There continues to be a lot of discussion in venture capital and entrepreneurial circles alike about the onslaught of early acquisitions being made by the folks at Yahoo, Google, InterActiveCorp and increasingly Fox Interactive Media. The question I am often asked goes something like, "isn't this really bad news for venture capital?" After all, if all the "good companies" are bought up before they have the chance to raise venture money, how will we VCs make any money?
Early acquisitions are nothing new. While it feels like they are occurring at perhaps a faster pace for the time being, it has always been the case that the "good companies" attract lots of attention quickly and end up with early acquisition offers. Sometimes entrepreneurs accept those early buyout offers. And sometimes they don't. But when the do it is by no means an indictment of the venture capital industry. It is simply a decision made by an entrepreneur at that particular point in time that the risks associated with continuing to build enterprise value in the future are outweighed by the certainty of a particular price paid today. To my mind, these acquisition offers are just like the new TV game show Deal or No Deal.
For those of you who haven't seen Deal or No Deal, it is one of the more brain dead game shows created. At the beginning of the game, a contestant stands in front of 26 models holding briefcases in their hands. Each briefcase contains a particular dollar amount, ranging from one cent to one million dollars. The contestant picks a briefcase but does not get to look at the dollar value in that case. She then proceeds to pick a half dozen briefcases, the dollar values of which are revealed. As each case is picked, its dollar value is removed from the board of potential winnings. Once the first six cases have been chosen, a fictitious "Banker" is asked what price he will pay in exchange for the case held by the contestant (this is perhaps the most glamourous job ever held by a statistician -- for insight into the Banker's psyche, you can visit his ridiculous Bankers Blog). In theory, the Banker knows no more about the contents of the contestant's briefcase than does the contestant herself. If the six cases eliminated were all low numbers, the Banker will offer a number in the tens of thousands of dollars. If the cases revealed high numbers, however, thus indicating a higher likelihood that the contestant holds a low dollar value in her chosen briefcase, the Banker will offer a buyout of mere thousands. The contestant then has to choose to take the offer based upon the information available or risk potential losses while turning over some more cards. The case picking and Banker offers continues until the contestant either takes an offer from the Banker or has chosen all of the cases and gets to reveal what is in the briefcase she originally picked.
Entrepreneurs who receive acquisition offers early in the lifetime of their companies are essentially faced with the same conundrum as that posed in Deal or No Deal. Relatively little information has been revealed about the long term value of the company, yet the entrepreneur must decide whether or not to take the offer and, in essence, stop playing the game. As can be seen from the game show itself, in many instances taking the deal early on is a good idea because as each new briefcase is opened, the perceived value of the case being held by the contestant goes down, as do the buyout offers from the Banker. However, in many other instances, as time goes on and risk is removed (all the low numbered briefcases are picked), the buyout offers from the Banker increase to substantial dollar values.
Some recent acquisitions and acquisition offers reveal the parallels to Deal or No Deal. Companies like Flickr, Delicious, Bloglines, Writely, etc. had early success and were offered solid amounts of money to sell very early on. Little had been revealed about their long term value but the early indications were excellent (the first briefcases picked were low numbers) and therefore Yahoo/IAC/Google were willing to pay millions of dollars to buy them early. On the flip side, Friendster had similar early indications of high long term value and accordingly Google made an offer to buy the company based upon those early indications. In that instance, however, the company decided to open a few more briefcases, and, unfortunately, each new briefcase revealed negative news about the long term value of the business (in other words, the briefcases all held high numbers). As a result, the offers from Bankers to buy the Friendster business have fallen precipitously. Another twist on the same theme is the Facebook story. Early indications on the Facebook were excellent and the management decided to pass on the first set of acquisition offers. Yet, as the Facebook continues to open briefcases, they keep finding nothing but good news. Thus, if the rumors are true, with each additional piece of good news, the Bankers have offered larger and larger numbers to buy out the company. The folks at the Facebook, however, continue to refuse buyout offers and play on. With any luck, their value will continue to go up until such time as they choose to sell or take the company all the way (I suppose, to kill an already wounded analogy, sticking with the original briefcase you chose and discovering it holds a million dollars is the equivalent of a startup going public).
I don't for a second want to suggest that the long term success of companies is purely a question of chance. Nor do I want to suggest that the key to financial success in a startup is only about selling at the right time. Unlike the contestants on Deal or No Deal, entrepreneurs have a lot of influence over what dollar values are revealed in the cases they choose to open. Successful entrepreneurs systematically eliminate risk while building increased value in their companies. While some factors are outside an entrepreneurs control (e.g. market adoption), many of the risks are influenced by the smart choices made by entrepreneurs along the way.
Ultimately there will come a point in time when each entrepreneur will have to ask him or herself, "deal or no deal?" That some entrepreneurs will choose "deal" early in their company's life cycle is not an indictment of the venture capital industry, it is merely an indication that the Yahoo and Google Bankers are making offers some entrepreneurs cannot refuse. That's good news for entrepreuners. And as companies mature and additional briefcases are opened, in many instances the Bankers' offers continue to grow. And that will prove to be good news for VCs as well. I just pray that Toby Coppel isn't replaced by Howie Mandel any time soon.