Paul Graham has written another epic post. Titled “Why There Aren’t More Google’s?” he examines Corporate M&A, the lack of boldness in VC’s and the growing gap between founder’s capital and traditional venture capital.
Having spent a decent portion of my career in Corporate M&A and now committed to financing in the seed stage market, I echo most, but not all, of Paul’s comments.
He states that corporate acquirers underestimate high potential startups. This is undoubetdly true in some cases. But, strategics are willing to pay more than any other third party and many entrepeneurs want to remain in control, so it’s unclear if there is a market clearing price anyway. Besides, for every Facebook and Google, there are many, many more high profile acquisitions which failed to live up to expectations. Skype, anyone?
Many will argue that strategics don’t realize value because they mismanage integration post acquisition. This is true in too many cases but many corporates purposely leave the startup alone and they still fail to perform to expectation. The reality is that it is very, very hard to change the world (or dominate an industry) and perhaps even harder to this while under a corporate umbrella. While high profile startups invariably have amazing potential, things happen. Incumbents react, new competitors emerge, and often the market just isn’t as big or disruptive as previously assumed. In this case, a fantastic company emerges, but it is rarely on par with Microsoft, Qualcomm, or Google. Strategic acquirers know this but startups always want to realize “full value”.
I was surprised Paul didn’t discuss pace of change as one of the causes for a dearth of blockbuster startups. It takes time to destroy one industry and build another. The Circle of Economic Life. While it’s certainly a faster cycle than in previous decades / generations, it’s helpful to remember that consumers need stability, standards and consistency. Perhaps there aren’t more Googles because the world isn’t ready for another Google, just yet.
One market that is ready for reinvention, however is the seed stage market. Paul is dead on when he says that VCs aren’t organized to pursue investments in early, early stage companies. VC’s won’t pursue these deals because they want to mitigate as much risk as possible. They want proof. They want data. They want market validation. Not unreasonable requests, actually. Who wouldn’t want this? The problem is that by the time these proof points are established many capital efficient companies will be close to cash flow break even and they don’t want significant investment capital. Just ask the domain industry. These entrepreneurs got zero VC love but many built successful businesses. Now, these company only do financings for acquisition and liquidity purposes.
The seed stage market is poised for a revolution. There is just too much of a gap between capital demand and capital supply. Plus, it’s incredibly inefficient. Entrepreneurs generally loathe “herding cats” or rounding up angel investors, as they call it. Angels usually work anonymously or in groups to avoid overwhelming requests from entrepreneurs and the demands of private equity investing.
Perhaps, it’s just my reflection but I see an increase in professionals in the seed stage market. There will be an influx of capital into this market, both individual and eventually institutional, because capital seeks returns. And there are great returns to be had in the seed stage market now. I hope Paul focuses his pen on this for the next essay.
1 Comment
April 30, 2008 at 11:36 am
This analysis was written using the blood from my veins. My company is staring large purchase orders in the face after two years of fighting the start up game. Yet, we’re struggling to convince “sophisticated” investors that the pittance of money we need to prep for manufacturing is a good opportunity. Long story, of course, but in a conversation yesterday with a PE firm, I was told that investors want three years of track record and positive cash flow. THAT was their definition of an opportunity. That is my definition of the stock market. Have fun with those returns.