing.

Thanks for the note, Bernie!

John Battelle has put forth his vision for The Independent Web. John is thinking of this concept in the context of the world he lives in, publishing and advertising, which makes total sense. 

I too am very taken with the idea of The Independent Web, but I am thinking of it in the context of the world I live in, investing in and working with web and mobile web services.

My partner Albert Wenger posted a "letter to Larry" (my words not his) yesterday on his blog. One of his wishes for Larry's vision for Google is this:

Supporting independent third party services instead of either trying to acquire them or competing head on with them.  Figure out how to succeed by making others succeed.

We have seen again and again that when a large company acquires a startup, they most often let it wither and die (myspace, delicious, etc). We have also seen that if that web services can be spun out (skype, stumbleupon), they can often be resuscitated. And so we believe that buying web services and aggregating them under some uber holding company model is not a great thing for the acquirer or the web at large.

Now Google is possibly the exception to this rule. As I said on stage at Web 2 last fall, Google has been hands down the best acquirer of web services. YouTube, Android, Doubleclick, Keyhole, and many more are proof that this is what Google does best.

But acquiring innovating emerging web services is not the only thing that big companies do that can be detrimental to the web. Worse is competing head on with them. Look at Facebook. They have ripped off Twitter, Foursquare, Quora, and many more small innovative startups. They haven't "killed" any of these companies but they have muddled the market and caused users to have to make choices that may turn out to be the wrong choices for them.

What I would like to see (and obviously Albert would too) is the emergence of a cooperative attitude on the web and mobile web where the big Internet companies and the innovative emerging web services work together to "succeed by making others succeed." 

Tim O'Reilly has been promoting this concept for a decade or more under the rubric of the Internet as an open operating system. This is an ideal I totally subscribe to. And I'd like to see more companies think this way, including companies that we are invested in that may not entirely see the world this way.

You can try to get as much of the pie for yourself or you can try to make the pie bigger and thus make your piece of the pie bigger. An independent web vision is the latter approach and, I think, the right approach.