We Need A New Path To Liquidity
Watching all these machinations between Microsoft, Yahoo!, Google, AOL, News Corp/MySpace, and their ilk makes me sick. They are playing around with Internet assets like they are toys. And meanwhile the services we have come to rely on like Flickr, AIM, Delicious, Yahoo Groups, FeedBurner, etc are an afterthought.
The Internet is decomposing into a vast array of micro-services that we, the end user, stitches together to make our own unique web experience. It is the de-portalization of the Internet and it is very real. And yet, these large behemoths are trying to do their normal consolidation play on the Internet. First of all, it’s not going to work. They are destroying value with all of their M&A efforts and the bigger they get, the more value they will destroy, for them and their shareholders.
But honestly I could care less about them. The only company on the list at the top of this post that I am a shareholder of is Google and I don’t see them bidding for assets, just sitting on the sideline trying to figure out how to extract some value out of this game of musical chairs that their competitors are playing. But even Google is not without fault. It has bought a number of assets over the years and several of them have languished. I see them making some decisions about how to consolidate these web services inside of Google and I scratch my head. And that’s Google, the best Internet company in the world.
Here’s the problem. The company/web service creation process needs some kind of end game. The entrepreneurs who spend years and risking a ton need a way to get paid for that effort. And those of us who finance their efforts need to get some return on our investment. We can argue about the magnitude of the return we need and a host of other things, but the fact remains that without a path to liquidity, all the innovation that is being created by the entrepreneur/VC equation will stop happening.
The IPO market is closed and frankly hasn’t really been that robust (at least for technology/web offerings) since the crash in 2000. And even when it’s open, it’s nuts to take any company public that cannot deliver consistent and predictable growth and earnings quarter over quarter for years. That’s what the public market investors demand and they should demand that as they have no control over the companies they invest in. The public markets should be for the best companies. Apple, Google, Amazon, eBay – those are good public companies. Skype, YouTube, and the current Facebook are not.
So if you can’t take a company public, how do you get out? M&A has been the primary answer in the web/tech sector for the past eight years. And it’s been a great period to sell companies. We’ve sold three in the past couple years out of our Union Square Ventures portfolio, delicious, FeedBurner, and TACODA, to Yahoo!, Google, and AOL, respectively. Were we happy to take their money? Yes. Were we happy with the outcome? Yes. Were they good buys for their new owners? On the face of it, yes.
But if you look deeper, I wonder. Delicious grew nicely for a while under Yahoo!’s ownership but recently the user base has fallen off pretty dramatically. I double checked this chart in compete and alexa and they all show the dropoff.
Well, what about FeedBurner? Clearly Google has done a good job with that acquisition. Well I am not sure. I don’t see any integration between Adwords and FeedBurner yet. I can’t buy FeedBurner inventory through Google’s text ad interface. I honestly don’t see any additional money flowing to me, the publisher of the feed, since the Google acquisition. There’s no way to know what the rate of signup by publishers has been since the acquisition, but I wonder if it’s increased much.
And TACODA? I know that TACODA had an incredible fourth quarter post the acquisition by AOL, blowing way past the numbers we were projecting in our annual budget. But in the first quarter, AOL fired Curt Viebranz, TACODA’s CEO, and many of the top members of the TACODA team are now gone from AOL. Another acquisition messed up.
But who am I to complain? We got paid right? So sit down and shut up.
Except I am also a user of these services. I see what happens when a company gets purchased. The service languishes. The team leaves. It stops getting better. And often gets worse. And so even though I am happy to take the money, I am left wondering, frankly wishing, if there is a better way.
This topic came up in the comments to my Decline of the Firm post and one thing that was mentioned is Goldman Sachs’s GS True market. As my friend Roger Ehrenberg (author of the awesome Information Arbitrage blog) explains on Seeking Alpha:
But now there is a new game in town, and it relates to IPOs: Goldman Sachs’ (GS) GSTrUE ("GS Tradable Unregistered Equity OTC Market") program.
It turns out that there is another private liquidity market under development called Opus-5.
The idea behind both of these new emerging (and currently illiquid) markets is to provide a place for private equity investors to trade securities with each other. The companies remain private, do not have to file with the SEC, and do not trade daily like public stocks do. When an entrepreneur or investor wants liquidity on a position they own, they come to these private markets, offer their position or part of their position for sale, and a trade is made.
We don’t even need liquid markets to develop to allow this to happen. We already have entrepreneurs selling pieces of their ownership in the later private rounds to VCs. And when we we decided to sell the Flatiron portfolio company Bigfoot Interactive three or four years ago, three of the top five bidders were private equity firms who wanted to buy out the VCs. We could have easily gotten as good of a return on our investment in that company by selling it to a new set of financial owners instead of a strategic buyer.
This post has already gotten too long. It’s looking more like a pmarca post than an AVC post, so I will stop here and let the discussion start. And I am sure it will be a good one. Because the comments are always better than the post here at AVC.
The demand for a private liquid market has been ever increasing since the bubble burst and now, given the macro economic issues, sure seems to be at an all time high. No IPO? No M&A? No problem, hit the private markets and see all of the ways to leverage your positions you’ve never thought possible before.Ok, I think, for the most part we’d all agree on this as a potential leverage strategy BUT at the end of the day when it’s all said and done the effectiveness of all of this will hinge on Value. The word value is tossed around like an old school buzzword that lost it’s worth, only it’s not and it hasn’t. It’s the word that suffers in a bubble or depression. It’s at the core of all of these issues, micro and macro. If you can add ‘valuetise’, multi directionally between founder/vc/advertisers/customers/etc then you will rise above the noise, you’ll surpass the me too crowd, you will have many liquid options. Consider and then deploy to create value through the every connection, and every connections connection.Value is the key, only we’ll need new sets of rules and new paradigms for value creation in the edge economy. Maybe we’d be better off not knowing how the current and previous liquid markets worked to create something powerful. Maybe we should be asking the unexperienced, weird, and wacky about business models instead of always consulting with our peers.Valuetise.
To me value always been and always will be the present value of future cash flows. Nothing new there. We just need buyers of those cash flows who will actually be incented to maximize themFred
How about a public roll-up that monetizes web applications? The company could provide liquidity and some platform elements (both business and technical), while keeping a decentralized management model.If you’re right about where the web is going, then such a company could be very successful.
“value” and “cash” are almost divorced; that in some ways is the essence of the current scenario
At least part of the problem, it seems to me, is that a lot of these “micxro-Web services” don’t have a clear path to making money either alone or as part of something else. As part of a larger entity, there’s theoretically potential for cross-leverage but–as you point out–things tend not to go as planned.
that’s the conventional wisdom for sure (that small services can’t make money) but i don’t share that view.i guess that’s obvious based on our portfoliofred
Its funny, give the reaction from my post I don’t think its the conventional wisdom at all 🙂
I am an enterpreneur who has tried desperately to sell his private equity stock and let me tell you, it’s not easy at all. What information do you disclose, so that you don’t breach any securities laws? How do you value the shares? How do you get around the company’s or existing investors’ ROFR? How would the sale price compare to the exercise price on the options that the company is still doling out?Speaking of this last one, question for Fred: in your companies how do you set the exercise price for stock options? Different people answer very differently to this question, despite there being published quite clear U.S. Private Equity Valuation Guidelines…
we strongly suggest that our companies get a third party valuation at least once a year and ideally several times a year. it’s expensive ($5k to $7.5k). but its worth it for a whole host of reasons.
I think Gordon is on to something. The services that have had a solid path to revenues or revenues themselves will likely always find an acceptable exit. Other services (like Delicious for example) have a harder time even post acquisition as that path is likely still not clear.Also from what I understand with the Tacoda deal AOL and the other interested party largely valued it for its technology value and the impact it might have on their larger networks (Tacoda’s revenue being a mere blip in their overal revenue numbers).
Just regarding delicious, aren’t you seeing the fall-off a little one-dimensionally? I agree that Yahoo! isn’t exactly pushing the innovation on that service, but what about the competition?Link-services like Twitter and now FriendFeed are getting hyped to the max, and it wouldn’t surprise me if those have an effect on how useful del.icio.us has become. The biggest problem with that service is probably its lack of social “moat”; It’s very hard to grow a productive network around delicious.Another, perhaps small, problem is that del.icio.us stopped working for me in places like twitterfeed (to feed rss to twitter) and wordpress rss-reader; both of which I use to spread news to an audience. This happened a few months ago, and certainly made the service less relevant for people like me.But your point regarding M&A destroying small firm’s drive to innovate, I do agree with. Jaiku is another company that no one ever hears of anymore.
If delicious had remained independent, don’t you think they’d have addressed all of those issues you cite?Once you sell, you kind of stop caring. It’s sad, but true.fred
So really it’s a management / incentives issue. How do you incentivise the team behind a cool service that gets bought to keep it getting better? They’re not really going to see any relationship between their hard work and options in AOL or Google or whatever – what they do has little effect on the shareprice of whichever behemoth they’ve joined. So they stop caring.Similar problem to being a Citigroup or HSBC really. How do you reward your wonderful succesful high performing team that does M&A for Healthcare firms in Germany when their superb individual performance is a rounding error in the context of the whole firm? Giving them options which depend on retail banking in Asia for their success isn’t very motivating. So you end up paying them lots of money…But to do that, they have to be making lots more money, which brings back to the question of “what’s the route to monetisation”? To be honest if Yahoo bought delicious without a good answer to that question, or some other technological benefit they were expecting, then more fool them.
Well, I don’t want to speculate about Yahoo!’s internal structure. For all I know there could be some very motivated employee busy with del.icio.us, and we’ll see some great features. Certainly Flickr’s recent video-move shows that stuff can still happen.While big businesses suffer from internal barriers to innovate, like politics, small ones also have problems, external ones, namely a lack of resources. And if a new company comes into the market with radically new social features, I don’t expect an incumbent like del.icio.us to jump up and react straight away. Of course, that’s speculation also.All I’m saying is that I think the drop in users could very much be related to other better services haven risen to the top, two of which are in your portfolio, which may make del.icio.us less interesting.
…and I agree with the poster above me, that part of the solution for larger firms is to create incentives for innovation to happen. Sadly, however, I fear that the priority is much more on gaining eyeballs, while shaving off costs, then it is to continue to innovate specialised services that may not fit the parent-firm’s core-focus.But then again, it’s a systematic problem, and M&A exits are just the choice start-ups tend to make these days, no doubt something that most investors do not object to, as there aren’t many alternatives.
The type of private liquidity market you describe is kind of inevitable. I see it similar to the rise in the past 5/6 years of a robust secondary market for VC LP (or even GP!) interests, W Capital was one of the first to do this in the dark days of 2001/2002 but look at the different players and products there now, very creative. Seems to me a short leap to make the next step. Yes lots of issues, but also lots of different value can be created.
I quote you. “But even Google is not without fault. It has bought a number of assets over the years and several of them have languished.”When a Google VP visited the FT lab regarding joint projects, someone asked him about the recent spate of acquisitions that seemingly disappeared. His answer was very long, but one quip caught my attention, “..oh, you mean our ‘nonperforming asset division’.My take away from that meeting was that they did not have a primary harvesting strategy for their acquisitions under a certain size – they were collecting people and IP.Regarding Delicious. I still use it as a research tool. I tell all my less wired cohort that they should consider using delicious rather than emailing links to me, and i show them the browser extension. The whole tutorial takes about 5 minutes…and never sticks.Combine this lack of stickiness of the less techno-savvy, with the fact that there are so many new services that encroach on delicious’ territory, and….some small measure of benign neglect on Yahoo’s part..and you spell MOTHER.
Isn’t the ifund set up to do an end run around this “narrowing of focus” issue and micro services by wiping the board clean by moving to the mobile net? They want the big idea to set the next stage that others will build off of/on.
What is the ifund?
The new fund from KPCB for the iPhone/mobile net
This isn’t a new problem. AOL messed up MovieFone, which it bought in 1999! Don’t some huge number of acquisitions languish under new owners unless it’s a direct consolidation play, in all industries? I noted the other day that Ford is undoing its Range Roger/Jaguar deal now as one example.
Just looked at March Comscore and Moviefone is #2 with 16MM uniques, behind IMDB which was another acquired property (Amazon bought it).
I tend to agree with Gordon Haff’s position … I would expand upon it to by saying that many of the web services out there make fine *features* — but it would be a stretch to call them stand-alone businesses.It is my understanding that the reason M&A has been so good to so many of these services is that the big, profitable, stand-alone companies have been treating the web services/startup market as one big R&D lab.They’ve been picking up the technology bits these services represent (and their so-called “customers”) at fair, if not discounted, prices. R&D and market research/feasibility all rolled into one.As an end note, I for one *love* the OPUS-5 concept and the move to introduce new competition in exit opportunities open to entrepreneurs and their investors. But I still feel that you need some valid business to exit from — if the business is a feature of some larger offering, acquisition is likely your only path to liquidity.
We can debate this point and we will because its central to my argumentThe third party monetization systems that the web (and the startup economy) is delivering will do a fine job of monetizing “features”It already is doing thatThere are literally dozens of facebook apps, maybe close to a hundred facebook apps that are profitableAnd they are all “features” of facebookNow I am not saying that they are businesses, at least not all of themBut they make the point that the world has changedThe web is decomposing into smaller and smaller piecesAnd those pieces are sustainable as standalone opportunitiesFred
Smaller and smaller pieces = smaller and smaller exits
As the pieces become “smaller and smaller,” the barriers to entry are lowered and thus there are more opportunities to enter the market. Lower barriers lead to intensified competition, reduced differentiation and lowered returns — even as the overall market grows. In such a market, the qualities of your implementation become irrelevant. Sustainability comes from one of: lowered expectations, integration with a larger platform or branding. Getting bought out early is the best thing you can hope for…Branding is ephemeral, lowered expectations tend to reduce the drive for innovation, and integration has a plethora of problems. It is hard to do, but even if done well, integration leads to the problem of the “whole being greater than parts.” The result is that it is exceptionally difficult to evaluate the marginal contribution of an integrated component. Rewards to the component builders inevitably end up being determined by their negotiating skills or their luck — not the true value of their work or their skill as innovators.I learned a great deal about the “component economy” with ALL-IN-1 at Digital in the 80’s. Then, I took what I had learned to Microsoft where I was Senior Product Manager for Applications Programmability in the early 90’s (91-93), I used to explain to people on a regular basis that by building a platform that encouraged components (COM, Active/X), we were “architecting monopoly” for Microsoft. The logic was simple. By providing ways that people could build components to extend Microsoft’s products, we would lower the barriers to entry into the software market at the same time that we lead people away from competing with us. Innovators would focus on developing small components that produced “sufficient” rewards to motivate them but they would find themselves in a competitive marketplace that limited their returns and thus ensured that they didn’t have enough revenue or energy to tackle competing with Microsoft itself. At the same time, as small developers built better components, those components strengthened the Microsoft platform and made competition against the platform itself unthinkable. Over time, the aggregation of innovations in any single component space would result in commoditization of the component. (i.e. dozens of small competitors, each trying to build a “better” component of type X would eventually define a “commodity” or standard implementation of the component.) Once a component was commoditized, the idea was that we would simply either build our own version of it or buy in one of the existing implementations. By packaging a component with the platform, we would remove it from the the realm of competition and force innovators to start the cycle over with some other component. I always argued that the preferred approach would be to *buy* an existing implementation, and to over pay for it, since to do so would lead developers to believe that one day they might be relieved of wearying competition by being bought out… The strategy seems to have worked for Microsoft… And, we’re seeing the basic pattern repeating, perhaps less intentionally, in the Web 2.0 space.As many others have said, much of what people are building today is “features” not products. As long as that is the case, raw economics is the real problem with the software business. Most customers want integrated, consistent systems and will prefer an integrated solution to a collection of “Best of Breed” implementations even if the integrated system is somewhat less powerful than a cobbled together set of Best of Breed solutions. Thus, the market drives us to integrate our components, yet we don’t know how to value and reward a component which is only a small part of a greater whole. Given that we have no model for valuing and rewarding component builders, we’re lucky that large companies are willing to buy out “feature companies” and component builders. If developers couldn’t look forward to such buyouts, they wouldn’t have the motivation to innovate.The alternative to building components is building platforms, but the market can never sustain more than a few platforms at once. The platforms that “win” are typically the first in a space since platforms attract component builders and rapidly become too strong to attack. Thus, the only things you should take to IPO are platforms. And, the only opportunity you have to build platforms is when there is a major market disruption or when the platform defines a new market. Thus, Microsoft, Apple and Sun became the “Graphical UI” platforms. Google, Yahoo! and Amazon got the opportunity to be “Internet” platforms. Now, FaceBook and a few others are hoping that the “Social Web” is enough of a disruption to justify platform creation. (I doubt it…)Well, this is already too long for a comment… Sorry to bore you.bob wyman
Great comment. Only problem arises when management blinks and refuses to step up and buy the commoditized component. Then, the component can reach back and eat the platform (ie Microsoft and IBM).
Your thoughts about the stagnation of former startups post-acquisition really resonated with me. This sort of activity reminds me a little of networks rolling out new cable channel after new cable channel a few years ago just to get the ‘shelf space.’ It seems like the big companies are staking out territory in new technology as opposed to aggressively incorporating it into their overall business plans.
another VC fund, no matter from who or about what, doesn’t change my views on anythingi think the mobile web will end up looking a lot like the web we have now from a business and technical archticturefred
I was going to write something longer, but it all comes down to the same questions…Why the insane need to destroy value ?I don’t get it.Will they ever learn ?If they don’t… is there a way to stop them ?Being a private company didn’t spare Facebook from getting the Microsoft call.Perhaps the only way to guarantee a healthy environment is by limiting the ownership that public companies can take from private ones.That would make nimbler companies a scarce resource, and Bigco would have to think it twice before destroying value.
Is it really the case that there are no exit options for companies making good cash flow? As I see it the real question is how many companies are really making money. If there are a lot of those without sufficent exit opprtunity, then perhaps this is a multi-brand roll up opportunity like the IAC of today or the Symantec of the mid 90’s. But somehow I suspect the problem is more on the value side than the dearth of buyers side. Of course you would be in a *far* better situation than me to opine on exit opportunities.
“The entrepreneurs who spend years and risking a ton need a way to get paid for that effort. And those of us who finance their efforts need to get some return on our investment.”Isn’t that what dividends are for? I know this might seem crazy in the recent business environment, but it might be a good idea to stop looking for an end-game. How about, *gasp*, growing these companies into profitable individual businesses and rewarding the shareholders with some of those profits?That was how businesses worked for 90% of the 20th century, and maybe a return to that kind of thinking would do us all a lot of good. Sure, you don’t get that big pot of gold at the end of the rainbow, but instead you get a river of gold that flows indefinitely. And, personally, I think if a company starts out with the aim of becoming a profitable independent venture, then I think they’re much more likely to succeed in that task than if they were to aim for an M&A event.
that’s right except for the fact that VC funds are ten year funds and we need way to “monetize” those dividends so we can give our investors their money back plus a return in the ten year time frame we have been given by our investorsfred
There are two options that I see, then:1) Increase/eliminate the time frame on VC funds (again, focus on the stream and not the pot)2) Encourage profitable (but not exited) companies to use retained earnings to buy back stock.All in all, I guess what I’m saying is that if the company focuses on long-term profit instead of an exit, they’re more likely to provide some kind of exit even though it is not their focus.
Debt is a form of monetization. Of course it might be a bit difficult to get debt if you have no profits and the markets are locked up. But other than those things, recapping is a legitimate form of accelerating finance.
Interesting discussion… I note that Fred is being intellectually honest in his contempt for the behemot’s inability to keep innovating post acquisition, possibly to his detriment.The root cause is not some secret anti-innovation policy that these companies have, the problem is that after the M&A the creative team is no longer there. Most people cash up and either go to the beach (or New Zealand) or start working on another idea… Even if they stay for awhile, they are not the same… Most of the time the technology/product is left to some corporate dummies to develop it.The problem for Fred is that If these big acquirers catch up on what he has discovered, they will stop paying premiums for the hyperdriven high IQ startups that he invests in… In fact there has been quite a few deals with substantial earnouts in the last few years, so they may be catching up on this already…
The problem here is that liquidity is linked to being bought by a slow-moving giant.You build a great business, and then sell out, only to find yourself hampered by your new parent.I agree that private equity seems like a great solution–cash out, but retain incentives to keep building (and keep building without interference).My worry, however, is that this simply adds one more layer of abstraction to the problem. Private equity firms still have to sell their stake to someone. It’s unlikely that cool companies such as Disqus will generate sufficient cash flows to justify a reasonable purchase price in any reasonable timeframe.Why would private equity firms buy a company if they didn’t think they could flip it back to the M&A market?
Great post Fred and a lot of good points.I work with some folks who are making a killing with Facebook/MySpace apps and folks who are struggling with large websites seen by millions every month. The game has changed.Now I don’t have any solutions but I do think it’s important that folks (to quote like it’s 1979) “rethink the organization.”If small is where the new profit centers are then folks who run large companies are going to have to change the way they manage and think about growth. And what you are talking about isn’t just an internet thing. It’s happening everywhere. Right now. http://www.myprops.org/cont…I tell people everyday to think smaller. And the next thing I have to say is “Think smaller than that.”
All about incentives.The current structure for getting paid and cashing out in small companies derives from the liquidity options available. As Fred points out, the history of execution post-acquisition, post-merger, post-liquidity event, is spotty and questionable: we all have tons of stories.But is it any easier for a company to grow organically?Create a way for people to get by staying small, and they will. Chartreuse is spot on as usual.
think small >> think >> thin
I think there are 2 dimensions here which will be increasingly unbundled:1. what governance/ownership model maximizes future profitability (from actual revenues) of a start-up? Does it *need* to be brought into a big player to leverage that parent’s user base, revenue stream, etc?2. assuming a future stream of profitability, how can some near-term liquidity be provided to those investing their time and money?I think it’s going to be hard to answer/change #2 until there are more cases of start-ups staying “independent” while reaching profitability.Even once that happens, the next question becomes whether, as a potential provider of liquidity, you can feel safe about future profitability, esp if your cash can be seen as reducing motivation of the founders… Staying independent raises an exec-succession issue that hasn’t been solved either…
If a private liquid market (PLM) develops, it could lead to (further?) stratification of the economy into public- and PLM sectors. It’d be interesting to see what the economic ramifications might be. On the regulatory side, there have already been calls for greater government oversight of the private-equity sector; that might be even more likely if a PLM sector were to become significant.
D.C. – You are spot on with the regulation, but for a different reason. VC funds currently get out of SEC resgistration and reporting by filing an exemption under Regulation D (rule 504, 505 and 506). On of the requirements for anyone selling securities (and LP stakes are just that) to get exempted from SEC registration and reporting is that THERE IS NO SECONDARY MARKET FOR THE STAKES.As soon as established, “official” markets get setup, it will be very hard to scoot around that requirement. People can get around it today because there is no organized market…..
You are looking for a path to liquidity and have stated that “value” is simply future cash flows but you take a very agnostic view of a web service’s revenue model. In a time when web services are cheap to build and the only way to monetize some of them is through selling eyeballs I think the difficulty in liquidating is justified. As subWindow stated above, if these are great businesses than why can’t they grow organically, generate profits and reward their shareholders conventionally?To me selling a micro service to a large web company is like a production company selling content to a major media company. They attract eyeballs for advertising revenue, nothing more. Some micro services are more or less content, not businesses. If they can’t generate profits independently then how valuable are they?
Great post and great discussion, and the angle on liquidity is interesting.From a founder point of view, there is a flavour of liquidity called “I have a successful business, it is growing, I make a nice income from it, and I do interesting work that I enjoy” For a lot of people, this is an attractive outcome, especially if the business can become self sustaining (think popular Facebook app that someone coded by themselves or with a friend and has a nice income stream from advertising).Now, how do you make investors happy in this scenario? Or do you do without?
Wow, your Blog really is the best conversation on the Web. This is a really critical topic that we have been discussing internally in our start-up. My simple take is that once a venture reaches profitability, liquidity is not an issue. Somebody can buy shares for dividends aka cash flow. I know that sounds really, really old fashioned. That buyer can be PE – buying the whole company – or an individual who wants to buy just some shares. That does require a private place to trade private shares. The AIM market in London is almost serving that purpose, relatively liquid but unregulated as it is only for institutional or wealthy. If the only way to profitability is being part of a bigger business, then trade sale is the only way. I do think that weak monetization models drive the need to exit quickly.
I have been on the VC side of the table and am now about to be on the other side. I agree with a lot of Fred’s points, but the IPO market which was the liquidity market of the late 90’s until the bubble burst for the most part was nothing more then public venture capital. Just look at some of the most successful IPOs of the late 90’s and they are gone. I think one of the metrics that will have to change is the annual internal rate of return that of a fund. With the IPO requirements too onerous for most you companies we are all going to be relying on M&A opportunities for liquidity events.In your case profitability and cash flow in the terms of dividends just isn’t going to get VC investors excited. I agree with what you are saying and I think there has to be a paradigm shift in terms of expectations and we are there yet.
Fred,I think what we really see is a new opportunity to buy up good startups without even trying to integrate them: the unsynergy corp. AOL has ruined everything from Netscape to Moviefone to ICQ to Mapquest to Tacoda Being bought by bigco is a disaster for an application’s users and fans; the only reason it is done, you’re right, is liquidity for the founders and investors. If I were, say, Carlyle today, I’d raise a fund to buy up and manage — but not synergize — some of the best applications and startups out there. I’d give them decent management and shared services (a la a later stsage Idealab, I suppose) but let them still operate independently and entrepreneurially. I also wouldn’t want to buy 100 percent of the equity; the founders should stay and have earnouts that motivate them to improve their products, give them the control necessary to do so, and still let them and their investors cash out. What I’m really proposing, then, is networks over corporations. If small is the new big — but, as Mark Potts said at my conference, “If you want to be small, you probably have to be part of something big” — then we need a new definition of big with all the benefits and none of the stupid corporate ruination. Just a thought
i thought that was what jon and ross were going to do, but it didn’t happensomeone’s going to do it Jeff. and that will be a good test of a new modelfred
Why don’t you?
Investors can inded be part of the solution in regard to maintaining innovation post acquistion, and in fact it may turn out that they are central too it. They have both the vision and influence to be a (if not the) determining factor.
Berkshire Hathaway has been doing that for years..Subhankar Ray
Fred – who are jon & ross, and what firm did they start?Jeff – interesting thought. The acquisition corp would seem to need to have an underlying platform for simplifying the connective tissue between the various services it buys (single sign on, etc) but maybe not much more than that to start. The earn-outs are key for sure, or some other dividend paying ownership structure in the service purchased.
that is what jon and ross wanted to doproblem was/is, valuations are just too high. there are no assets priced rationally — only for venture return like IRRs — so there is no roll up strategy that makes sense
That is probably true steve.But times may be a changin’ to steal a line from robert zimmerman
Very insigtful thinking!! As they say, it’s always about the incentives (being properly aligned).
What Jeff describes does seem like the obvious next phase of tech “growth/later-stage” funds, especially as vc/pe firms are looking to more money to work. As Fred mentioned, it seemed this was where Velocity was headed (which didn’t really happen).This strategy extends to many of the types of deals that are probably viewed as successful as well. At the time of its acquisition, Myspace HAD to get acquired by someone like News Corp. because the company and its backers–Redpoint–couldn’t fund its huge and growing cost structure. Was Myspace worth more than $150mm (remember it was Intermix that sold for $580mm…Myspace was just a piece of that overall deal)??? In hindsight it would obviously seem so, but without News Corp. coming in with its big balance sheet the cost of business would have killed growth and Myspace would not be Myspace as we know it today.However, a Carlyle-funded late-stage Idealab would have been a great buyer/investor. Redpoint gets a good return on its earlier stage/higher risk investment, and Carlyle funds/grows Myspace into a fast growing, highly profitable business. The story would be the same for Youtube and many other top start-ups.However, for many micro-services/applications, I agree with poster Nathaniel above who writes:”To me selling a micro service to a large web company is like a production company selling content to a major media company. They attract eyeballs for advertising revenue, nothing more. Some micro services are more or less content, not businesses. If they can’t generate profits independently then how valuable are they?”Not all applications or services should be viewed as long-term, sustainable businesses. As the cost of starting a company–or more accurately, building and launching an application–goes to basically zero (other than human capital) innovation will continue at an increased pace. As soon as an application or service gains some traction and users/customers the new, cooler application will be launched. Follow Techcrunch for a day and you see this all the time. However, I think there can still be value to Big Media as Nathaniel describes: the application/service can be viewed like a production company selling content to a major media company. I think we’ve already seen this with some Facebook applications…and I’m sure we’ll see more with the launch of the iFund and the trend toward “Level 3 Internet platforms” (Marc Andreessen). Big Media would buy up some of the apps and monetize the users as much as possible (and in a way that the company couldn’t on its own) with the expectation that interest in the app/service has a shelf life (how long can Survivor actually run?!?). Obviously, those deals would need to be valued accordingly.
Am I the only crazy one who feels maybe we should PAY for these small, incremental, content piece services??? The world has gone digital advertising crazy and as many studies, articles and real world startups know today (SNS, web 2.0 community types like Digg) users dont care or even pay attention to ads any more.. Stop banging your heads against a wall that you cant fully knock down even with super duper Tacoda targeting.Each day now I pay a micro amount for some valuable event or service and by the end of the month that bill isnt small.. eg small ATM service fees, tips to a waiter, a mobile phone call, a travel booking commission etc etc..Who here wouldnt pay say a range of $5 to $20/mo for a subscription to a new business service and busmodel, lets just call it “TWOdotO”??? This would be a hosting, payment, monetization platform for the new small pieces of our distributed online economy. A much more broad and robust facebook with different goals. Companies would join, users would select the services they want from a menu and a reasonable bundled price for those assigned and charged. The more you use, the more you pay each month. Everyone from SNS to music services to IM to webapps could be part of it.. So facebook, Soho, last.fm etc.AND for good measure throw in one more twist…. with the open portability, and hey my data is for my profit not yours Mr Facebook move. Lets add a function called MyNet.. MyNet would be a new adnet system which allows any subscribers to provide the key to advertisers dreams, a fully relevant (geo, demos, income, interests, needs etc) and 100% owned by you profile which could be used by either a TWOdotO owned adnet and independent large publishers or other adnets. Why keep guessing about my behavior or profile, Ill give it to you. But the hook is I get a share of any CPM/C/A money generated and its credited to my account to help pay for all my services. For good measure, throw in paid search if you want. Looking at JP Morgans Imran Khan’s recent report, an avg user generates about $10/mo in display and search revs. CPMs are low as long tail eats into this, but I would argue you could increase that by working to provide your “adprofile system” to top CPM earners. So why shouldnt each and everyone of us get a piece of that and make advertising more relevant and interesting and advertisers happier in the process… and most importantly at the same time be able to use it to provide a viable platform for this new paradigm to grow.
Slashdot do this (sort of).http://meta.slashdot.org/ar…
I get your general point, and kind of like it …. and I am no AOL fan… but still think it is important to inject a few facts into the conversation, per Comscore March: Mapquest is the largest service in its category by far (2x over Google Maps), Moviefone is #2 behind IMDB which was also integrated via acquisition into Amazon. Netscape and Tacoda are messes to be sure, and they probably should have never been bought, but Advertising.com, another purchase is pretty much the strongest display ad network out there. So, I suppose even in a tough environment like AOL, some companies flourish and some perish, much like the private company world.
I have been in a kinda down mood about the potential fate of tools like delicious which I like and use almost daily. I was very happy to read this post because it gave a voice to what I have been feeling about the “trading card” mentally of late with Microsoft, Yahoo! and cohorts.The ONLY ray of light to cloud hanging over my utility use of delicious has been Google and I’m going to consolidate more of my use of their products and services after the dust is settled. Google will be the ultimate winner among these bigs of Internet service.The upshot for myself and others will be I’m sure to be wary of startups that are purchased by any of the actors in this current play. When data portable is the norm maybe we will see far more attention paid to the user community of services being purchased, assimilated and ignored because anyone can packed their information and leave for another service.A big acquisition will not create value for shareholders quite the opposite, in studies large acquisitions have been proven to be bad for the companies involved and I believe it will be damaging to their brand. Nobody has explained how merging any of the current players together will solve their internal strategic problems. All I read about is the numbers of visits per month , lack of monetization of content and the need to catch up with Google.Management of Microsoft, Yahoo!, AOL and News Corp don’t have a clue or vision. There will be a merger and in five years when they do the write down they will blame it on the acquired company instead of their bad management. Think eBay acquires Skype times five. Shareholders run do not walk for the exist.Ultimately new startups will be created that do a much better job responding to user needs and the dance will begin again.
I’m with a company that was recently acquired. Innovation has ground to a halt. Fun has left the building. Why? It’s not because we don’t “care” anymore…..but that’s exactly what it looks like. The real reason is that we’re now required to “integrate” everything we do. The catch? The company we now work for doesn’t have the resources to deal with the integration on their side….and we don’t have the resources to deal with both integration and innovation on our side. So innovation dies, fun leaves, and everyone wonders what happened. And it happened very quickly.I’m sure this happens a lot. Executives (on both sides of the transaction) underestimate the resource/tech requirements of “integration”….
That works I think if the biz is profitable. Then a PE firm can be the unsynergy corp. Thats what they do. But a whole lot of unprofitable units within one company? That is what VC is for. There is enough VC to take ventures to profitability.
I agree with Gordon and inbqx. Calling these facebook apps stand alone is a stretch. Third part monetization is good, while the party lasts. How many of these have a good exit mostly from financial perspective rather than strategic.These third party application are only fun if the parent company decide not to roll the feature in house. I wanted to see what is going to happen to Imeem with facebook chat coming out.
This is the most thought provoking post that I have read in awhile, in part I’m sure due to the informed nature of the writer.A few thoughts:L- The nature of capitalism is such that these type of acquisition events are going to continue- The key question is how do Internet properties retain their momentum (product features, user base, integration with parent company) post acquisition. YouTube comes to mind. Although the monetization hasn’t been figured out yet, they continue to excel as part of Google. And Flickr as part of Yahoo. So it very clearly can be done.- Using YouTube and Flikr again as examples, companies have been smart in regard to branding. Many everyday people do not know YouTube is part of Google, nor that Flickr is part of Yahoo. And it’s better that way.- Large behemoths (the big 4: Google, Microsoft, Yahoo, AOL) that can operate best as startups (is Brickhouse Yahoo’s effort? can’t remember) will have the competive advantage- Google, Microsoft, Yahoo and AOL, we must never forget, exist within the overall marketplace, and as a result are subject to market disruption. It is to their compeitive advantage, obviosuly, to extract full market value out of their acquired properties, for competitive advantage. As Microsoft took on giant IBM, the startsups of yesterday and today (Google vs. Microsoft, Facebook vs. Google and Friendfeed vs. Facebook) will always be in their face pushing that competitive challenge.
“Many everyday people do not know YouTube is part of Google, nor that Flickr is part of Yahoo.” You certainly know that Flickr is part of Yahoo due to the ridiculous sign up process they now force on you, rather than the simple one Flickr used.
Two Issues as an intermediary that are front and center to this discussion IMO.- Regulatory environment: Sarbox (sarblox) changed the landscape – sarbox will put major road blocks up to new liquidity options whether in the public or private domain (this line is being blurred too) – you cant just create new paths to liquidity without either running in to a road block, or it coming at your from washington quickly. Sarbox killed the IPOs of the first bubble, and the recent spate of private equity disaters that will only get worse is going to hit the tax payer in the pocket book through its contribution state retirement funds who have placed capital with these vehicles and lost, with the defaults on all the leverage out there causing chapters, resets and so on.Volatility: this is an area that continues to perplex me. Atomizing the web, has seen value creation accelerate exponentially. Surely this can be taken away just as quickly. Social Moats i saw in a response? is that not fundamentally against the notion of user control? So regulations and volatility are two headwinds int he face of these creative new approaches to liquidity IMO.
Great post! and great discussion. Its a sad and true situation that amazing and innovative services get acquired by at times, what would seem a great parent and future innovation supporter, only to have the innovation lost in integration or lost as a result of departing management.The even more interesting point is that perhaps its time for the financial community to foster some innovation of their own to create better liquidity markets and options for companies that want to remain private but could provide good financial departure terms for the VC’s and/or entrepreneurs so that the innovation and passion can remain with these companies as they grow but leave room for the innovation cycle to continue.
Fred, doesn’t it also have something to do with the founders or management team getting restless and wanting to do something else? Even if the delicious team (for example) sold to a private party, who hoped they would remain in place, don’t you think the team would lose their motivation anyhow? At least if you do the marginal analysis, if a group of entrepreneurs sells for $100M to a PE investor who hopes to realize the future cash flows (agreed to be a good definition of value) and has an incentive to keep the team around and help build the business, doesn’t the team’s upside seem rather diminished? They just cashed out for whatever % they own of the $100M, they’ve been rewarded for building this company, isn’t the incentive or natural inclination at least, for them to go build something else? Most entrepreneurs aren’t the kind of people who should or would want to be building their medium, successful company into a big company that could be taken public or sold to a bigger PE shop privately. Also, even if you kept some of the team in place and supplemented it with bigger company-minded people, wouldn’t you still suffer the same problem of inadequate motivations? Those who sold (like the people at Google who joined pre-IPO and hung around until their options vested) don’t have the same motivations as those who joined later, and those who joined later may lack or have a different vision, creating a potential mismatch of visions and priorities. Also, the one advantage of these strategic combinations is economies of scale, which you’re right get washed out if the acquirer does not generate additional value from the acquisition, but still can be an issue…if you don’t sell to Microsoft, you run the risk that they try to do what you’re doing and crush you in the process.
very valid points john! remember, founders are the “heart and soul” of a company, if you are an acquirer how do you keep them on board and motivated?Earnouts is one way to go and they are becoming more popular. There is a better way, though: if I am the acquirer, I would just try to make them happy and comfortable and support their creativity internally. Most creative types probably do not really enjoy everything in the enterprenual process: raising money, finding a lease, hiring, building the administrative support, etc. They put up with it because of the creative freedom their startup let’s them enjoy. If you go to a Big Co., Inc and they put the shackles right away, it obviously won’t work. But if Big Co. says, here’s space, here’s budget, here’s equipmnet, you don’t have to worry about all the mundane stuff (HR, benefits, insurance, banking, etc.), just do your stuff, if it works you get rewarded (say bonus equal 5% of future EBIT from the new idea/incremental improvements). I bet many people would find that attractive.Cheers,
JohnkYes, you are right that it’s hard to keep a team motivated but I am involvedin companies such as alacra, comscore, ibiquity, and return path where thefounding/early stage team is still at it 10 years after starting thecompany. You have to keep re-incenting people, increasingly with cashincentive comp plans in addition to equity. You need to build an amazingculture (which is something that all companies need to constantly work on),and you need to keep the work interesting and engaging. It can be doneFred
there is one option that internet entrepreneurs rarely seem to consider and that is: don’t raise any institutional money, don’t seek exits, and just build your business. in other words, continue running it as a private business. make money the old fashioned way by actually generating earnings ala Craigslist
There are several venture funds that have been set up in the last couple of years that will buy shares from employees to give them some liquidity before a company can be bought or go public.
It seems you are crying foul about devaluation of services, while at the same time you are a proponent of the devaluation of music and video.’all the innovation that is being created…. will stop happening.’As I’ve said ad nauseum.
It’s probably not relevant to your world-view as an investor, but what about bootstrapping, not selling away your company to investors and building value and revenues over time. And letting the marketplace decide whether you succeed or fail. You know, like regular businesses do. Or like craigslist. Sounds like greed – on the part of the investors and the entrepreneurs – is at the heart of the problem. Everyone wants their big score.
that’s a great thing. i advise every entrepreneur to do that if they can.
Fred,VCs need big companies to mess up acquisitions. That’s what creates the opportunity for your next round of investments. That sounds cynical, but it’s what happens. If every company executed well, there would be many fewer startup opportunities. Existing companies have so many advantages (customer base to learn from, capital, brand name, etc.), but they often squander these.I am also skeptical that these kinds of private equity swap markets will generate real VC returns. It may be a way out of a deal, but it won’t be a big multiple, which is what VCs need. I only see a few ways to get a big multiple on an early stage investment: 1) get big enough to go public, 2) get purchased by a strategic buyer who will value the company beyond what the balance sheet says, and 3) build the company over time with modest amounts of capital so that it can be sold to a financial buyer (PE fund, etc.) on a reasonable multiple of cash flow.I wrote more about this here: http://www.thefeinline.com/…
thanks mike. excellent thoughts as usual. i like scenario three and that’s why our fund sizes are so small.
Background: I spent my whole professional life bouncing back and forth between tech entrepreneurship and M&A investment banking. One of the companies I founded got its first round on April 4, 2000 – ‘nuf said. Your post resonates with me. A lot.Let me try this on you: maybe we need a new type of investor more before we look for a new path to liquidity. A truly long-haul investor, who does not necessarily plan the exit before writing the check. An investor who stays in for the cash flow rather than windfall at the end. You know, the kind of investor who so far has been looking at boring, metal bashing businesses. The businesses that make money and don’t change hands all that often. Since it is infinitely easier and cheaper to develop a product today than it was in 2000, internet companies don’t need to become very large for dollars to get to the bottom line and get distributed to shareholders – as long as that’s the entrepreneur’s objective. Oops, then we need a new entrepreneur as well. The list is getting long: a new path to liquidity, a new type of investor, a new type of internet entrepreneur…I think all of this is part of the growing pains (growing as in getting more mature, not bigger) of the internet as a sector. The automotive industry was not all that different in the early 1900s.
I agree with most of this. But institutional vc funds can’t wait forever to get paid. Neither can entrepreneurs who can’t feed a family on their founders stockWe need a mechanism for the risk and rewards to flow more fluidlyFred
Institutional VC funds and entrepreneurs don’t need to wait forever – they need to have slightly different priorities. Easier/new paths to liquidity require a new set of investors/buyers coming to the table. Entrepreneurs can achieve that by focusing on “making” rather than “raising” money. That requires VCs to look for “path to cash flow generation” before “path to exit”. And that fixes the starving entrepreneur problem too.You point out how lots of fun companies get bought by the big guys only to end up languishing. Maybe that’s because they ultimately can’t sustain themselves in a world where there’s no liquidity event to work for (you are already public) and you have to make money to survive. Some of those products are just ignored or mismanaged and could have thrived otherwise, but maybe – just maybe – some never deserved to exist because nobody is willing to pay the bills in some way. I love del.icio.us, I use it every day (or at least until the Firefox addon broke in Ubuntu, but that’s a different story), but I am not sure I’d be willing to pay for it.
One very notable place where this is not going to work is in drug biotech. With 15 years development cyclenot many would go that way if there is not a robust mechanism to reward risk reduction, rather than cash flow…
Agreed Fred. My worry is that we’re really seeing here is the market saying venture doesn’t need to be as large an asset class any more, the companies being created and capital required don’t warrant it.That is another way of reading a shrinking exit market.
you are so right Paul. the companies don’t need the money so the late stage market should move toward providing liquidity to the early stage investors and founders.
drug biotech still needs lots of money, however, even that pales in comparison with energy. $100M rounds are becoming quite common in that group. You have not seen exits yet, it is very new, however a few companies will make it out big: Ausra, some of the geothermal plays…
As a former tech banker myself Lucaf, I completely agree with you on this point. What’s the matter with owning and operating and getting dividends from businesses? I think the first LT ivnestment fund that does this will cause a tidal wave as some big institutions (CalPers, Harvard, etc…) will be happy to harvest above normal cash-flows over a 20 year timeframe. This short-term thinking is a requirement of the VCs who really want to cash their carried interest. Maybe carried interest needs to be changed to some form of cash flow sharing.
If this exchange is limited to web businesses then the transparency could easily come with mandated metrics tracking similar to what happens when a site joins any affiliate network. This could give potential investors detailed insight into traffic growth and quality which is ultimately what is used to drive the valuation equation of any web business.In the long run, if M&A exits don’t make sense, then these companies, once they have reached scale, are going to have to pay out regular and substantial dividends to continue to attract investors and provide an exit for the investors who risked their capital initially.
The marketplace would then cater for a wide range of types of investors: from investors with a high-risk profile who are looking at substantial returns on their initial investment to low-risk profile investors who are looking for the income paying securities in a well established company. This diversity in the type of investor is what provides the liquidity (and therefore exit) in the marketplace.
I only have one question for you, Fred: are you willing to make less money?That is the real question you need to answer. As an investor, you invest in entrepreneurs, like me, who are counting on their hard work paying off int he future. I’d estimate that 1/1000 entrepreneurs are able to raise funds, and about 50% of those will actually break-even. Investors need to recoup that marginal risk, and tie financial strings around the company founders and management to ensure that their motivation is properly aligned with a large liquidity event that will give the investors a nice return.You know all this, and don’t see your question answered yet. So why did I just re-iterate what you know?Because you know the solution already, and it starts with you (and other investors). The founders set the tone for the rest of the future for their businesses. They are creative innovators, and are motivated, mostly by money, and that is ok. The trouble is that investors are not interested in the founders building innovation into the company culture, and building a truly sustainable business. For that to happen, you’d have to leave some amount of equity value on the table to continually foster further innovation. Most companies have historical growth that rarely looks like a series of sharp hockey sticks, but rather only one, followed by a sad plateau.It’s the same in most industries. Look at Private Equity and the fast food business. Baja Fresh experienced explosive growth as seasoned PE strategic managers micro-managed every aspect of the burrito chain, and produced impressive growth and value. The company sold to a fast food chain, the food and service quality went straight down, and is experiencing financial woes today, within several years. How about Chipotle? I remember the cool new slogans like “anything wrapped this good should be illegal”, and the new flavors and dressings coming out when I was in college at U of MD in 2000. The company has produced no new innovation in the menu, the service, or any slogan since it’s liquidity event. In this field, Potbelly Sandwiches are next…I don’t blame any investor more than I blame myself for still drinking water from plastic disposable bottles, instead of refilling it. Change only comes when people forced into it. Rising oil prices and fewer supply will force an alternative, not a gov subsidy, etc…-my two cents
Would you be surprised if I told you that in 20+ years of the vc business, I have never forced the sale of a company except in a distressed sale where we were just trying to salvage a bad investment?The reality, at least my reality, is that entrepreneurs are largely in control of these decisionsAll three usv exits that I cited in my post were driven exclusively by the foundersThe idea that vc’s, at least this vc and my partners and the vcs I work with, are impatient is a myth. Its not trueFred
Hi Fred, I’m not surprised at all actually. I mean, and you mean I take it, most VC’s don’t replace entrepreneur-CEO’s with their own, or force a company to sell, unless they have a real reason to. Typically its a last resort and not a good sign. You’re very bright, obviously, and experienced, as you said, and I wouldn’t expect you to have made many investments that require you to take that sort of action.I will clarify that my comment was not intended for this point. What I mean by “properly aligned entrepreneurs”, is their sole use of your investor funds towards creating tangible value for some form of exit, and inspiring utmost devotion towards this goal. No Google-esque R&D for the entrepreneur, investors ensure a long line of entrepreneurs who already invested their own credit and lives in initial R&D before they were allowed to come to you, and that is why they are naturally right in line with the highest exit strategy possible, as opposed to highest sustainable business strategy.In no way do I assume to know more than you. I only know what it’s like to be me, the entrepreneur, so I could be completely off base here. I just think that you’d not be interested in my investment, even if I had the greatest idea and passion you’ve ever seen, unless I’d already completed the initial proving ground and gone into significant debt doing so. I have and that’s why I’m similarly motivated towards a higher exit.
sorry if i sounded irritated by your comment. i wasn’t. in fact, this whole conversation is amazing me. clearly it struck a chord and that’s a great thing.if we had a private market that created liquidity, ideally partial liquidity, for all the stakeholders, whenever they want it, it would solve a lot of these problems that all of us have been raising in the comments
You have created a great discussion and I’m happy to contribute, congratualtions.I agree with the need for a privately liquid market, but I think that term is an oxymoron. That’s part of the reason I’ve had such a hard time getting funding. You simply can’t just advertise a stealth-mode startup, or even beta to the world. Due diligence demands too much information for any eyes. Now, if we’re talking about a Grameen Bank type model, where another investor vouches for you, well that’s not very different from what’s here today.”No-shop”, “first-right”, and “vesting and forfeiture” related clauses impede this sort of possibility, do they not? I’m also not convinced that the VC community would be on board with a company whose founders were selling little chunks of equity off to god knows who. It seems like companies would have many more investors, and provide a lower average return. I also think the cost of capital would sky rocket, though it may become more readily available in smaller amounts.
Great points. I realize that what I want may not happen, or at least my ideais naïve and idealistic. But I know that we need to think harder about allof this stuff.
Completely agreed. Both founders and investors need a partial sale possibility to work with the risk/return in their positions. It would be absolutely great to be able to have something different from all or nothing which is the case without this partial liquidity.
I’m not sure whether I’m going to name my next garage band “Sad Plateau” or “Burrito Chain”. Either name would be golden.
Does anybody know why the NY Times no longer includes delicious as a share option? I’m not sure when this occurred but it would be interesting to determine whether the decline in delicious unique users correlates with its exclusion as a share option.
Why not fund companies with a real business plan?! Now that we’ve entered recession, REAL companies will have a better chance of survival than ever. All these “Web 2.0” companies that are looking for quick flips will go belly up faster than ever!
I propose the “Mork and Mindy” approach to startups. A web service is started by a big company and innovates very slowly. Then after some time, the big company takes away all of the money, puts the company in a tiny but really cool office space, and stops talking to the founders.I know this doesn’t make any sense, but I’m trying to reference Mork and Mindy at least once a day, and my colleagues are getting sick of it.
It seems that startups and the investors investing in them have often been focusing on getting a large user base quickly and then cash in on that. At the same time a lot of those companies manage to keep the burn rate low, but hardly create enough revenues to be sustainable. I am no expert on this matter but I do often wonder if too many entrepreneurs and investors have been investing in the “next” Facebook/or whatever cool service only to find out afterwards that revenue creation is really, really hard.I am glad risks are taken and ideas get a chance to become a business. There are however few that have a truly unique or creative business model that provides constant revenue streams. Too many have jumped the free-but ad based business model which only a handful can execute extremely well.
Isn’t the problem with the acquired company as much as it is with the acquiring company?Acquisitions usually fail for a number of reasons. But one of the most significant is that the internal drive of the founders is usually lost. The founders were driven by the startup and everything about it – the small company feel, the potential for wealth, and the excitement of being the underdog. All of these things vaporize within a few months of the acquisition. Sure, the acquiring company should account for this, and probably doesn’t do a great job.But let’s face it – the company getting acquired is at *least* 50% at fault for these things failing. Even if they had no control once the deal was done, they knew damn well what they were doing while inking the deal. If you’re about to be acquired and don’t like the possibility that your product might get sunk – don’t do the deal. But, at the end of the day, these founders know that they don’t have a better option, and they take the cash, then blame the acquiring company for screwing it up. That is a horrible thing to do.The right answer is to do fewer acquisitions and to make sure startups have a real path to viability rather than a path to being acquired.
I wonder what you think of entrepreneur’s shares being convertible to other stock classes in pre-IPO rounds (ie. what Founders Fund is doing with FF stock). This doesn’t get rid of the need for a new path to liquidity, but it does allow founders to ‘hang in there’ and build a long-term, sustainable, business without risking their paper fortune.It seems to me that share structures like this would be quite helpful in the ‘new path’. If there was a relatively liquid market for private shares like GsTrue, and founders could liquidate a percentage of their position, founding CEOs could be much more rational and selective in the M&A process. Taking credit card bills, mortgage payments, and other personal considerations out of the equation might lead to much longer term thinking on the part of founding CEOs.
That is a good idea and I think we’ll see a lot more of that kind of thing.Kudos to FF for their innovation in this area.Fred
I have to agree with your post completely. Ultimately what you are creating though is some sort of secondary public market. Low volume, higher risk, higher reward. It’s basically a rich man’s sport. You sit on a business while you think it is creating value. You are in the market for $1 mil – $5 mil businesses while others are in the market for $5 mil – $50 mil, etc ….While you don’t want the management of a private equity firm necessarily, you do want the money and as the stock gets traded, the value can increase. What you are saying is an earlier exit so why not exit at multiple rounds in which shares are trade at hopefully a higher price. Ultimately the value of a stock is from the perspective of a buyer (what they expect future cash flows to be).What it sounds like is you simply need a secondary market for these earlier stages that late stage people accept. Ultimately isn’t the end game still the same? Somebody is going to have to swallow the smaller companies or alternatively they naturally evolve into higher value companies building up value for the secondary markets that they are a part of. You are just saying that you need it earlier.Perhaps I’m thinking to abstractly here? Also as a side note, this sounds like a secret plan to get rid of investments at an earlier stage. Not happy with some of yours? 😉
Good post, Fred. I have argued in the past that there is a disconnect between liquidity events currently available to start-ups and the VC model (see http://abovethenoise.blogsp… but I had not taken into account the real price that is paid – the deterioration of the services.
Fred, here is my two cents in the wake of your catalytic post: http://www.informationarbit…. Thanks for getting the ball rolling. I spend more time talking about the markets side of it and less about the acquirer/target dynamic.Roger
innovation will NOT stop …. M&A has been a pyramid scheme …. private liquidity is just a refinement …. services cannot exist on ads ….. free won’t go away …. conclusion is obvious
Maybe the services you want to fund and the services you want to use don’t have as much overlap as they used to. A lifestyle business for the entrepreneur is going to give you the continual service improvements that you want since the entrepreneur will be working their tail off to earn their growth (and increase their earnings). However, VCs and Angels don’t want to fund lifestyle businesses and rightfully so because there is not a big end game unless the entrepreneur wants to buy you out if it is wildly successful.What if a new funding model is the invest and hold strategy for companies that will pay dividends regularly? Frankly it is getting cheaper and cheaper to start the kind of companies you want to use unless you want to invest a bunch of resources in a “hit it out ot the park” strategy with a huge marketing budget, etc.Granted there is an issue of how to handle “free”, but I think that entrepreneurs can create companies that earn real dollars from partnerships (not necessarily just advertising) with larger companies that will allow them to still provide a free service. Free accounts are a cost of doing business today and I think there are ways to make money with a free service and without placing all of your bets on a big exit through M
A nice long post, Fred. I’m not sure why big companies lose track of what they started out to create. Maybe the juggernauts just gain too much mass and momentum to slow down the machine of M&A for no other reason than to grow and gain. Might one go so far as to point at greed as the prime motivator in unfettered acquisition?
Public companies are already trying to do this. Internet Brands is one example — they try to buy brands in a sector, but they do that primarily to get better ad rates, reduce infrastructure costs, etc (not a lot of focus on integration of solutions). The problem with these companies is that as soon as things turn downwards even remotely, they do what just about every public company does — manage to the quarter. Inevitably that rolls down the portfolio companies in the form of spending freezes, trying to control product plans, squeezing vendors, etc. So even though things like earn-outs are in place to ensure that both the company and entrepreneur’s incentives are aligned, the pressures of being a public company end up overriding this.I think the private part of the equation is just as important as the aggregation part.
I apologize for not completing due diligence and reading every post, although I did read alot of them and no one has mentioned the indie desktop apps group (specifically for OS X). there are several companies squeaking out a living by making and selling apps for the desktop at a small price. They seem to be happy and continue to innovate with new products. one example would be panic. Why can’t someone do this with web apps? like Obvious Corp or what it was supposed to be? maybe a business like ycombinator could help these companies to a point of liquidity and take small profit sharing amounts from each at the end of the fiscal year based on percentage in the company.Anyway, I agree, this M&A fiasco has got to stop.
@Michael,Bootstrapping a business is a totally viable option. In fact, it is becoming more viable everyday. I work at Joyent. We run a Cloud Computing service. We’re bootstrapped, our revenue is in the multiple millions and it’s growing at 550% a year.While our cloud is used by a large number of big companies, such as Major League Baseball and the LA Times, we also have literally thousands of small start-ups. If they are building an application that runs on Facebook or on OpenSocial, we give them starting infrastructure for free. Facebook and OpenSocial give them at least some free distribution and marketing. We’ve seen plenty of companies go from one guy in a dorm room to millions of users all within months.When VCs are not involved, the dynamics of liquidity events change substantially. With social networks and cloud computing, suddenly, it becomes reasonable to build a software business in 6 months, generate a couple of million in revenue and then flip it.- Rod
I don’t want anyone to sit down and shut up. It’s great that this all takes place in a public forum.I could kind of understand it Fred if you sometimes feel guilty about being a capitalist. I could understand it, but in your case I absolutely don’t believe it. Not for a single second. :-)I do however believe that you wish you could have your cake and eat it too. It’s a very human response. “I wish I could sell the company, but still have it run the way I’d like to see it run!” I imagine many VC and entrepreneurs feel that way after acquisitions. But it’s still just wanting to have your cake and eat it too. We all want that at some level, but it’s just not possible.Did Jeff Jarvis really say AOL wrecked ICQ? A business with no revenue, and (in 1998) no clear business model. Didn’t AOL buy Mirabilis for like 9 figures — close to 300 MILLION? In 1998 dollars? You don’t think Yossi Vardi would cut that deal again? C’MON!!?!Isn’t it a little similar with delicious and Feedburner (I can’t really speak to TACODA) – nice products/services – with scale, and in the case of Feedburner at least some revenue. But was there a really clear notion of what the business model was going to be or how much longer growth (usage) could continue?Could delicious have held out, and pasted ads on the feeds? Sure. But what would that have done to acceptance? And even if they’d just held out longer to try to get more scale before selling, in this environment would waiting have been worth it? Would it have made the difference between a 2x sale price? 3x? 10x? For a service with no clear business model that didn’t cost much to run/suport?It’s fine to want to manage how Google integrates FB into its mix, but that lack of integration wouldn’t be on your mind if Google hadn’t bought the company (at 9 figures?). You wouldn’t do THAT deal again? Really? Help me understand.Let’s say there was $10m into FB, and it was sold for $100m – in the Opus 5 model, what happens? Did you as an investor feel certain that by holding on to FB for another couple of years it would be worth $500M or $1B? Factoring in the time value of money, etc, if a company can get a 10x return like that in a hurry – you wouldn’t do it again if you just weren’t really honestly very sure whether the company would be worth more or less than $100M in two years?I’m hearing a lot of whining – big companies screw up everything they touch! Oh boo hoo! Didn’t they pay for, among other things, the right to screw it up? It kind of sucks, yeah. But is it a tragedy.If you think it’s such a tragedy, riddle me this: Does any of that wind up mattering? How come 1998 was a lot better online experience than 1988? How come 2008 is so much better than 1998 from the end user’s perspective? If you disagree with that then a.) wow, and b.) please, please, please blog about why someday!Even capitalism won’t solve wanting to have your cake and eat it too. Neither will Opus-5. But capitalism does create the option to buy a lot of cake and it does grease the wheels of progress. Big companies sometimes/mostly/always mangling acquisitions – it’s all a part of the process. It’s probably as human of an outcome as wanting to have your cake and eat it too. Not even capitalism is any match for human nature.Stand up and speak out! But please get over the cake having/eating thing. 🙂 Unless you can explain it better – I don’t see how the private liquidity model changes any of this, at least not in the case of companies with scale, but without crystal clear business models – whether ICQ in 1998, or delicious and Feedburner in 2007. If I’m missing something, I’d love to know what it is.
what you are missing robert is that the founders drove the sale of all of those companies, not the VCs.and yes, i do think that delicious, if it had stayed independent would have become something way more than it is now, because it would have had to in order to survive.same with feedburner.
delicious definitely. I would still argue that it’s the best property acquired by any of the big companies and what do we have to see for it.
Thanks, Fred. Write stuff like this more often! Yeah, yeah, I know, easy to say…I don’t want to sound stupid on your blog (again), and I’m not cantankerous about whatever it is I’m still missing. but I really am missing something and want to understand. Separately from that, I’m sure you’re right that delicious would’ve been more on its own, I’m not as sure about FB.But let’s take the case of delicious. Would the fund/private equity you wrote about keep the founders from wanting to exit, or would it just allow you to buy them out, while keeping the company in your portfolio as it grows whether the founders play any continued management role or not?I guess what I’m asking is what you’re talking about game changing for everyone, or just the investors?
for everyone. if it doesn’t work for the founders and management, it won’t work for us. entrepreneurs are the raw material of the VC business and anyone who forgets that does it at their peril.i believe that we missed an opportunity with delicious. we (usv and others) should have bought it from joshua instead of Yahoo!but what’s done is done. no sense crying over spilled milk. but we can learn from it. we did and hopefully others will too because of this discussionfred
You’re at least educating people through the process. I do understand now, thank you.
This a structural problem in the markets. The problem isn’t the IPO market, its the venture market. The excess capital in the venture market inflates the values of venture-backed companies. The IPO buyer isn’t willing to pay up for companies with limited feature sets and limited staying power. Larger offline media and growth starved Internet companies searching for more growth pay the highest price, driven by optimistic thinking that they can create value by subsuming these venture backed companies.The venture market needs to first stop over paying for deals and second build companies with more longevity. This problem is a sympton of too much venture capital, not an IPO market. Perhaps venture capitalists need to learn how to put several venture companies together in an effort to build larger and more complete business franchises. The egos and entry valuations of most venture investors keep that from happening.
This is a good try, but I think the fault is not from VC’s overpaying. Actually, VC’s tend to underpay as part of their doctrine, unless it’s as close to a “sure” thing as possible. (Ebay before they went public – 1998-1999).VC market dynamics do not equate to American consumer’s current financial troubles from taking debt they cannot finance. As a matter of fact, VC’s tend to flock, and pass on 99% of deals, whereas mortgage lenders gave lower income families loans that should only go to higher income brackets.This post centers on company sustainability, post-liquidity, and I think too many here are commenting on other topics, like saturated VC markets. Commentators should keep in mind that a business must grow to produce shareholder value, and a VC fund must subsequently do the same. Intelligent acquisitions at good prices can do this, theoretically, but ingraining constant innovation into your culture, like Gillette, Apple, and Google do so well, will ensure business sustainability. I wrote about this in my comment below, but focused on the investor-who-is-a-customer’s dilemma.
Bullshit. You have direct lines to dozens of post acquisition founders — do you really think that Joshua, Stewart, Andy and I all stopped caring? The Dodgeball guys? Veen?There are many reasons why services flail post acquisition. But at least in the world of founder-driven web services, I have a hard time believing that anyone seriously says “I got my money — time to rest and vest.”
Effing Hell — this was a response to: http://avc.blogs.com/a_vc/2…
I have all the respect in the world for you Eric, but I believe there are folks looking to rest & vest, especially after a long time at the wheel, if you get my meaning. I knew the founder of lowermybills.com from my grad school, and pasted an article, below, that shows the company is not doing well after his exit. I’ve interviewed him, met with his co-workers, and read articles about what he had to do to stay ahead of competitors in his new market. That is the intangible value that a founder’s desperation and devotion can bring to a business, and I really don’t think it can very easily be replaced by safe and salaried management. I don’t know for sure yet, but I think there are different entrepreneurs: those like yourself and myself that want their business’ to have lasting value and will continue to be devoted to their baby, and those that are happy to have the pressures of the business lifted off of their shoulders after many years.August 26, 2007, 8:55 amLowerMyBills Lowers Its Ad BillBy Brad StoneTags: advertising, LowerMyBills.comThe dancing aliens must have gone back to their home planet.lowermybills.comThe once obnoxiously ubiquitous ads from the mortgage lead generator LowerMyBills.com seem curiously absent from major Web sites these days. The notorious ads, with their dancing silhouettes, shimmying green aliens and bizarre boogeying office workers, were once plastered across many major Internet sites, including NYTimes.com. They are now much harder to find.Our colleagues Louise Story and Vikas Bajaj write about how the advertising of online lenders is weathering the credit storm. LowerMyBills, which has the most annoying online advertisements of the bunch, appears to be among the hardest hit.Heather Green, a spokeswoman for Experian, which acquired LowerMyBills in 2005, declined to disclose whether the company was reducing its mortgage advertising. But she said the company’s large portfolio of businesses — which include its primary credit reporting business as well as the comparison shopping site PriceGrabber.com — “gives us the flexibility to shift focus to best leverage our brands in a dynamic and changing market.”There’s little doubt that LowerMyBills is suffering from the credit crunch: 2005 and 2006 saw unprecedented sales for mortgage lead generators like LowerMyBills, but by all accounts, the market has, suddenly and dramatically, dried up.LowerMyBills seems to be responding with a weird blend of desperation and moderation. Before it pulled back, it blitzed the Web with that absolutely bizarre Flash video ad of two women dancing in front of their office computers who are then surprised to find that they were being watched. As usual, this had nothing to do with loans.Recently we heard, and LowerMyBills confirmed, that the two women in the ads were daughters of a LowerMyBills senior sales manager, Sherry Harris. Ladies, I hope you have enjoyed your peculiar Internet notoriety. Those are some dope dance moves.More recently, LowerMyBills tried a slightly more logical approach to the credit meltdown: tweaking the language in its ads. The ads used to say, “Mortgage Rates Fall Again!” But since that tagline is now insupportable by fact, LowerMyBills ads typically now say, “House payments fall again!”We’ve also heard of some layoffs at LowerMyBills, though Ms. Green said there were no significant changes to its employee numbers.
EricI am curious what you think of my post and the argument as a whole, not just the rest and vest thing which I undertand got your irish upFred
Fantastic post, Fred. Best blog post I’ve read in a long time.
Perhaps the VC community could push this along and make it more real faster. Its in your best interest.
I like the idea of a private liquidity market(s), for venture capital or entrepreneur liquidity, since the public markets have essentially been killed off by their own greed or the regulators, and Bigco acquirers are so bad at integrating what they’ve acquired…
It’s too bad that the users of these services can’t provide liquidity to the startups prior to an IPO through some sort of micro-funding. I’d gladly invest anywhere from a few dollars to a few thousand into the products I’m passionate about for an early equity stake and a chance to allow the team to remain independent.
Maybe it’s not about liquidity and markets, maybe its about acquisition structures. And ensuring that companies stay independently run and founders have an incentive to grow the company post acquisition. Think Goog’s done a decent job with YouTube and the Flickr folks are doing the same at Yahoo. Big companies just have to make acquisitions like this the rule rather then the exception.
“The entrepreneurs who spend years and risking a ton need a way to get paid for that effort.”How does that hold up with age? I’m young, and if I start another company– I can be there for 10 years and be just fine with illiquid shares. I’m not supporting a family, putting kids through college, etc.”And those of us who finance their efforts need to get some return on our investment.”Do dividends play a role? If dividends (this obviously depends on the structure of the term sheet, etc) increase the raw dollar return on a great investment by a few million, investors can at least recover part or all of their investment while waiting for liquidity.”We can argue about the magnitude of the return we need and a host of other things, but the fact remains that without a path to liquidity, all the innovation that is being created by the entrepreneur/VC equation will stop happening.”why is that a bad thing? you can argue that you see less liquidity in a recession. that can stifle innovative startups that just might not have enough cash or enough users to continue to operate. a lack of innovation can be one of the best times to start a company– you have less competitors.”The IPO market is closed…for the best companies”I agree 100% that only the best companies should go public. from a founders standpoint, and a vc’s standpoint, is an ipo less than ideal? investors like it when management has skin in the game and it can take the founder many years to cash out. yes, they have liquid wealth, but can be significantly penalized for cashing out (yeah, sure, they sell shares in the ipo, but i think you get the point). some vc funds tend to return stock to LP’s and others return cash. LP’s generally prefer the latter. either way, an LP has to wait until the fund determines it is ready to sell shares, etc. you can still see some vc funds that are still majority stake holders of public companies.”and many of the top members of the TACODA team are now gone from AOL”that’s a problem, but if you’re an entrepreneur at heart, you might not stay long after an acquisition. you might want to go on and start your next project. that’s can be a great defense for an entrepreneur negotiating terms (triggers, golden handcuffs, etc).maybe large companies can spin out smaller teams as startups. fund them, and give them a percent of the upside. don’t let them fall victim to the big company culture.what are the effects of a lead vc selling their shares in a private market?
Really great post! Wish I had the answer. If I did, I could start a company, get some VC, sell the thing off, and then never have to be involved in the venture again…:)
Isn’t that the same as saying we need a new market for housing?ie the market is not clearing, the price that sellers need is higher than what buyers are willing to pay given the uncertainties, so transactions aren’t currently taking place. Therefore we need a different market structure.What’s stopping buyers and sellers from doing it in public markets? is there some pool of buyers (or sellers) that might behave differently with a new system?If so, then maybe there is something to the private market, and maybe there is a problem with the IPO / public market.Otherwise, maybe the private markets are just ways for Wall Street to circumvent IPO regs, and skim some more off the top.I’d love it if my house was more liquid too 🙂
My sense is that, from a financial perspective, the flow is:IPO to M&A to Strategic Investment to the GS / Opus-5 model…My thought is that there is an opportunity for a middleware that enables these micro-services, as you call them, to consolidate not from a financial perspective, but from a consumer perspective. Thus, such a consolidation could then be monetized. Certainly a different nut, but if cracked both the consumer and the entrepreneur profit.More on this here: http://www.gbrandonthomas.c…
Two thoughts Fred. The first right out of your own book – microchunking. It happens to vc money too. no need for large investments, particularly in businesses that can avoid door-to-door sales.Second one, has been bugging me for long time – advertising and free are dangerous and broken models. Hey startup, how do you make money? Duh – its ads! So wrong, so wrong for many reasons. Number one reason? Big media companies are looking to get out of ad only business and diversify. If it was that good no one would be getting out of it. CPM is about to stand its ultimate test – recession.So maybe we are overlooking businesses where people pay money. Not large sums, but even Flickr like – $25 per year with mililions of users is an interesting business. And maybe the problem is that VC can’t get paid in private companies unless there is IPO or exit. Maybe we need to invent better ways of doing ROI for VC in companies that generate revenue?
There’s nothing wrong with free. You really just don’t understand it.http://cg.urbantwelve.com/2…
CG, I understand free just fine. You do not understand that free kills startups.
Freemium using free to get enough of an audience and social interactionthat you can then start charging for stuff. A number of our companies areusing this model very well.
Focus on cash flowing your silly internet companies and you wont have to worry about selling them to others at overvalued levels.
I respect the point that you are making but calling them silly is a bit muchfor me
I quote, “The public markets should be for the best companies. Apple, Google, Amazon, eBay – those are good public companies. Skype, YouTube, and the current Facebook are not.” Importantly: ‘The Current Facebook’Currently valued at $15B, and adonomics puts it as $100B. however, you say the current facebook is not the best company for Public Markets. Not to say that i disagree with you, but i am still trying to understand what is the strategy for Facebook to get there. i know this is a bit of tangent from what the real context of your post is, but i find myself dwarfed by some of the other people commenting here on subject of VC funding & exits.However, i would like to hear more about your thoughts on facebook and where do you see it going.
very very great insight!Another thing I heard is that Alibaba is considering the result of the deal. This is also a great problem.
That’s the subject of a full post or a series of posts, but I think Facebookneeds to get its revenue model working to the point where it can becomfortable projecting out several years of good growth and enoughearnings/cash flow to justify the valuation they would be seeking(presumably north of $15bn)Fred
Fred,I would love to read your insight on facebook’s future. Plus more onhow they are planning on getting there. I am sure you see themchanging their platform to better suit the needs of their user, but inthat process curbing the growth of new applications and maybe reallygood applications which could propell facebook from just fun to moreproductive utility. A large part of recent success of facebook iscontributed by app developers like for ilike, funwall, texas holdem;this is a result of their policy to open api for developers, now it istheir responsibility to evolve and in the process get the next set ofdevelopers who can feed the needs of growing / already out of collegeusers on facebook (which is about 40% of total users).
Great post Fred. I’m with the commenters that throw the fault on the entreprenuers: 1) They want to “rest and vest” 2) There’s a culture clash between the young companies and their new big organizations 3) Incentives are wildly different once acquired for every player involved—–How do VC’s get liquidity without an IPO, M&A or GS secondary market? Maybe a new micro-bond market emerges where the companies issue bonds and buy back stock with the proceeds? I bet there are sovereign wealth funds out there that can’t own equity stakes (for political reasons) that would love to have a new class of high risk, high yield bonds.
133 comments, I don’t think I can add much to the mix except to say that you’ve got a somewhat confused set of at least three different issues that make it hard to follow what the problem is that you want to see solved. The companies selling non-revenue generating services have sold features not businesses, and as a consequence, the product-driven startup team that becomes part of a larger performance-driven organization is going to find itself marginalized at best. So, it’s no surprise that these entrepreneurs leave, and this may be the best thing for all involved. Very few startups are interested in building a large business these days, they want to either build a large audience or a small business. The M&A market is closing for the former, and the latter was never fundable, and the tech business has never been kind to companies that don’t have scale and barriers to entry as the HuddleChat fiasco has shown us.
great – 134 comments. You beat me.
I didn’t realize we were competing Howard. Now I do. 🙂
I am happy to see issues like private securities markets create such in-depth discussion and varied viewpoints. Hypothetically, If a VC firm decided to move toward being an acquisition firm, with the firm holding companies and selling share on private exchanges would the implied purpose of VC’s be altered? Also, do you think it would alter your appetite for risker ventures?
Funny remark about pmarca. But seriously,i hope the GS TrUe market grows and develops. Small cap companies taken public in the current environment don’t do well.
Fred, a GSTrue type liquidity event for entrepreneurs and VCs is my takeaway from the post. Going public has a higher hurdle and comes with huge compliance overheads. If M&A exits dry up, a startup doesn’t have options. Private equity markets offer a great choice if perhaps yet untested with smaller companies.The rest of the post, about how GYM et al are doing with their acquisitions took away from the excellent point that you made and perhaps didn’t belong in the same post.
>Am I the only crazy one who feels maybe we should PAY for these small, incremental, content piece services??? TNo, I’ve been saying this, and I think users would pay the micropayments IF they could also monetarize their time online using these services and paying these micropayments through their willingness to do market surveys, or sell advertising. Sure, sounds tacky, but there are plenty of people who will do that. More sophisticated versions could allow forums moderators and email users to select themes or have Ad Sense type ads — just make it more easy to do!As for the private market without the SEC regulations, I wish you’d fast forward this, imagine it far expanded, and ask if the public would be screwed in any way…
The comments are actually more interesting than the original post. Can’t recall that ever being the case before.
Are you kidding me? It happens all the time. Check out the comments to ³thedecline of the firm² post
Adopt a “patient capital” approach and stop selling off your companies.
I see some basic flaws in such private exchanges.a)Signals despair : Private exchanges have no market makers; and hence no two way quotes. The very fact that a VC investor is putting up his stake for sale declares (a) the investment has turned bad; or (b) the investor is in a hurry to exit. There is only an `ask’ and without a counter `bid’, VC has bared all her cards. Out goes her bargaining power.b)Disillusions founders: Founders look up to VCs to provide them strategic support, connections and mentoring. If VC stakes change many hands, the founders lose orientation and may even stray. They feel they’ve been taken for granted.c) Tax treatment of Income : Trading thro private exchanges meant for a special category of investors like VCs will make them ineligible for concessional tax treatments (capital gains / business income) available to traders in public markets. Proceeds from such divestments may get treated as windfall / speculative income – that could suffer far higher rate of tax.d)Cartel plays : It is possible for a group of high networth investors to get together and indulge in price manipulation or badger a VC into submission. All they need to do is quote their bids in unison with a time stamp. Take it or leave it.A better way I think, is [to let VCs like Fred not have post-selloff remorse] is “stock warehousing”. VCs can found a platform with high networth investors and build a fund that offers liquidity in lieu of stock placements, with a promise to take them back at a later date at a pre-determined price. Just have a neutral body for valuations. VCs get liquidity, they don’t forego control and the business is run as usual.
What would this neutral body look like?
A mini regulator ( can be a board with nominees from NVCA, Institute of CPAs or Audit professionals) of sorts.
You should be looking to Private Equity firms who look at growing and proftiable businesses as part of their discipline to sell to. The problem is, they won’t give you the valuation that Google/Yahoo!/AOL/Microsoft will, so it becomes an obvious choice to sell to one of the bigger internet companies, no? They will put a HUGE premium on taking a competitor or wanting to get into a particular business, whereas a PE firm will have a lot of other choices and won’t compete with a bigger internet company. So, wait a minute, don’t know why I started the post with the first sentence above since I came back around to selling to a larger media company, but this probably demonstrates the train of thought.
But as I mentioned in my post, that wasn’t the case when we sold bigfoot and we made a great return on that investmentFred
Frankly, I don’t see how you solve this problem since it comes down to the difference in how large corporations and startups manage and develop products.Corporate product development model = stringent requirements gathering/documentation, multiple stakeholder buyoff – ad nauseum, corporate prioritization of resources, centralized development, no single point of ownership for development, vendor negotiation, purchasing, deployment, prioritization, etc…with repeat and rinse cycles until nearly all creativity and value is expunged from the organization.Startup product development model = just do it.One could say you simply keep the startup separate until the product has matured — but then you lose the benefits of what makes the larger corporation great. In theory, I would say the ideal would be to apply the innovator’s solution to the problem of acquisitions, but I can also tell you there is nearly zero appetite within the ranks of large corporations for such nonsense. 🙂
Well these are all fascinating comments. I am sad that Umair has not chimed in as he would surely add some spice to the mix. what is the significance of the decay of the exit provider?These large companies are consolidating on top of quicksand surely. All these services you invest in, are in constant motion by design, I see what these guys are doing as a defensive posture against the atomization of the web. Literally as soon as one of these services is bought, its value falls. The control today is so on the side of the user, i argue the value of these services in terms of assets to the big guys is harder to pinpoint today than it ever has been.
Umair wrote a post on this at the harvard business school blog on fridayFred
Fred, one point to consider: All the examples you cite were sold well before the ‘standard’ 5-7 year time frame of a VC investment.If you consider the risk curve as down and to the left (that is, early in time is very risky and then as time passes more and more risk is removed), then it’s no wonder that younger companies who are acquired have a higher likelihood of failure/being screwed up big large Internet cos. I am willing to say that the failure rate is going to be the same for any type of company acquiring at this earlier stage.What you seemed to be hinting with the private market is that exits should be fractionalized. But that is already happening with firms like the Founder’s Fund and others letting the founders take money off the table. The timing and scope of that is obviously a topic for hot debate (too early and too much is obviously a bad thing) but in abstract it’s exactly what you are advocating (keeping incentives alive, keeping founders motivated).My main point I guess is that the examples and many of the companies that languish inside the larger structures didn’t even play out their venture timeline. That is, it wasn’t like USV held delicious for 5-7 years and the company felt obligated to reach an exit for you.So the problem essentially is that promising companies aren’t really playing out the venture timeline anymore. And I am a believer that progressively taking founders money out as the business reaches greater and greater success milestones would change that and wouldn’t screw the incentives if done right. And wordpress and Facebook are probably the best examples of that.
Fred,Isn’t that just the nature of capitalist societies? I mean, shallow minded VC’s and business owners look forward to the obscene payday if and when they get acquired. The acquirer’s eyes bulge at how the recently acquired firm can give them competitive advantage, access to new technology/markets, etc. Shareholders salivate over what it will mean in terms of dividends.But at the same time the best employees leave, the owners may take a world tour for a few months and then start another firm, users lose interest in the service, and industry analysts start talking about the next new, sexy, shiny, app.We have a disposable-consumerist-throw-away society, so isn’t this to be expected? I don’t know that much about economics, but as a layman it looks like these companies and the services they provide are pawns that are bought and sold. It’s a cycle.I learned this when I read about the Vitamin Water acquisition. They were bought for 10x’s their revenue. I mean it’s crazy, I understand that it makes Coca Cola more competitive, gives them access to new markets, etc. but I just don’t think this is sustainable.You have a small group of people that make money very quickly… only to look for the next opportunity. I don’t know, it just doesn’t seem sustainable to me.Raza Imamhttp://SoftwareSweatshop.com
Venture funding has always been a game of changing expectations and a longer time frame to exit. Mercifully, valuations have returned to earth. Investors expectations need to do the same. Most companies — rockstar plays aside — require care and feeding over many years, not quarters. Anyone who invests without understanding what capital is needed and where it is coming from for the next years is bound to get pinched. Now, more than ever, investors need to be very picky.
Fred -You are absolutely right. There have been only two exit routes for venture capital and founders to acheive liquidity – a sale to a corporate buyer or an IPO. I have felt for a long time that a third alternative is really crucial to improving the venture capital market; however, I’m not sure either the Opus-5 solution or the Goldman alternative is the right answer.If you look at the Buyout world, the exit alternatives looked much the same as the venture market does today. Then people began to realize that selling a company from one private equity firm to another firm provided a third form of liquidity – a secondary sale. A good a fair value is often obtained for selling assets this way – yet venture capitalists and founders rarely sell to another venture capital firm.We started Saints in 2000 to provide an alternative exit for investments made in the venture capital market and have acquired almost $2 billion of investments in the past seven years and we currently manage over $1 billion of capital. The concept of a market to trade shares of early stage companies where diligence is very difficult and the ability to understand the underlying technology, capabilities of management, etc. for an investment whose success is much more dependent on those factors than current financial performance make trading “quasi-publicly” very hard.The fact that firms like Saints focused on providing liquidity for these investments is a real near term solution for providing liquidity in the venture capital market and more venture capital firms need to be comfortable that an exit to another venture capital firm is an accecpted form of exit.
That’s a good solution Ken and I’d like to learn moreFred
Yes, I agree. But, your model is a little bit out of line. When I contacted your firm to sell my founders stock one of your associates didn’t return two of my calls. Your model ONLY works for large portfolio acquisitions of existing VC funds that are nearing there 10 year date.
you have no idea what you are talking about
That’s a bit rude and uncalled for. I have had interactions with Saints and came away really impressed. They are smart, efficient and get to the point. There’s no real reason for you to lash out like that, without substantiation…
The problem is many of these ventures don’t have a sustainable business model. Without a sugar daddy in the form of a VC or big corporate parent to pay the bills, they can’t keep giving their stuff away for free.This is the downside of the “free is good” argument.http://avc.blogs.com/a_vc/2…It’s fine as long as it’s a loss leader for your revenue generating products, but when the free stuff is your product then you can’t survive.Eventually the VCs and Corporates get sick of subsidising something that doesn’t add to the bottom line and grow disinterested too.
i feel you are explaining two groups.- Venture Capitalist one with a short term return motivation and the second wanting long term viable. businesses.- EntrepreneursI on the other hand think you are complaining about some bad choices:A good post, thanks, however the internet is still a trendy beast, an infante in diapers.You said,”services we have come to rely on”Flckr, Facebook, and other things are just trendy toys, and can easily be replaced by a better service.You outlined the good companies like Google.com, ebay, probabably Amazon.com.I own a large Travel Site, I do not partner with toys, I partner only with solid companies that will not divorce me, Flickr, MySpace, etc will divorce, I do not agee on the YouTube.com, I think they will remain viable, but lesser important as they become diluted by competition. Most companies will soon host videos on their own servers when he tech become availalbe.But.. Do not rely, do not partner with trendy companies, but trendy companies do make big money for VC money.But the Entrepreneur needs to create a stand-alone system, like YouTube.com, Google.com, Ebay.com.It is the system a VC should buy, not the trendiness, an autonomous system will succeed, the to be the first one is the hope, but in the end you must contiually expand and innovate.I feel you have created some entangled business partners that some of your VC companies rely on and now the return has dropped. They company managment made the choice, not the company that purchased, so the company lost interest, like delicious, so what, the error was not the bad management after the purchase, it was the company that became entangled in the company in the first place.Solution: Stand Alone Web Site, not relying on others to thrive, but relying on the whole Web to survive, the viability of a company should not be dependant on a wanna be trendy site. And if you need to partner up, google.com, Ebay.com, the big boys with long-term goals, nothing so trendy.Andy an American Citizen in Panajachel, Guatemala
The Venture community absolutely needs a new liquidity option. Without it, the whole business (and value proposition) will collapse.But I don’t think that entrepreneurs need a new liquidity option. I think the only ones who truly do are those who are first and foremost in it to get rich (not win, not innovate, not create great products, but simply cash out).And sorry… but the lack of liquidity does not destroy innovation. Innovation exists outside of the capital market.
Go to http://www.unifiedmarket.com.
Go to http://www.unifiedmarket.com.Robert
I totally agree with you on the theory, but I am wondering how one would deal with the frenzy which such a “private” exchange would create? I mean that when a private company is looking for liquidity to continue its growth (or to allow an exit for entrepreneur and VCs), then secondary offerings are already a very active way of providing more liquidity. And there are very well known PE funds, and funds of funds, already on top of their game at sourcing good secondary opportunities in the Boston area and elsewhere.So, if “good” private companies can privately exchange/offer some of their shares to accredited investors more easily than it’s already the case, it will attract more and more investors dying to enter these companies capital, and you will end up with a “private OTC exchange”…Am I totally talking rubbish, or am I on the right track?Thanks for your answers
PG weighed in on this vis-a-vis Umair’s “Fix VC” post today…http://news.ycombinator.com…My take on this is that profitability = sustainability. Businesses that are producing cash flow have all the options in the world (as long as the founders can get some liquidity)
Interesting idea.As an active Angel investor looking for options to increase venture value and liquidity, please let me know of developments with a Private Equite Market / Exchange.Regards,CAILRon Thompson905-940-9000 X244www.cail.com/angel
Trading of private equity has been occurring since 2005 in Canada amongst high net worth accredited investors on Genesis Exchange. The company is a private seed stage private equity exchange blessed by the regulators in 2004 (see http://www.genesisexchange.com). Some notable groups with similar systems operational in this market are Restricted Stock Trading Network (RSTN) and New York Private Placement Exchange (NYPPE). As far as I know Genesis Exchange is the only market dedicated to the companies from seed stage through middle market. Full disclosure – I am the chairman of Genesis Exchange.