Opinion, Berkeley Blogs

Corporate Acquisitions of Startups: Why Do They Fail?

By Steve Blank

For decades largecompanies have gone shopping inSilicon Valley for startups. Lately the pressure of continuous disruption has forced them tostep up the pace.

More often than not the results of these acquisitions are disappointing.

What can companies learn from others failed efforts to integratestartups into large companies? The answer-there are two types of integration strategies, and they depend on where the startup is in its lifecycle.

The Innovation Portfolio

Most large companies manage three types of innovation:process innovation(making existing products incrementally better),continuous innovation(building on the strength of the companys current business model but creating new elements) anddisruptive innovation(creating products or services that did not exist before.)

Companies manage these three types of innovation with aninnovation portfolio theybuildinnovation internally, theybuy itor theypartnerwith resources outside their company.

innovation portfolioFive Types of Innovation to Buy

If they decide to buy, large companies can:

    license/acquire intellectual property

    acquire startupsfor their teams (and discard the product)

    buy out another companys product line for the product

    acquire a company for the product and its installed base of users

    buy out an entire company for its revenue and profits.

    Silicon Valley a Corporate Innovation Candy Store

    Corporate business development and strategic partner executives are flocking to Silicon Valley to find these five types of innovation. In response, venture capital firms likeSequoiaandAndreessen/Horowitzare hiring new partners just to work with their portfolio companies and match them to corporations. They are actively organizing annual and quarterly activities to bring the portfolio and Fortune 500 decision makers together in both large events and one-on-one visits. The goal is to get a corporate investment or an outright acquisition of the startup.

    VCs like acquisitions as much as IPOs because theacquiring companies often can rationalize paying large multiplesover the current valuation of the startup. For acquirersthis math makes sense since they can factor in the potentialimpact the startup haswhen combined with their existing business. However, these nosebleed valuations make it even more important ingetting the acquired company integrated correctly. The common mistake acquirers make is treating all acquisitions the same.

    Is the Potential AcquisitionSearching orExecuting?

    Notall new venturesare at the same stage of maturity. Remember, the definition of a startup isa temporary organization designed to search for a repeatable and scalable business model.(A business modelis all the parts of a strategy necessary to deliver a product to a customer and make money from it. These include the product itself, the customer, the distribution channel, revenue model, how to get, keep and grow customers, resources and activities needed to build the business and costs.)

    Startupsare those companies that are still in the process ofsearching for a business model.Venturesthat are further along and nowexecutingtheir business model are no longer startups, they are nowearly-stagecompanies. Large corporationscome to the valley to looking to acquire both startups which are searching for a business model and early-stage companieswhich areexecuting.

    Companies that acquire startups for their intellectual property, teams or product lines are acquiring startups that are stillsearchingfor a business model. If they acquire later stage companies who already have users/customers and/or a predictable revenue stream, they are acquiring companies which areexecuting.

    Whatgets lost when a large company looks at the rationale for anacquisition (IP, team, product, users) is that startupsarerun byfounderssearchingfor a business model. Thefounding team is testing for the right combination of product,market, revenue, costs, etc. They do it with a continual customer discovery process, iterating, pivoting and building incremental MVPs.

    This phase of a new venture ischaotic and unpredictable with very few processes, procedures or formal hierarchy. At this stage theparamount goal of the startup management team is to find product/market fit and a business model that can scale before they run out of cash.This search phase is driven by the startup culture which encouragesindividual initiative and autonomy, and createsa sharedesprit de corpsthatresults in the passionate and relentless pursuit of opportunity. Thisis theantithesis of the process, procedures and rules that make up large companies.

    In contrast, early stage companies that have found product/market fit are now inexecutionmode, scaling their organization and customer base. While they still may share the same passion as a startup, the goal is now scale. Since scale and execution require repeatable processes and procedures, these companies have begun to replace their chaotic early days with org charts, HR manuals, revenue plans, budgets, key performance indicators and other tools that allow measurement and control of a growing business. And as part of their transition to predictable processes, their foundersmay or may not still beat the helm. Often they have brought in an operating executive as the new CEO.

    Predicting Success or Failure of an Acquisition

    So what? Who cares whether a potential acquisition is searching or executing?

    Ironically, the business development and strategic partner executives who find the startup and negotiate the deal arenotthe executives who manage the integration or the acquisition. Usually its up to the CTO or the operating executive who wanted the innovative technology (and at times with a formal HR integration process) to decide the fate of the startup inside the acquiring company.

    It turns out thesuccess of the acquisitiondepends on whether the acquiring company intends to keep the new ventureas a standalone division or integrate and assimilate itinto the corporation.

    Actually there isa simple heuristic to guide this decision.

    If the startup is being acquired for its intellectual property and/or team, the right strategy is to integrate and assimilate it quickly. The rest is just overhead surrounding what is the core value to the acquiring company.

    However, ifthe startup is still in search mode, and you want the product line and users to grow at its current pace or faster,keep the startup as an independent divisionand appoint the existing CEO as the division head. Given startups in this stage are chaotic, and the speed of innovation depends on preservinga culture thatis driven by autonomy and initiative, insulate the acquisition as much as possible from the corporate overhead. Unless you want to stop innovation in your new acquisition dead in its tracks, do not pile on the corporate KPIs, processes and procedures. Provide the existing CEO with a politically savvy corporate concierge to access the acquiring companys resources to further accelerate growth. (It helps if the acquirer has incentives for its existing employees that tie the new acquisitionssuccess to those that help them.)The key insight here is that for a startup still searching for a business model, corporate processes and policies will kill innovation and drive the employees responsible for innovation out of the acquiring company before the startups optimal value can be realized.

    If the acquisition is in execution mode, the right model is to integrate and assimilate it. Combine its emerging corporate KPIs, process and procedures with those of the acquiring company. Unless its the rare founder who secretly loves processes and procedures, transition the existing CEO to a corporate innovation group or an exit.

    Acquisiton strategy

    Lessons Learned

      Corporate acquirers need to know what theyre buying istheiracquisition searching or executing

      If the startup is acquired for its IP, talent or revenue, itshould be rapidly integrated into the acquirer

      If the startup is acquired for its products and/or users, preserve its startup culture by keeping it anindependent unit

        Appointa corporate concierge to access the acquiring companys resources

        Incentive programs need to tie together the new acquisitions continued success and the rest of the company

        Acquirersneed a formal integration and on-boarding process