Three types of acquisitions

There are three types of technology acquisitions:

– Talent. When the acquirer just wants the team (generally just engineers and sometimes designers). As a rule of thumb, these acquisitions are priced at approximately $1M/engineer.

– Tech: When the acquirer wants the technology along with the team. Generally the prices for these acquisitions are significantly higher than talent acquisitions. Sometimes they are even in the hundreds of millions of dollars for fairly small teams (e.g. Siri). The calculation the acquirer uses to price tech acquisitions is usually “buy vs build”. An important component in this calculation is not just the actual cost to build the technology but the opportunity cost of the time it would take them to do so.

– Business: When the company is either bought on a financial basis (the acquisition is “accretive”) or bought based on non-financial but highly defensible assets (Google buying YouTube which had minimal revenue at the time but a huge network of producers and consumers of video).

As large companies mature they move from doing just talent acquisitions to doing talent and tech acquisitions to eventually doing all three types of acquisitions. Usually it takes a startup beating the large company in an important area for the large company to realize the necessity of business acquisitions. For example, Google seemed to dramatically change its attitude when YouTube crushed Google Video. Eventually every large company has a moment like this.

Selling pickaxes during a gold rush

There is a saying in the startup world that “you can mine for gold or you can sell pickaxes.” This is of course an allusion to the California Gold Rush where some of the most successful business people such as Levi Strauss and Samuel Brannan didn’t mine for gold themselves but instead sold supplies to miners – wheelbarrows, tents, jeans, pickaxes etc. Mining for gold was the more glamorous path but actually turned out, in aggregate, to be a worse return on capital and labor than selling supplies.

When a major new technology trend emerges – say, the rise of online video or social media – entrepreneurs can try to capitalize on the trend by creating a consumer product (mining for gold), or by creating tools to enable consumer products (selling pickaxes).  For most technology trends, the number of successful companies created in gold mining and pickaxes are comparable, yet the gold mining businesses tend to get much more attention. In online video, YouTube is often thought of as the big winner; however, to date, more money has been made by online video by infrastructure suppliers like Akamai. Y-combinator is known for their high-profile B2C startups but their biggest exits to date have been in infrastructure (most recently Heroku which rode the popularity of Ruby on Rails to a >$200M exit)*.

When you start a company, the most important consideration should be working on a product you love (a startup can be a 5+ year endeavor so if you don’t love it you probably won’t be able to endure the ups and downs).  A secondary consideration should be matching the skills of the founders to the market.  Tools companies tend to require stronger technical and sales skills, whereas B2C companies tend to be more about predicting consumer tastes and marketing skills. A final consideration should be the supply-and-demand of startups in the space.  Because B2C companies tend to be “sexier” and get more press coverage, many entrepreneurs are drawn to them. This tends to lead to greater competition even though the market opportunities might not justify it.

There are many exciting technology opportunities emerging today: some are horizontal like mobile, location, and local; others are vertical like fashion, art, real estate, education, finance and energy. If you are an entrepreneur thinking about starting a company around these trends, consider selling pickaxes.

* Note that there are many great B2C YC companies, so the list of exits will no doubt change and probably skew more towards B2C over time.

The ideal startup career path

For most people I know who join or start companies, the primary goal is not to get rich – it is to work on something they love, with people they respect, and to not be beholden to the vagaries of the market- in other words, to be independent.  The reality is being independent often means having made money and/or being able to raise money from others.

A while back, I posted about how I recommend thinking about non-founder option grants.  In the comments, Aaron Cohen made the point that given today’s “good” exit sizes and standard equity grants, most non-founders will not gain independence even in the (non-extreme) good cases:

Most startup employees need to realize they are on a journey and that in addition to making a few hundred thousand dollars on a good outcome they are learning how to become more senior at the next company. Real wealth creation will take founding, seniority, or staggeringly large exits.

As Aaron said, you shouldn’t think of joining a startup as just joining a company. You should think of it as joining the startup career path. This career path could mean starting a company as your first job.  It could also mean working at a few startups and then starting a company.   (In my view, if your goal is to start a company, it is mostly a waste of time to work anywhere but a startup – with the possible exception of a short stint in venture capital).

Maybe you will make some money working at a startup, but more importantly you will hopefully work for founders and managers who are smart and willing to mentor you and eventually fund or help you fund your startup.

The startup world is extremely small.  If you’re smart, work really hard, and act with integrity, people will notice.  Contrary to popular wisdom, you will actually have more job stability than working at a big company.  And hopefully you’ll go on to start your own company, gain independence, and then help others do the same.

function my_exit_payout(…)

/* aggregate_options_strike_price = your options strike price per share * number of shares you own
company sale price is 1) if private transaction: amount paid by acquirer plus any funds in startup returned to investors,  2) if IPO = market capitalization.
note: if you assume all financings were 1x preferred, investor preferences == total amount of money the company has raised
to do:  add condition for participating preferred, graph various scenarios

*/

function my_exit_payout(  company_sale_price, your_percent_ownership, your_aggregate_options_strike_price, investor_preferences, investors_ownership_percent)
{

if (investors_ownership_percent * company_sale_price < investor_preferences) investor_converts=FALSE;
else investor_converts=TRUE;

if (investor_converts) return your_percent_ownership * company_sale_price – your_aggregate_options_strike_price;
else {
common_stock_proceeds = company_sale_price – investors_preferences.
your_percent_common = your_percent_ownership / ( 1 – investor_ownership_percent );
return common_stock_proceeds * your_percent_common – your_aggregate_options_strike_price;
}

}

TheFunded term sheet

TechCrunch has a post today about TheFunded’s ideal first round term sheet.   I think what Adeo Ressi is trying to do with TheFunded is great, and he has clearly been a leader in exposing VC shenanigans and simplifying term sheets.

I looked through his ideal term sheet and from my summary reading the only thing I disagree with is full acceleration on single trigger (company is acquired).  The term I favor regarding single trigger is to have acceleration such that the founders only have a maximum N (say 12) months remaining. This seems to me a reasonable compromise so that 1) the founders only have to stick around at the acquirer for a maximum of N months (since they will probably be miserable at BigCo if they have to stay longer) 2) the acquiror gets some comfort that the founder will stick around long enough to integrate the startup into BigCo, thus getting the full value out of the acquisition.

I know some lawyers are telling entrepreneurs they shouldn’t have any acceleration on single trigger because it will make the company less attractive to acquirers.  Having been through a couple of acquisition negotiations on the business side (I know many lawyers will say they’ve been through many acquisitions but lawyers only see 10% of what really goes on in the process), what I learned is that acceleration on single trigger doesn’t hurt you from an acquirer’s perspective as long as founders are incented to stick around for some reasonable period of time (approximately 1 year, not 2-4 years).

Actually, the negotiation over acceleration on acquisition ends up pitting the founders against the investors, not the acquirer.  The way the (rational) acquirer figures it, they are going to agree to pay, say, $100M for a company with founders who have built incentives to stick around (some vesting left).  If the founders get full acceleration, then the acquirer figures they are going to have to set aside, say, $10M for future incentives, so will only pay $90M to buy the company, thereby leaving less for the investors. I didn’t understand this dynamic until I went through the process myself.

Of course a lot of this depends on the type of acquisition.  If it is a small trade sale the acquirer will probably want the founding tech team to stick around for as long as possible.  If it’s a profitable business then BigCo will probably want to put their own managers in charge and only need founders to stick around for 6-12 months.

I definitely support TheFunded’s full acceleration on double trigger (company acquired and founder is fired).  In fact – I think I might be alone on this one – I support double trigger for all employees.  I don’t see why only founders should have this basic protection.

I didn’t see any mention in the term sheet of initial vesting of existing founder shares (maybe I overlooked it…?).  I think that this is a very important term and that founders should vest over 4 years from seed funding or perhaps starting a few months before (for “time served” as they say).  In my experience, entrepreneurs way overestimate the odds that greater initial vesting will protect them from the VCs, and way underestimate the odds that less initial vesting will protect them from their co-founders.   I don’t care if your co-founder is the greatest person in the world, things happen in people’s lives, moods change, relationships get complex, etc. and founders leave startups.  Pretty often.  A better way to protect yourself from VCs is to only do deals with high integrity ones.