If You Build It…

Stuart Ellman

Eric Wiesen

“Should I build my company to be a profitable, standalone business or should I be aiming to fit into the long-term plans of my likely acquirers to facilitate an M&A exit?”

This is a question that entrepreneurs ask themselves every day. If you asked a hundred venture capitalists this question, I suspect the overwhelming majority of us would give you the canonical answer – build for long-term profitability and a standalone business, because the tides of M&A can come and go. In the previous era, many VCs liked to see every investment as an IPO candidate. And that made sense in an era when a pre-revenue web company burning cash could actually go public. But in today’s market, when even nine-figure companies with positive EBITDA can’t go public, it is worth asking this question again.

The argument for the traditional answer is simple and compelling – when you go to start your company, you don’t know what Google or Cisco or Dell will be buying in 3-5 years when you achieve sufficient scale to be interesting to them. As a result, if you build toward M&A, you’re likely to build toward whatever they’re buying when you start, and that will likely change significantly over the build period of your company.

There is also a huge issue of stage and valuation. Acquisitions tend to happen in two lumps. First is the “cheaper and quicker” route. This means that Dell can buy something for $10 to $25mm because it is cheaper and quicker than building it themselves. The second is “they already have scale” route. Obviously, a company like Dell can pay a great deal more for a company that sufficient scale that cannot be reliably replicated simply by recreating the technology. A good example of that would be the acquisition of Pure Digital Technologies (creator of the Flip video camera) by Cisco. Could Cisco build its own version? Sure. But they paid almost $600mm because Flip already had brand and scale . (BTW, kudos to Jonathan Kaplan, CEO of Pure Digital and a former RRE CEO). If you are selling in the “cheaper and quicker” category, it better be at a single-digit valuation. Nothing past a Series A.

The emerging counterargument is that the IT landscape has so significantly consolidated that the it’s become easier to project the tectonic movements of the “continental” companies like Microsoft, Google, Cisco and Dell. But is this true? Can you forecast what these companies are going to do? We sold MessageOne to Dell because it wanted to make a big move in hosted services. Could we have forecasted this in 2001 when we funded the company? Again to the Pure Digital example, how could you have guessed that Cisco would be going after the consumer market in 2002 when Jonathan was raising his first round.

We think this question is being answered in real-time. The standard advice to build for the long term is still good advice, but if all the exits are going to be via M&A for the foreseeable future, we’ll be thinking pretty hard here at RRE about what the big guys are really looking for. We still want to fund great entrepreneurs solving big problems in growing markets. But we also want to know what acquirers are looking for. Time to get smart in this area.

The Other Social

We’re happy to have a post from our colleague, Girish Gupta, on social venture.

Hi everyone! Its taken far too long for my first post to this blog, but let me take this chance to digress slightly from the conversation we’ve had running and spend a few moments on a topic that is incredibly important in a different way…

Entrepreneurship at its core is a path that’s paved with hope and opportunity. I use such broad terms because today, more than ever in recent history, new ideas and plans are needed that will create sustainable enterprises that not only seek profits but also further causes for social good.

So what makes a venture social? To me, it means using the principles startups have used for years to combine technology and market opportunity in a way that addresses global challenges such as human rights, poverty, education, and healthcare. Are you providing services to markets previously under-served by established players? Are you finding new ways to build a profit seeking enterprises in places others wouldn’t? Are your products fill a gap made apparent by poor infrastructure? Many entrepreneurs are. Here are some of my favorites:

• The Khaya Cookie Company – Founded by a former banker who left the Wall Street life to pursue a passion for teaching women in South Africa valuable life skills. Today they have built a great company that not only creates jobs but also some amazing cookies.
• Frogtek – A fresh approach to business tools that’s leveraging Android to give micro-entrepreneurs in South America the access to accounting and inventory management software without costly IT systems.
• HumanRightsLive – How would you use the internet to change the way people think about Human Rights? How about giving them a reason to care by simply connecting people from all over the globe.
• The Factionist – An apparel company who’s using fashion to inspire action.

Despite the common good many would recognize in the ideas above, every social entrepreneur I’ve spoken to is facing one of two problems: 1) finding someone with the vision and the resources to commit serious funding and 2) finding smart, motivated people to help them grow. To address the issue of funding, many believe, including myself, that a venture funding-like process should be more commonly used in the non-profit world. I also think that today represents a unique opportunity for many of the greatest minds in our generation to start focussing on these problems in a seriously entrepreneurial way. Why aren’t people jumping at any opportunity to be a part of what these companies are building?

Lets take a look at these challenges. In my opinion, I have seen far too many bright minds chasing an opportunity to be “the next (insert_startup_with_high_valuation_here)” all the while missing the chance to meet markets starving for attention with innovative solutions. Our previous post on Hard vs Easy business models is entirely applicable to this conversation. Fundamentally, these are “easy way” opportunities. The challenge is finding the right people to support your vision, or at least communicating it in a way that resonates with institutional investors. Our job as VCs is to be good stewards of the capital our limited partners entrust to us. So with that in mind it’s hard to swallow a corporate mission statement of “We will eradicate poverty by 2015”. It’s not what we do.

What we do is analyze markets and opportunities and look for innovative solutions that address unmet needs in a novel way. If you’re an entrepreneur in this age and you’ve never once considered B.O.P. opportunity, I’m disappointed. No one is suggesting reaching those markets will be easy, but that has never been a reason for entrepreneurs to avoid them in the past. Seasoned entrepreneurs have a knack for diving head first into market segments where people previously saw little opportunity to create new value and through a confluence of execution and timing, great companies get built.

What would happen if you brought together entrepreneurs and and non-profits — you’d get interesting solutions with big markets like the ones above. What would happen if you mashed a VC firm into a grant-writing foundation — you’d get operationally demanding, performance focussed results like those sought by the Gates foundation. Sources of funding like this are are starting to grow, but performance-based funding is still not common practice in the non-profit world.

RRE is certainly no stranger to these concepts. Like us, many firms have taken on the this mantle through investments in green tech, a great example of a market where social good and profit motives are not mutually exclusive, but rather aligned. RRE also takes it a step further in inspiring social innovation in a new generation of entrepreneurs through its partnership with Youth Venture, helping young social venturers build with skills and resources available to our portfolio companies.

So I think its time for all of us to play a more active role in social ventures, both entrepreneurs and funders to use what we know and employ in our day-to-day operations to help those who are creating new products and services that address global problems. I don’t mean to say that we should all forget the web and flock to impoverished nations, but our resources and skills will surely go a long way in getting companies and solutions like those I mentioned further in the market.

Stages

James D. Robinson IV