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April 15, 2008

Built to Last vs. Built to Flip

Fred Wilson wrote a blog last week on VC exits, bemoaning the lack of liquidity paths.  I admire Fred tremendously (both as an investor and blogger!) and think It's a great blog, but it only covers a part of the story.

First, a bit of background.  VCs need their start-ups to exit in order to pay back their limited partners.  The IPO window is effectively closed for VC-backed companies and even when it was somewhat open in 2006-2007, the bar was very high (typically you needed $100m in revenue, profitability and 7-9 years of operating history).  The practical path to liquidity for entrepreneurs, therefore, is to sell your company to a larger (typically public) company for cash and/or stock - an M&A exit.  Fred points out that, as a rule, Web start-ups simply do not thrive when snapped up by the (depressingly few) prospective acquirers like Google, Yahoo and AOL - leading to an unsustainalble cycle.

Why do I think Fred's blog only covers a part of the story?  Simply put, there are huge industries and parts of the economy where VC-backed start-ups are competing that are not covered in his analysis.  The life sciences industry, which has become a massive opportunity for entrepreneurs and VCs, has seen some terrific exits in both biotechnology (Flybridge Capital's senior advisor, Christoph Westphal's company, Sirtris had a strong IPO in 2007 and has a market cap north of $350m) and medical devices.  Our portfolio company, Brontes3D, was acquired by 3M for $95m after raising only $8m in capital.  Brontes, by the way, has indeed thrived under 3M's leadership.  Nearly two years later, the entire management team under CEO/co-founder Eric Paley is still there and 3M's resources and distribution channel has helped support taking the company's novel intraoral dental scanning device to market (as featured in yesterday's Boston Globe). 

The wireless industry has seen some nice exits for companies like Enpocket, 3rd Screen Media and m-Qube.  Enpocket's management team under CEO/co-founder Mike Baker remains at acquirer Nokia and has taken on responsibility for all of Nokia's mobile marketing initiatives.  Finally, the enterprise software industry (selling to, gasp, IT) isn't (as my partner Chip Hazard likes to say) dead yet.  Some strong exits in that market in the last few years include Outlooksoft and Virsa (both bought by SAP), AppIQ (HP) and IM Logic (Symantec).  IMLogic's CEO/co-founder, Francis deSouza, remains at Symantec 2 years later as an SVP running a huge part of their business (nearly $1 billion in revenue, last I heard).

A cynical observer might point out a sharp contrast here.  The "easy come, easy go" Web 2.0 start-ups may not be building real, sustained value and so vaporize under an acquirer as quickly as they appear, with "quick flip" entrepreneurs running off to do their next big thing.  Meanwhile, the "built to last" entrepreneurs across a range of "long-term value creation" industries -- life sciences, medical devices, enterprise software to name a few -- are more likely to stick it through and help their acquirers see real value through continuous improvement.

But then again, I'm a former entrepreneur.  Optimism wins out over cynicism every time.


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how do you distinguish between "quick flip", "built to last", and a serial entrepreneur?

depending on the economy, and also your stage at life, an entrepreneur might opt to sell their company sooner, rather than raise more capital and weigh potential dilution. you can encounter this in all industries-- even long term value creation industries

you might have a built to last entrepreneur building a company in a long term value creation industry, but that doesn't necessarily mean they will stay long after an acquisition. good entrepreneurs will build good, sustainable businesses-- but they may build several. sometimes they don't have the incentives to stay on for several years to grow their acquired company, or often they want to move onto the next challenge. if i started another company, i could spend the next 5-10+ years building a sustainable business. but i think after an acquisition, id want to move onto a new opportunity.

i think a lot depends on the incentives that an acquiring company creates, as well as the culture.

So does this mean that VCs and CEOs should start paying more attention to non-traditional exits because of the limitations of fund life?

Might we see the emergence of a growth equity market to completely buy out VCs but keep startups private as a parallel path to M&A from the big players?

Hey Jeff, whether he says it or not I find myself always reading Fred's comments as "web startup" centric.

As a "web startup" entrepreneur, I actually find myself wondering a lot about whether technology, commoditization, and plummeting barriers to entry are creating a new category of "small business" that will eventually necessitate an entirely new investment and growth strategy. Which leaves me following YC, Founder's Fund, First Round, and CRV's approaches carefully.

BTW, I believe you mean Enpocket, not Empocket.

Startups don't (usually) thrive after an acquisition by a web giant because their goals aren't aligned. Giants like AOYahooglesoft make their acquisitions for strategic purposes; their goal is for the startup's business to help them, not for them to help the startup's business. They buy the bus for the parts and the passengers.

While there might be some entrepreneurs who are okay with that, I think it's more likely that the kind of entrepreneurs who can reach that kind of success do have bigger plans, but need money(of their own, without the deadlines of a VC's fund closing) to accomplish them, and are willing to build and sacrifice a venture to get that money.

That said, not all early exits are a bad thing for the startup. The key is to be acquired by a larger business that has the resources(monetary and existing business processes) to expand the startup, and is acquiring them because they want to do so. These acquirers are entrenched businesses, capable of recognizing new technologies potentially disruptive to their industries, and willing to use them to innovate and bridge the old business with the new, gaining or extending supremacy over their competitors.

Of course, startups who meet those needs are also usually the ones with the best ability to supersede their potential acquirers. But not all the blame can be put on entrepreneurs for the infrequency of this happening. Where are the VCs willing to pass up lucrative exit opportunities for the fickle fortunes of an IPO? Where are the VCs willing to risk with the entrepreneurs, not in money, but where it counts: time, connections, reputation? There might be plenty who say they are, but entrepreneurs have to be prepared if they're not; they have to be willing to accept exit, or IPO, as success.

I hope you'll agree. If so, and you'd like to hear about a startup with the kind of potential I described, I'd love to grab coffee with you Jeff.

you are so right. my post left out vast swaths of the VC sector and i think that sectors where acquirers are purchasing real IP, like biotech, nanotech, even green tech, should have better experiences with M&A

but web/tech is not full of great M&A stories and that's why i think we need some new thinking in the sector that we focus on exclusively


Great complement to Fred's post.

I agree with Jeremy. If a company has completed market research and applied this to it's plan (incentives), it is more likely to succeed, both with acquiring VC's and Customers for the long term.

Its a nice website. we can learn a lot here.

It is very unfortunate that entrepreneurs are sometimes frowned upon if they go into a business with the idea of a sell-out or other exit strategy.

Most obsessive entrepreneurs we know do this so they can put all their effort into creating the company, find exceptional people to run it, find someone to invest in it or buy it and then move on to the next idea.

You would think VC's are looking for people just like this to follow around!

Why should you be embarrassed for being a successful idea person?

It's just odd...

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