The "Build It/Flip It" Bubble Discussion

Great post from Ross re  A Flip/Flop Bubble of Microventures? in which he "attacks" the concept of  startups launched and bankrolled by former "bubble entrepreneurs" for the sole purpose of flipping them to large established players.

[...] there are a ton of former entrepreneurs getting back in the game these days. The lure isn't just that markets are opening again. A mindset is developing in the valley that you can and should develop startups for quick flips. If you have your own cash, you can seed a play like this yourself, filling a targeted niche -- both in product, market and engineering expertise. I even heard of a major portal getting into seed funding to encourage it. Perhaps this whole thing was started by Google's micro-acquisitions. I don't have any data on this trend, as it is the most private part of equity, but it is the talk of many a Silicon Valley coffee shop.

I've always believed the VC No of "is it a product, or a feature" is lazy thinking. All great products start as features and great teams evolve them with a mission in mind. The flip approach avoids this entirely. Just focus on the feature. Think for a minute how inefficient a market can be when the spoils of a previous bubble can be invested by seeding flips targeted to buyers instead of companies targeting real customers with real business models. [...]

That discussion is not new, and as I wrote quite a few times, I just don't see how you can successfully build a company to flip it and make reasonable money doing so (reasonable meaning that the founders end up with windfalls of at least several million dollars) - and not just a cool sign-on bonus (which is the case in micro-transactions like the ones Ross is referring to).

What we have seen in the past few months are early takeouts of promising companies that had assets, talents and buzz that justified for their acquirers spending tens of millions of dollars (Bloglines, Flickr, ...). In some cases, a choice was made by the founders to get cash now, and scale the company leveraging much larger footprint and resources, as opposed to playing optionality, accept the dilution of VC financing rounds, and have a go at it alone.

I would venture that you can't build a company solely with the express intent to flip it, because you can never plan where your potential acquirers will be in their own development as you are "getting ready" for a take out. Not even mentioning the fact that if you don't have more than one company interested in what you have, negotiating the price becomes challenging... if ever you get there in a first place.

Built to last, with the option of an early take-out, is where I see opportunities.

I disagree on one point though: "[...] and the amount of creative destruction this (building to flip)  could incent [...]". So many innovative technology or concepts remain at feature stage, meaning they can never be turned into a product or a "real" company, that allowing their inventors to reap some (limited) rewards through such an exit is actually not a bad thing. Better for a technology to get some usage by a large company than accumulating dust (or being "mothballed").

Comments

[Dan]

You said: "I just don't see how you can successfully build a company to flip it and make reasonable money doing so (reasonable meaning that the founders end up with windfalls of at least several million dollars)"

But your examples (Bloglines, Flickr, etc) seem to prove otherwise. Neither had taken a venture round and both were acquired for numbers in the 8 figures. Unless they had the worst angel deals in history, the founders each made at least several million.

[Jeff Clavier]

Dan> Very good remark. I don't think they were built to flip per se, and both could have received substantial VC investments to define and implement a "real" business model.

[David McClure]

note: another option is that those deals (or similar ones) could have been done as earnouts, with a 'floor' price as an up-front payment, and a performance-based 'ceiling' payout over the first 1-3 years based on adoption / revenue / other metrics.

when my first company was acquired (consulting company, small deal), the acquisition was structure as an earnout over the first 18-24 months. it worked out fairly well for both parties, in that it allowed the acquirer to make the acquisition at a low # to start, and defray risk. at the same time, we were able to perform relatively well and maximize the value over time.

particularly for smaller technology companies being acquired by larger portal players, this strategy makes a lot of sense -- the big benefit to the startup is not having to do a big marketing spend to get to a lot of customers, and the benefit to the portal player is the possibility to sell a new service to existing customers & [re-]monetize their usage.

however, the uncertainty of adoption rate / future revenue is the big question mark for setting a value too early / at the time of txn. An initial downpayment, plus a performance-based payout over time allows both parties to minimize risk & maximize potential, and get past the hassle of a long, drawn-out negotiation and a price that might seem too hight to the acquirer.

the only caveat to this is the acquired company should make sure earnout metrics & control options are clearly stated & maintained, so that they aren't squeezed out. however in most cases this will occur only when the acquisition isn't working, in which case the "floor" downpayment made initially pretty much becomes the purchase price anyway.

[Jeff Clavier]

Dave> Yes, earnouts are ways to make some deals "work" on valuation and incentives of the acquired team - but they can't be applied to all cases.

Unless the acquired company is ran as an independent subsidiary of the buyer, these types of earnouts are difficult to implement for early stage companies where the growth in traffic/usage/revenue/users (pick the metric) may depend from the parent to deploy integration, marketing, co-sale efforts.

I have actually seen occasions where acquirer and acquired ended up fighting in court claiming both that the other party had not implemented their side of the bargain, etc.

[Clarence Wooten]

Very good post. I have read all of your and Om's discussions on this subject. It is a subject that is near and dear to my heart. So much so, that our firm has built a large part of our strategy as a venture fund on the opportunity that this creates. I would love to get your feedback on our postings. They address many of your concerns related to "build-to-flip" as a viable opportunity for venture investing.

http://www.vpfund.com/archives/about_us/index.html