This time of year is frequently one of prognostication and the VC biz is no different. The National Venture Capital Association (NVCA) and others have all outlined some broad trends for ’06. I think Jeff Bussgang’s point about the early-stage capital gap between angel/seed investors and larger VCs with “mega” funds will grow even more apparent in the coming year.
I wanted to expand on one point that the NVCA statement made about the interaction between VCs and the three big, standalone, pure-play internet companies (Google, Yahoo!, eBay). As online advertising and services have enjoyed a small resurgence over the last 1-2 years (embodied by the Google IPO and post-IPO runup), VCs have picked up their investing in parallel with increased M&A activity in internet software/services. The gist of the paragraph dedicated to this point in the NVCA piece is that, on balance, these three will be a complementary force to VCs investing in the sector. Essentially that the VC-backable deals will mostly still go to VCs and that the “smaller” deals will be taken out directly by the big three.
I’d argue that these three are in fact markedly different in their M&A/investing strategies. Of the three, I’d say eBay is the most “VC friendly” with Google the least and Yahoo! in between. When I say “friendly” or “not” I don’t mean that the companies have a formal stance or bias towards or against venture capitalists, simply that the overall strategy, corporate culture, and innovation preferences happen to suit VC investment patterns to varying degrees. It’s also worth pointing out that internet companies have an ever wider range of interested suitors beyond these three (oft-cited example of traditional media w/ MySpace – News Corp, About.com – NYT).
eBay tends to buy larger enterprises with partially or wholly commercialized products at premium valuations ($000s of millions or more). It’s a very well-run company and I don’t mean to pigeon-hole, but broadly speaking eBay’s strengths are in marketing and operations more than in innovation and engineering. Time will obviously tell how the Skpe acquisition plays out, but eBay’s purchase of Half.com (helped expand beyond auctions format & collectibles to fixed-price & commodities) and PayPal (capture payments, PP now >25% of total eBay revenue) have been clear successes. So this approach suits their overall strategy pretty well and happens to dovetail well with VCs preferred path of funding higher-risk innovation, building a revenue-generating business, and exiting at a high multiple.
At the other end of the spectrum is Google. It’s a very well-run company and I don’t mean to pigeon-hole, but broadly speaking Google’s strengths are in innovation and software development more than other areas. If you look at Google’s acquisitions, they are almost exclusively very early-stage companies which have rarely taken VC investment. They’re purchased at “cheap” valuations (by Google or VC’s exit standards, though most of these entrepreneurs are more than happy at least from a financial perspective) in the single digit or low double digit millions. The list of examples is endless from Keyhole (technical foundation of Google Earth and Maps/Local) to Blogger to Dodgeball (social networking on mobile devices) to Google’s attempted purchase of Friendster (prior to the investment by Kleiner & Benchmark) to a bunch of smaller deals which were done but not publicized. Since most of the value growth from these startups happens within Google post-acquisition, it’s harder to proclaim which have been successes for the company though I think at least the first two can be put firmly in the win bucket. In all of these cases Google was literally buying half a dozen guys and some bits of software code rather than established businesses, so one might construe this really as a recruiting rather than an M&A strategy. Either way, while Google was arguably one of the biggest VC wins of all time, Google is clearly a competitor to VCs interested in consumer internet companies if you believe most of the examples above would have been “venture-backable” and then profitably exited .
Yahoo! is not easy to put in an analytical box. Historically they have acquired larger venture-backed companies similar to eBay, some which have been fairly big successes for Yahoo! and others which can legitimately be debated. Their recent purchases have more closely mirrored Google’s approach in terms of size and stage (think Flickr).
My guess is that 2006 will see a reinforcement of rather than a departure from the pattern of these three. But it will indeed be interesting to see what the New Year brings…