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First They Ignore, Then They “Invest”, Then They Capitulate and Buy

Friday, February 17, 2017 6:20
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There are stages of competition that I have seen when it comes to how corporations compete with startups. First, they ignore it. The competitors are too small to be meaningful. It doesn’t affect their business in any way. Ignoring it is the right decision for them. Meanwhile, the startup builds their business. The absolute best way to get a corporations attention is not to partner with them. It’s to compete with them at the margin. Get to customers they want that they can’t afford to service.

The next thing that happens is corporations “invest”. I put the word invest in quotes because there are several ways they can invest. They can direct invest in companies via a corporate venture capital fund. But, they can also invest in different ways. They often go to their regulators investing time and money to try and change the regulations to limit competition. Maybe they change their pricing scheme to crush the startups distribution model.  They can invest in more R+D to try and roll out a new product that captures the market the startup created.

I am not against corporate VC at all. They make different partners than traditional VCs and they have very different charters.  It really depends on why the corporation is setting up the venture capital arm.  It also depends on how the venture arm is seen by top management of the firm.  Sometimes they make great partners.  Other times they don’t.

Corporates may also “invest” by setting up incubators and accelerators inside the company.  Employees may be able to use them to innovate.  They might also bring in outside startups and try to incubate them.

It is extremely difficult to change a corporate culture that never embraced innovation and turn it into one that treasures it.  The core reason is corporate politics and failure.  Tolerating failure is not something a corporation does very well, especially when it’s publicly traded.  Failure is a hit on earnings.

Meanwhile, while the corporation is “investing”, the startup continues to grow.  They move from the margins into some of the core cash streams of the corporation. This is when it gets interesting.  The startup creates value for the corporations other competitors.  They might buy the startup in order to gain entry into the market.

If the startup can continue to grow and can continue to eat up or maintain some market share, the corporation capitulates and bids for them.

One of the things that I am watching is to see how early corporates start bidding for startups.  How big do they have to be in terms of market size or top line revenue?  I think that if the Trump administration drops the corporate tax from 35% to 15%, you are going to see a big change in the way corporations engage.  I think they start buying a lot earlier in the cycle.  Combine a change in tax law with a corresponding change in interest rates and the internal corporate hurdle rates for M+A change drastically.  How they calculate risk changes.

That’s going to be very tough on entrepreneurs and investors because of risk/reward.  Do you take the sure thing on an early bid, or do you try and build a blow out business that sells in the nine figure or more range?


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