Buddy Media made their first acquisition today – a NY-based start-up called Spinback. I am excited about the acquisition for many reasons: I like the Spinback team, their analytics are a good fit with Buddy Media’s product, and the combination extends Facebook’s social graph into retail and ecommerce. The acquisition ultimately got me thinking about building platform companies and how this tactic has helped us generate large returns over time.
Over the past five years we have invested in a lot of companies at Greycroft – by the end of this month our tally will be close to 50. We have been fortunate and have had a large number of break-out successes, including Buddy Media. In a different era these break-out companies would have gone public already, but now they are putting up big growth numbers, and in some cases tens of millions in annual profit, as private companies. Given the way public markets work these days I would not be surprised if our companies remain private for a long time.
As a result of this trend, VCs are increasingly splitting their time between large companies and start-ups. Often times these large companies make acquisitions to get high caliber engineering and product talent. For instance, in the last four months I have had three acquisitions across my subset of the portfolio (Collective has quietly been consolidating the Ad Tech market), and there are more pending. The challenge that I am facing now is that while I am scouting good acquisition targets for my platform companies, I am also looking for good early stage companies to fund for myself. Once a company raises a VC round it is no longer a great candidate for one of these small acquisitions, so as an early stage investor I am right at the crossroads. We have portfolio companies in many verticals now so I find myself asking the following questions more and more often, “Is this something that can be big on its own? Does it have he right team and is the market big enough? Or, am I better off merging it into one of my existing investments?”
This paragraph may be controversial, but in many ways the acquisition path is an easier path for VCs. Let’s assume I own 10% of a platform company, and this platform has skilled management and a fully-built sales team. They have gone through the hard work of getting to profitability and made it to a pole position in their respective market. If my platform company buys an early stage company I might take a little dilution, but at the end of the day I basically own 10% of an entity that includes both companies. And the likelihood of success is high. On the other hand, I could invest in the start-up and it will remain independent. For the next 5 years or so I will devote significant time to helping this team recruit and scale their business. With some luck it may be a platform company some day, although the more likely event is that it exits for a smaller number.
There is a limit to how many start-ups I can fund, but at the same time I can do many more tuck-in acquisitions. And at the end of the day it takes the same amount of time for me to help a company with $100mm in revenue as a company that has $1mm in revenue. When I put all of this together it seems like the tuck-in strategy makes a lot of sense for VCs – it allows us to capture a much larger universe of value creation, with less work, and it has a higher likelihood of success because we have all the right elements in place already.
This article is not meant to suggest that I have given up on entrepreneurs. In fact the exact opposite is true, and I am actively looking for new platforms to fund. But if your company is in a crowded market, surrounded by a lot of VC-funded competitors, you should not be surprised if a VC refers you to meet with one of his or her CEOs. I have to add that taking the early exit is often a good result for entrepreneurs too, particularly when you can piggyback on the success of a major platform. That is the case with Spinback and Buddy Media, and I think history will prove that this was a great decision on both sides.