“Flipping Startups 101″ Gets a Failing Grade

There is a silly discussion underway out in the blog-o-sphere, one that purports to be rational noodling about how best to set up your startup company to be flipped to Google/Yahoo/Microsoft. The nut is this paragraph from Dare Obasanjo’s original piece:

If you are building a Web startup with the intention of flipping it to one of the majors, only three things matter; technology/IP, users and the quality of your technical team. Repeatedly ask yourself: would Microsoft want our users? would Google want our technology? would Yahoo! want our people?

I disagree. If you are building a startup solely with the intent of flipping it to one of the majors then you are playing Russian roulette using a gun with five full cylinders, and one cylinder containing a bullet that flits in and out with 50% probability. It is, in other words, a stupid game, one that ex post looks more rational than it would truly be to have done ex ante.

The best way to get purchased by anyone — GYM included — is to build a great team, find a large and growing underserved market, build a great product/service for which people will pay more than it costs to provide, grow faster than the market, and stay paranoid that a hundred other companies are gunning for you all the time. If that sounds a lot like the path to building a company, not merely one that is built to flip, it isn’t just a coincidence.

Building companies to flip is a dumb exercise, one that more often than not produces neither a company nor flipping.

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  3. Startups More Valuable, or Just More Expensive?
  4. The No-Ringtone Rule for Pitching Wireless Startups
  5. Starting Stealthy Seattle Startups by the Seashore

Comments

  1. Jeff Clavier says:

    Could not agree more.

  2. Mark says:

    I think there is something to the idea of building a company to be flipped that differentiates it from other companies. I say this because there are clearly companies built that were never meant to be sold. If a buyout is your ultimate goal, I don’t disagree that it is wise to follow your advice on basic successful business tenets. However, many buyouts would have been better purchases (and theoretically more attractive to the buyer) if their management had built them with scalability in mind. A better question would be, is it possible to build a company that excels in its market while at the same time planning for the possibility of a purchase. I think so, but it certainly complicates things.

  3. Jason Wood says:

    Paul nailed this cold.
    As we all know, there’s an ongoing dialogue about whether this whole “Web 2.0″ movement is becoming a bubble. While I’ve generally been of the opinion that we’re not in a bubble…yet, the notion that companies are being built with an exit to GYM as the primary option is a frightening indication to the contrary.
    To then think that we’re now ENCOURAGING this as if there’s some sort of best practices, rule book to follow borders on the obscene.

  4. Whether you care to admit it or not, lots of so-called “web 2.0″ startups are built to flip. Or do you really think del.icio.us classified as “a great product/service for which people will pay more than it costs to provide” ?

  5. Greg says:

    I wouldn’t describe del.icio.us as ‘built to flip’ – from what I understand it was built for fun and its growth to the point where angels, VCs, and Yahoo became interested was largely serendipity.

  6. Jason Wood says:

    Dare,
    As Greg correctly pointed out, del.icio.us started out as a personal experiment by Josh Schachter that evolved. In that case specifically, I think he was smart to sell now as the model didn’t appear to scale in its current form, at least in a profitable manner. But again, he didn’t set out to create del.icio.us with the idea of getting a big payday from GYM, et al…and that’s why it worked out. The idea of social tagging drove the entire lifecycle [and ultimately the purchase by Yahoo!].

  7. Dorrian says:

    Jim Collins wrote his prescient Built to Flip article for Fast Company in March 2000 (the same month I started a sobering entrepreneurial journey at a company we named HigherMarkets). It is an excellent read (like his books) and for those looking for some comfort, you’ll especially like this part:
    “But here’s the good news: Built to Flip can’t last. Ultimately, it cannot become the dominant model. Markets are remarkably efficient: In the long run, they reward actual contribution, even though short-run market bubbles can divert excess capital to noncontributors. Over time, the marketplace will crush any model that does not produce real results. Its self-correcting mechanisms will ensure the brutal fairness on which our social stability rests.”

  8. Once del.icio.us accepted VC funding it stopped being a fun project built for growth. The question to ask yourself is whether there was ever a business model or whether the exit strategy was to flip it.
    I suspect the latter.

  9. Michael Robinson says:

    Paul K: “The best way to get purchased by anyone — GYM included — is to build a great team, find a large and growing underserved market, build a great product/service for which people will pay more than it costs to provide, grow faster than the market, and stay paranoid that a hundred other companies are gunning for you all the time.”
    That’s sound advice, and all, but where are you going to get the cash required to do all that great stuff?
    From VCs?
    To get the money from the VCs you need to play all sorts of VC mind games. If the perception in the VC community at the time you’re going out to raise that money is that there is a “GYM put” operating in the market, then you are negligent if you do not polish your attractiveness as a GYM acquisition in your pitch:
    http://paul.kedrosky.com/archives/002212.html
    Don’t blame the enterpreneurs for this pathology of VC culture.

  10. Interesting comments… especially the one left by my friend Jeff Clavier. Our firm has spent a considerable amount of time analyzing what Jeff talks about when he says:
    “A better question would be, is it possible to build a company that excels in its market while at the same time planning for the possibility of a purchase. I think so, but it certainly complicates things.”
    We firmly believe that it is absolutely possible to fund/build a company with both possibilities in mind. Capitalization must stay below $3MM until the MARKET determines the best exit for the company. However, this can only be done with companies that have a real business model. It is the market that determines what is ultimately best for a company — not the entrepreneur, not the VCs… The Market. If a company is funded prudently during the critical market validation/acceptance phase of its development… and market forces dictate that early exit is the best route… an early exit can still be profitable for both the entrepreneur and investors. If momentum, sales, network effect, etc. take-off, further funding and investment in significant route-to-market infrastructure should be the direction — with an ultimate later-stage exit in mind.

  11. jeff Clavier says:

    Right on Clarence, you keep options open but build for the long term.

  12. Ajay says:

    You’re exactly right, Paul. However, you’re speaking to the wrong crowd. The crowd you’re speaking to is just looking to make a fast buck by flipping and they’re only encouraged by the big-money chumps (News Corp, Yahoo) who add fuel to the fire with their dumb acquisitions. The VCs and built-to-flip entrepeneurs would be fools if they didn’t look for ways to part the big chumps from their loot. But that line of work hasn’t much to do with what you’re talking about.

  13. Big Flipping Deal

    I remember sitting in a Manhattan apartment a few years ago with an old college friend and his buddies, all of them alumni of the Wharton School at the University of Pennsylvania. When you study engineering at Penn, as I did, you tend to stereotype Wha…

  14. Mark says:

    Clarence, thanks for the accidental compliment (that was my quote, not Jeff Clavier’s).
    I believe that you are getting to the crux of the matter; if a developing company can make itself attractive to the big players who have a history of grabbing little guys for innovation, and do so without negatively impacting its core businesses, it should do so.
    The magic 3 (GYM) have demonstrated that they will buy small companies for exactly the things listed in the linked article (Users, technology, employees), so clearly developing those assets improves your chance of a buyout.
    Mark

  15. Paul, you’re dismissing Dare’s observation that growing a user base is key to building value. This is especially true for sites built on user contribution like Del.icio.us and digg. There are literally a dozen social bookmarking services out there, many of which are more functional and better designed than Del.icio.us.
    Joshua knew perfectly well that Del.icio.us had value to the Google business model: targeted advertising. That pile of tagged links is extremely valuable as hints to search engines. The fact that it started as an “experiment” is irrelevant to its eventual value.
    So why is Del.icio.us worth 8 figures and not the others? It’s the users, who are pumping value into Del.icio.us to the tune of tens of thousands of bookmarks a day.
    Simply hiring all the smart people you can find won’t make you attractive to the big players. Their recruiters might want your phone list, though.

  16. But…otherwise you make a great argument for the Old School Smith, Barney type of valuation. It’s hard to disagree with the principles you endorse, but the truth is that startup culture is very much focused on exit strategy. Ten years ago the options were IPO or acquisition by a larger company, but of course you know that these days the IPO route is open to very few. So the focus on acquisition isn’t just a “Web 2.0″ thing–it’s a reflection of prevailing market conditions.
    My recent startup experience: DataPower Technology was acquired by IBM in October: http://del.icio.us/Hybernaut/ibm+datapower

  17. Andrew says:

    My favorite comment on exit strategies came from someone who is now a serial entrepreneur, but used to be in VC. Build a good business, and an exit strategy will present itself.

  18. EclectEcon says:

    Advice for IT Start-up Companies

    Many people seem to have the notion that the way to get rich in the information technology industry is to start a company and then sell it to Google, Yahoo, or Microsoft [GYM]. That kind of thinking is a clear example of the

  19. Pooran Prasad says:

    Well said