Monday, July 19, 2010


This is a bit of a continuation of my previous post on exits. What VCs can do better than most, by virtue of seeing a lot of deals, is to spot an opportunity to merge two companies together to form something much stronger. So as an alternative exit, they can create a strongly investible company that will exit later but at much greater value. If two startups are really products or features, not companies (earlier Blog) then sometimes they can be combined so that 1 + 1 makes 3 ... or even five. This is usually very hard to do, and a sceptic might say putting two crappy companies together makes a really crappy company, but certain VCs really have a knack of pulling it off.

I never appreciated this until I started looking at lots of similar deals, and it really jumps out at you when you see two companies pursuing the same opportunity, and one has really differentiated technology but no "go to market" ability, and the other has a solid operational team but weak IP--or, one company that has survived waiting for a market to emerge because they have the best solution for that market, and another that has a completely different solution for the same market that together would be best of breed and actually make the market emerge by ability to feed an easy low cost solution and stimulate the market to grow, and then segment the market for the better solution later.

What usually kills these deals is the existing investors who may have carried the company for a long time and have very high expectations that are going to be dashed--also the management team has a hard time accepting, and especially having to tell their investors that there is another company out there that has a better solution than they do.

As the new investor trying to be a matchmaker you get the fun task of trying to set a realistic valuation for the combined companies and there usually isn’t enough in the deal for everyone to get a fair piece, especially if the existing investors are short on funds.

I've seen probably four of these in the past year, where you would have loved to combine the two companies to create something really significant and investible, but it was just impossible to negotiate with the existing VCs. As an entrepreneur this is very frustrating because you watch the market need continue to be unmet until another player steps up and creates the solution that could have been yours.

The better outcome happens when the existing VCs realize that there has to be a put-together and start actively looking for such a deal. During the last tech downturn, we saw many of these deals and unfortunately not too many good outcomes because these were mostly driven by need to exit rather than opportunity to create best of breed value.