An alternative to VC: “Selling In”

Silicon Valley prides itself on its ability to transform entire industries, yet it is surprisingly resistant to change itself, notably in the way high tech deals are conducted, from investment to acquisitions.

I am a serial entrepreneur, currently on startup number three, having sold two previous businesses, one to a public company, and one to a private company. The third one is on the block now, at VentureBeat’s new marketplace VentureBoard.

The market for emerging technology deals is inefficient (unless you’re a hot property like YouTube). The process is broken. It forces entrepreneurs to spend a lot of time searching for acquirers or partners, and makes starting a business riskier. The way companies get funded and sold can cause entrepreneurs to think about raising money first, product second. While some companies like 37 Signals can bootstrap their way to profitability, this is the exception, especially in capital intensive industries like telecom.

With VentureBoard, we have a new path for entrepreneurs to consider. I’ll call this RPS, or “rapid prototype and sale.” To a certain extent this has already been happening with early stage buyouts, like Yahoo’s purchase of Flickr. If we had a more organized market for early stage deals, entrepreneurs would have more options.

Entrepreneurs currently face a range of problems: 1) With venture capital, or even angel funding in some cases, it is difficult for founders to make money in a small deal (under $5-10 million); 2) Nobody wants to bother with small deals. VCs don’t want to fund a firm that will be lucky to net a few million dollars, even with downside protection. Investment banks and advisors won’t touch them either. This is unfortunate because there are more niche opportunities than there are runaway hits like YouTube. This is one reason why venture capital firms are struggling, witnessed by Sevin Rosen’s decision last week to not raise another fund. There also more companies that can afford to do small deals.

The conventional path of starting a tech business assumes you’ll go it alone and build an entire organization. This can be wasteful and risky. You’ll spend a lot of time and money creating functions and building audience that other companies already have. Few products sell themselves. It’s easy to get into a trap where the company you built, or at least the founder’s common stock, is worth less than what you put into it.

RPS, on the other hand, is a minimalist approach, where you focus your effort on building a product and assume it will be distributed via someone else’s channel. By keeping your cost basis low, in terms of investment and time, you can profit even from a small deal. This approach views an early sale as a conscious strategy to leapfrog a product into widespread use, essentially as a way to leverage someone else’s audience and organization. This doesn’t preclude you from deciding not to sell, but it sets you up so you can sell profitably if it makes sense.

This is good for buyers. Smart, efficient teams will be able to build a product, sell it in the mid millions, and still do fine. Buyers will be able to fetch more products and their teams, and can adopt a portfolio approach. This type of deal can also be priced simply, to mitigate risks for both sides, by building technical and economic milestones into deals.

A suitable buyer can take a product, sell it efficiently, and get you to a point where you have millions of users with a fraction of the risk for you and your investors had you gone it alone. Becoming a subsidiary frees you to focus on your product while someone else worries about things like accounting and HR. Big companies are imperfect, but a well managed firm will give you access to resources you would never have even at a KP backed startup.

Selling a company has typically been a secretive process. Secrecy is inefficient for smaller acquisitions because investment banking is a transaction based business that’s not optimized for smaller deals. An analogy I like to use is that it’s like a real estate market with no MLS service, where houses are sold in secret. An entrepreneur is at risk of being fleeced because secrecy always favors insiders. Small entrepreneurs are almost never insiders.

The idea with Venture Board is to create a more open and transparent forum for emerging tech companies to advertise their products, for sale or for acquisition; to buy and sell services that emerging companies need; and to promote the idea of team hiring. It’s as much a community like Craigslist as a place for people to float proposals and find buyers.

With that in mind, I’ve kicked off Venture Board with a listing for my business, Open Communication Systems. Both the products and our team are on the block, and we invite readers to have a look at what we’ve built. We’re a small company and small news compared to blockbusters like Facebook, but if we’re successful, we hope to have created a trail for other entrepreneurs to follow.