• Silicon Valley Banker to Buyers: Acquire Like You’re Mark Zuckerberg

    KellyPorter_smKelly Porter isn’t terribly conventional. The Palo Alto native is a vivid storyteller. He has had more careers than most, including as a media planner, a CEO, a venture capitalist, and, today, as an investment banker. In fact, as a partner and managing director of the investment bank Woodside Capital Partners, Porter has become known for the firm’s annual, invite-only M&A conference, which is hosted at a Great Gatsby-esque, 30,000-square-foot mansion that Porter purchased in 1999 (and is now keen to sell).

    Porter also has some provocative thoughts about what acquiring companies could do better, as I learned Friday morning when we met in a bustling restaurant in San Francisco’s Laurel Heights neighborhood. Here’s part of that conversation, edited for length.

    The common perception is that M&A doesn’t work. How many tech-related deals are done each year, and what percentage fail, would you say?

    There is an extremely high failure rate. According to [S&P] Capital IQ, when it comes to software and Internet services, there are between 3,000 and 5,000 acquisitions every year. And two-thirds to three-quarters of all acquisitions don’t achieve their [expected potential].

    Interestingly, there’s this common wisdom in the innovation ecosystem that certain serial acquirers acquire most of the companies. But there’s a very long tail. Over the last five years, the top 25 acquirers have only made up about four percent of all acquisitions. Google is in the several-hundred-companies range, then it drops off as you [move down the list to] IBM, Oracle, Microsoft, Yahoo, Autodesk, Cisco, Apple. When you get down to the 25th largest acquirer – and these are announced deals – they’ve only done 11 acquisitions over a five-year period.

    Is there a correlation between failure rates and the number of companies a buyer acquires?

    I think one of the reasons there’s such a high failure rate is that the acquirers are primarily acquiring out of the venture-ecosystem. And in that ecosystem, one or two startups pay for the rest. But if most acquirers are acquiring three or four or five companies over a five-year period, they’re not really assembling a portfolio.

    Should they be, given that acquisitions are huge distractions? What of the counterargument that the more companies a buyer acquires, the worse off all of them will be?

    Acquirers, since they are acquiring from that ecosystem, are subject to portfolio dynamics. They’re probably picking up the best companies that don’t go public, but they’re still picking up companies that are fragile, that are early-stage. And there are some unique dynamics in acquisitions that make success even more difficult, like differences in culture, poorly articulated goals, strategic visions that are different, entrepreneurs who want to get on to the next thing and so forth. It makes that portfolio piece even more important.

    The real problem is the CEOs and CFOs are very focused on Wall Street, because if they acquire five or ten companies and five of them fail, they’ll get skewered. Google can afford to [acquire lots of companies] because of the concentration of ownership that Larry [Page] and Sergey [Brin] enjoy but also because Google is [adding] $1.5 billion to the bottom line every month, and you can bury a lot of mistakes in that kind of growth. Facebook is a similar situation.

    Speaking of Facebook, what do you make of Mark Zuckerberg’s recent moves?

    I think they’re very interesting. He’s in a unique position in that he has so much control over that company that he can make bold bets as he did with Instagram and WhatsApp. He’s getting skewered for having done them, but it’s like being an entrepreneur at a very large scale. And I think that’s an admirable thing that we don’t see much in this ecosystem.

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  • Focusing on Privacy Issues, Before the Sale

    subscriber listsEarlier this week, The Recorder observed that maintaining strong privacy standards is now a serious requirement for startups interested in M&A, not some “item on a deal-making checklist or a vague commitment to users.” Since the biggest asset of many startups is often data like subscriber lists, neglecting privacy standards can be a deal-killer, the outlet observed.

    Surprisingly (to me), one attorney told The Recorder of the issue: “Only a tiny minority of companies really have their act together; a good number of companies are completely out to lunch.”

    To find out more about how big a sticking issue privacy has become for acquirers, I talked yesterday with Christine Lyon, an attorney at Morrison Foerster who focuses on privacy and employment law.

    Lyon told me that a big part of the shift owes to increased regulatory scrutiny, saying the Federal Trade Commission “has been more active in privacy enforcement generally.”

    I asked Lyon who tends to be the most “at risk.” She cited mobile app makers, largely because “they might not think of themselves as collecting personal information, when they are.” (Names and email addresses are considered Personally Identifiable Information, or PII.)

    Sometimes, she said, it’s simply a case of “delayed compliance. The [mobile app] startup thinks, ‘Once we’re up and running and have more money, we’ll roll out a policy.’” Unfortunately, says Lyon, “at that point, you’ve collected data, and you’re sort of stuck figuring out how to implement [a privacy policy belatedly].”

    Perhaps unsurprisingly, Lyon also mentioned that two other types of companies that should pay special attention to new state and federal privacy laws are sites that either cater in some way to children or deal with health-related information. When it comes to both, the risk of a misstep is much higher, said Lyon — not to mention that buyers in both cases are always “very interested in what sorts of consents were obtained.”

    To correct what the FTC would consider a material issue in their privacy policies, a startup can do a couple of things. First, it can try getting the consent of its users retroactively, though most users won’t give it. (Who wants to be bothered?) Another option is to offer users the opportunity to “opt-out” from permitting a company to transfer its data to an acquirer.

    Unfortunately, neither solution may be enough to appease a potential acquirer in the current environment. “An area that’s high risk for enforcement will get buyers’ attention,” she’d told me. “We’re just seeing a lot more issues like this cropping up and sometimes killing deals.”

    The lesson here is obvious: companies that skimp on privacy could ultimately end up leaving a lot of money on the table.

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  • With Little Notice, Seed-Stage Valuations Begin Falling

    mo moneyA widely held belief in Silicon Valley is that valuations are still on a one-way trajectory toward the sky, with founders firmly in the driver’s seat.

    But the reality for seed-stage companies may be a bit more dire than that — and getting worse by the month.

    According to the research firm CB Insights, both average and median seed-stage valuations have fallen since last year, with the average valuation dropping from $2.2 million to $1.7 million and median valuation falling even more precipitously, from $1.7 million to just .6 million.

    Data from AngelList, a matchmaking service for investors and seed-stage entrepreneurs, also shows declining valuations. According to AngelList, which tracks thousands of startups in its system, the average seed-funded company’s valuation dropped from $3.9 million in the third quarter of 2012 to $3.6 million in the third quarter of this year. That isn’t a massive dip, but AngelList founder Naval Ravikant tells me that “by the time [a shift in one direction] shows up in the averages, it’s pretty pronounced.”

    A recent quarterly venture capital report out of Pitchbook, which operates a subscription-only database of private equity and VC deals paints a rosier picture. Pitchbook found that median pre-money valuations for seed-stage, VC-funded companies have nearly doubled over the last three years — from $3.2 million in 2010 to $5.2 million through the first three quarters of 2013.

    Still, this same report observed that lofty valuations are only making it harder for companies to raise Series A rounds. Pitchbook further noted that the rise of valuations can’t go on endlessly, suggesting there will likely be more flat and down rounds in coming years.

    Ravikant — noting that “everyone’s dataset is incomplete” — suggests the future is now. Though he can’t pinpoint exactly when things began trending downward, he thinks valuations “kind of peaked around the Facebook IPO, when it turned out to be less than people thought it would be.”

    According to Ravikant, there “hasn’t been a mass exodus out” out of the seed-stage investing market, mainly because “people still believe some percentage of your portfolio should be early-stage. But there’s increased recognition” that it’s a tough racket, with many angels suffering from investor fatigue and suddenly becoming more realistic about the chances of their portfolio companies receiving follow-on investments.

    There will always be a market for the most promising seed-stage startups, in other words. But evidence from CB Insights and AngelList suggests that for entrepreneurs just setting out, the road ahead looks bumpy.

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  • Will Alibaba Draw VCs Back to China?

    china-sky_1814294bAlthough the American financial press seems preoccupied with Twitter’s impending IPO, Alibaba’s IPO could be an even bigger story. The China-based e-commerce juggernaut, which could go public as early as the first quarter of 2014, racked up revenues of $1.38 billion for the quarter ended in March, and analysts estimate that the company could be worth anywhere from $120 billion to $200 billion. (Facebook’s market cap as of this writing is $125 billion.) 

    As the Alibaba offering approaches, one can’t help wondering why U.S. investors have had so much trouble capitalizing on Chinese tech IPOs.

    Although Yahoo remains among one of Alibaba’s biggest shareholders – with a 24 percent stake, half of which it plans to sell at the IPO – Alibaba has few U.S. investors other than GGV Capital, an expansion-stage firm on Sand Hill Road that invested in Alibaba in 2003; and Silver Lake, the private equity firm, which reportedly invested $300 million in Alibaba in 2011. (Japan’s Softbank owns 35 percent of the company; Alibaba’s founders and senior executives own another 13 percent.)

    American tech types have tried repeatedly to capitalize on the country, but factors like partner defections, accounting scandals committed by China-based companies, and a slowdown in the country’s GDP growth rate have yielded disappointing returns.

    Still, success will only come if a firm is willing to stick it out and take the time to forge relationships within China’s close-knit entrepreneurial community, says David Chao, co-founder and general partner of DCM, the early-stage venture firm.

    Since 1999, DCM has backed more than 200 companies across the U.S. and China, and three of its most recent IPOs are China-based companies, including  Renren, Dandang, and Vipshop. (DCM owned 20 percent of Vipshop went it went public last year with a market cap of $600 million; today it’s valued at $3.2 billion.)

    Last week, DCM scored another China-based investment win when Kanbox, a personal cloud storage service that is often likened to Dropbox, was acquired by Alibaba for an undisclosed amount.

    Pointing to a separate, recent deal – the Beijing-based search engine Baidu’s agreement to pay $1.9 billion for China’s popular smartphone app store 91 Wireless – Chao says that it’s actually becoming easier for savvy investors to generate returns.

    “Five years ago,” he observes, “almost all successful Internet companies were destined to go public. Now that you have a second generation of successful Internet companies going public — large cash companies,” Internet investors can expect exits through M&A, too.

    Other shifts Chao has witnessed include an “angel investor boom in the last year that will probably continue for a while,” and less copycat tech and more innovation, particularly when it comes to smartphones and mobile social networks. (Chao characterizes several companies as “way ahead” of anything we’ve seen in the U.S.) “What we’re seeing isn’t a 180-degree shift,” he adds, “but 10 years ago, 99 of 100 business plans were largely focused on being analogous counterparts to successful U.S. or Japanese Internet companies; today, that number is maybe 80 out of 100.”

    I ask Chao if it’s too late for firms that still haven’t made a foray into China — as well as whether he thinks U.S. investors have the intestinal fortitude to stick it out. Will Alibaba be the company that refocuses their attention?

    “It’s more difficult than it was 10 years ago” to enter the market, Chao notes. But plenty of venture brands are still being established in China, he says. Succeeding in China is all about the long game, he suggests, but “a firm can make its name in very quick order.”

    Photo: Courtesy of AFP/Getty

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  • Don Dodge on Indoor Marketing: VCs Missing a “Huge” Opportunity

    DodgeDon Dodge – a Google Ventures advisor who helps developers build new applications on Google platforms and technologies – says VCs are still outsiders when it comes to indoor mobile location services. He likens the moment to the earliest days of maps and GPS, which are now integrated into just about every application on the Web, but that few investors knew what to do with initially.

    Here’s an excerpt from a conversation we had last week:

    You’re very focused on indoor marketing. Why?

    At a very high level, we spend 90 percent of our time indoors, and indoors is where commerce happens.

    What’s one of the most interesting things you’re seeing?

    There are a bunch of companies that can create [digital] floor plans of stores like Toys”R”Us, Office Depot and Walgreens. Stores then give them SKU [stock keeping unit] maps that tell them where products are located on the shelves for inventory purposes and so forth, then [the apps] use indoor location technology to recognize in what aisle a consumer is standing, and by what products. It isn’t too far of a leap to imagine that as you’re looking at the Gucci bags at a department store, you receive a coupon from Coach.

    What strikes you promising beyond retail applications?

    Think about mobile games that could take of advantage of location, like Risk or Monopoly or Capture the Flag, and how they might incorporate the store that you’re in or the university dorm that you’re in.

    There are social aspects, too. Say you’re at a concert and know that five friends are there amid 50,000 other people. Indoor location technologies can tell you exactly where those five friends are. And there are probably 400 more examples of market applications that no one has thought about yet.

    There are numerous technical approaches to all of these things. How different are they?

    One is Wi-Fi, where you phone accepts signals and triangulates where you are. WifiSLAM, an indoor GPS company that Apple recently acquired, was one example, but there are about 15 other companies that are doing things with Wi-Fi triangulation.

    Another area is Bluetooth beacons. Every smartphone has Bluetooth to connect to other devices. Well, the same Bluetooth channel can be used to bounce off known locations to determine where you are.

    Other companies are using sound waves, while others still, like Bytelight, are using LED lights in the ceiling. They pulse at a rate of a hundred times a second, which is faster than the human eye can see, but the front-facing camera of a phone can pick up the pulse and know by which light you’re standing.

    Apple reportedly paid $20 million for WiFiSLAM. A number of other companies, including Cisco, Ruckus Wireless, and Aruba Networks, have recently acquired indoor technologies for undisclosed amounts. Is there going to be a big breakout story here?

    It won’t be like social, where there are one or two leaders and everyone else is an also-ran. Instead, there will be hundreds of winners because there are so many different market applications and vertical applications.

    And you think VCs are missing all the action. Why?

    There have been at least three major acquisitions over the past four months, so now they’re saying, “Hey, there’s something going here.” But by and large, it’s a new, emerging area, with probably 50 small, unknown startups with angel investment or a little VC money that [other] VCs aren’t paying attention to.

    When you see more stories about companies being acquired by big companies, then there will be a land grab.

    Photo courtesy of Google Ventures.

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