The Tug Of War Between M&A and VC
Entrepreneurs and the companies they create are the raw material of the startup world. There has been an ongoing tug of war for their hearts and minds between big companies and VCs.
For a while the big companies were winning. From the internet bubble burst until recently, most every hot company to come out of the Internet startup scene was acquired or at least seriously considered being acquired by a big company. Skype is the iconic transaction. Yahoo!'s failed bid for Facebook also comes to mind. But it appears that VCs are making a strong comeback led by newly energized later stage investors and even some hedge funds.
The innovator in this trend is a russian investment firm called DST, which did a $200mm financing for Facebook last May. That financing was a combination of primary (money went into the company) and secondary (money went to buy shares from employees and existing shareholders). Since then DST has also done a similar transaction in our portfolio company Zynga.
But there's something new going on that bears mentioning. VCs are starting to compete directly with the M&A market.
Last winter, when word broke that our portfolio company Twitter had rebuffed a $500mm acquisition offer from Facebook, I received several calls from late stage VCs who essentially said "well if that didn't work for you, how about an investment'? I introduced those VCs to Twitter who did two rounds of financing in 2009.
And now comes word that Elevation Partners is doing a $50mm round (primary and secondary) in Yelp in the wake of Yelp's rebuff of the Google purchase offer. Apparently these kinds of deals are being called "DST deals". Silicon Valley is all about recognizing a good idea and running with it. And I expect we'll see a lot more "DST deals" coming.
I was discussing this trend with the CFO of a large public company last friday morning. He asked the right question, "will DST and the others make a good return doing this"? I told him we'll know in three to five years.
The reason that is such a good question is it gets to the sustainability of this model. M&A is and will always be a sustainable exit model for entrepreneurs and VCs because big companies are always in need of new products and technologies and don't always need to be able to extract a cash flow stream from their acquisitions.
But companies like Facebook, Zynga, Twitter, Yelp, etc, etc will need to go on to become large profitable public companies in order to justify these financings.
Of course, it is possible that these late stage deals are simply prolonging the time before these companies are bought. That would be the natural outcome if any one of these companies concludes the "go it alone" strategy is not going to work. In that scenario, there may still be good returns for these late stage investors. But there may not be.
Left out of this discussion is the IPO. I do think we will see a resurgent IPO market this year and going forward. But entrepreneurs are waiting longer to take their companies public and that's a very good thing for everyone. With the emergence of this new layer of late stage/primary+secondary capital, we can all wait a bit longer. And not sell out. And that's a very good thing.