Category: Exits

Planners from all over the world try to replicate the success of Silicon Valley with varying levels of success. Everyone from New York City (Silicon Alley) to London (Silicon Roundabout) to Hong Kong (Silicon Harbour) to Moscow (Skolkovo) has mimicked Silicon Valley in an attempt to build their own version of the lucrative startup hub.

The problem is that Silicon Valley has unique features that have allowed the region to become the world’s center of gravity for innovation. Simply copying the things that allowed Silicon Valley to become such a success won’t work, as some regions have already discovered. The tech hubs need to play to their strengths and evolve in their own unique ways.

Silicon Valley’s Recipe for Success

It’s easy to see why governments want to create their own version of Silicon Valley when looking at the valuations the California region is blessed with. There are now at least 74 startups there valued at more $1 billion each. The total value of these so-called “unicorns” is $273 billion.

The reasons for Silicon Valley’s success are many and most of them can’t be easily copied. Geographically, the region is perfectly located near San Jose, San Francisco, and Oakland. Historically, Silicon Valley has experienced decades of success with well-established companies like Google, Facebook, Apple, Fairchild Semiconductors, Intel, Tesla, and other esteemed companies.

In Silicon Valley, everyone knows somebody who has gotten rich off of stock options they think they’re smarter than…which in turn propels them to take a risk at a startup. Perhaps most important for the region’s growth is this competitive and creative culture that continues to allow so many companies to thrive. Not to mention, an endless supply of elite students from Stanford and Berkeley graduate (and dropout) each year to create the next crop of potential tech giants right in the Valley.

But this formula can’t be bottled upon and shoehorned in anywhere. The wealthy people in San Francisco might work at Google and the likes, yet in Hong Kong and New York, the upper class tend to come from finance, and in Los Angeles it’s Hollywood—hopefully you get the idea. This still doesn’t stop governments and business people from trying to replicate Silicon Valley without taking culture and demographics into account.

Being Unique: Playing to Your Region’s Strengths

Every would-be tech hub has its own unique characteristics and features that need to be taken advantage of. If you go to a Starbucks in Los Angeles, you’re likely to bump into a celebrity or similar entertainment personas. For Hong Kong or New York City, odds are high that you’ll fall into a conversation around recent market performance and SEC developments.

Playing to a specific region’s strengths helps lead to success. Modeling a hub exactly from Silicon Valley in areas that don’t carry the same characteristics becomes a major disadvantage. New York, Hong Kong, and London are better suited to be fintech startup hub than Silicon Valley. Los Angeles is better suited to be an entertainment startup hub than Silicon Valley. Playing to those unique strengths make more sense than trying to replicate Silicon Valley.

Fostering Growth

Government benefits are a welcome way to help foster startups, yet they’re only the baseline and not the endgame. All those helpful benefits (friendly tax policies, real estate deals, subsidies, incubators, etc) only go so far. The barriers of entry to create a tech innovation center in the vein of Silicon Valley are so high that these benefits are simply the table stakes. A bigger, greater hook is needed for regions to succeed.

Regions need to embrace what makes them unique and build off of that. With everyone trying to copy Silicon Valley, there’s plenty of room for new players with their own strengths. Any place that simply tries to do exactly what Silicon Valley is doing will pale in comparison to the original.

During the snowstorm of January 2016, travel basically stopped from airports in places on the East Coast of the US like New York City. People couldn’t get out.

And even when the weather cleared up, the travel problems continued. Imagine your chances of getting out from an airport on time when more than 3,900 flights are canceled in one day. You have as much chance of flying on an airplane as a flying on a snowflake in this kind of situation.

Similarly, there has been a lot of talk about a startup winter during in 2016. The consequences don’t look great for everyone involved. Especially people waiting for startup exits.

The last plane just departed
Did startups and investors miss getting the last seats on the startup exits airplane out of startupland? During 1Q2016, we witnessed the IPO of SecureWorks, which is a tech company though not exactly a classic venture backed startup. This promptly resulted in zero excitement during the aftermarket.

If there are no new tech companies going public for IPOs, what other modes of exits exist? The traditional US tech giants are slowing down their M&A activities. The trend at Google is well known while many others are being distracted by activist investors to pursue more share buybacks. Of course Facebook is always a wild card but that’s a pretty short list.

So it seems like both the IPO and tech M&A exit airplanes really have left the airport and everyone still waiting is stuck. That’s terrible news for startups and investors.

Forget about flying
Would other types of exits be possible? As a very rough proxy of how important tech companies are, the sector breakdown of the S&P500 Index shows that tech is the largest sector at about 20% of the total index.

That still leaves 80%. Traditional non-tech companies are clearly big, but are they interested? They’re not flashy, so think of them as trains. Yes, they are increasingly getting involved in startup ecosystems, including M&A exits. Most of these are smaller deals which work very well for capital efficient startups. So that may not leave much space to cram many unicorns inside. But there are also larger outliers, like Monsanto buying Climate Corp or GM buying Cruise.

There are obviously differences between planes and trains. So before running to catch a train, it’s worth understanding what you’re getting into. But at the very least there’s an alternative way to get an exit. For some startups, the train may actually be the better choice.

There’s no way on earth we’re going to get out of here tonight
Beyond trains, is everyone else simply stuck with no hope? Sticking with the airport analogy, there’s another entire building which most people haven’t noticed.

It’s called the international terminal.

The international terminal is gigantic and has umpteen airplanes, plus high-speed trains too, with heaps of seats looking for passengers. Companies from China are leading in activity and the momentum shows no sign of slowing. Importantly, it’s not just China – cross-border M&A is a global trend.

Why is this happening now? These global companies are just starting to feel the potential opportunities, and more importantly risks, of tech innovation. For people living and working around the Silicon Valley tech sector, the mantra of software eating the world is old news. But for companies on the outside looking in, the impact is just starting to be realized.

So whether it’s late or early depends on your relative position. If you’re trying to catch a domestic airplane for a startup exit, it may be too late. Instead, check out the train schedule. Even better, head over to the international terminal where the planes and trains still have plenty of seats available.

Just in case, make sure to keep an eye on international weather conditions.

There’s more than US$2.1 trillion in offshore cash held by US companies looking to buy startups.

A Bloomberg report analyzed the details and concluded tech companies are leading the way:

“Microsoft Corp., Apple Inc., Google Inc. and five other tech firms now account for more than a fifth of the $2.10 trillion in profits that U.S. companies are holding overseas, according to a Bloomberg News review of the securities filings of 304 corporations.”

Earlier in 2015, I wrote about a cash funnel starting with low interest rates and ending with more tech M&A. Here’s the section that discusses why:

“Why are these tech giants expanding their already gigantic cash reserves?

1. Low cost of capital. This is the most obvious reasons. If you could raise US$1.35 billion at a cost of less than 1% per year, you would certainly not hesitate.

2. Balance sheet envy. US$90 billion seems like a very comfortable cash balance at first glance, but it feels a lot less comfortable when compared to your key competitor having US$178 billion.

3. Competition via acquisition. The outlet for competition among these companies is startup investment and M&A. Microsoft buying Minecraft for US$2.5 billion, Alibaba acquiring UCWeb for at least US$1.9 billion, Apple buying Beats for US$3 billion, and the list goes on.”

This week, we saw another example with Activision Blizzard announcing a US$5.9 billion acquisition of King, the company behind the hit game Candy Crush. Not surprisingly, there were some questions around the valuation, summarized best by this tweet from Sean Rose:

Activision acquires Candy Crush maker King Digital Entertainment for $5.9B in the largest accidental in-app purchase in history.

— sean rose (@sean_a_rose) November 3, 2015

But there’s a twist.

Activision is a US company and is using offshore cash to buy a non-US company. This point was made by Shakil Khan in a tweet that was the catalyst for this post:

@tytusm interesting to see that Activision used their offshore cash pile and debt for the purchase.

— Shakil Khan (@shak) November 5, 2015

Looking deeper into the numbers, another Bloomberg report concluded that Activision was able to save US$1 billion in taxes by using offshore cash. That’s a big number for any company.

The natural follow up question is:

How many startups can the US$2.1 trillion in cash held by US companies offshore actually buy?

If the average acquisition is US$5.9 billion, then that would be 356 companies.

But we know that most startup acquisitions are smaller. What if the average was US$300 million? That would be 7,000 non-US companies that could be purchased with just the cash sitting offshore on the balance sheet of US companies.

It’s true that there are a lot of startups right now. But it’s also true that trillions of dollars have a crush on this startup candy.

One of the obvious consequences of the current low interest rate and bond yield environment is how it impacts the cost of capital for companies. As a result, large tech companies are aggressively growing their cash reserves.

Apple closed its most recent quarter with US$178 billion in cash. Yet the company just raised US$1.35 billion of debt at a cost of 0.28% to 0.74% per year. Not to be outdone, Microsoft just issued the largest bond offering in its history as a company, raising a total of US$10.75 billion to add to its existing cash position of US$90 billion.

US companies are not the only ones getting aggressive. Tencent recently raised US$2 billion in bonds and Alibaba issued US$8 billion of bonds at the end of 2014. Of course, the Alibaba bond issuance came soon after the company’s record US$25 billion IPO, so companies are also raising equity in public markets.

1. Low cost of capital. This is the most obvious reasons. If you could raise US$1.35 billion at a cost of less than 1% per year, you would certainly not hesitate.

2. Balance sheet envy. US$90 billion seems like a very comfortable cash balance at first glance, but it feels a lot less comfortable when compared to your key competitor having US$178 billion.

3. Competition via acquisition. The outlet for competition among these companies is startup investment and M&A. Microsoft buying Minecraft for US$2.5 billion, Alibaba acquiring UCWeb for at least US$1.9 billion, Apple buying Beats for US$3 billion, and the list goes on.

Regardless of what happens to financial markets, one constant over the coming months and years is that this funnel of cash will be used by the tech giants for even more aggressive investment and M&A activity, which is good news for both entrepreneurs and investors in terms of future startup exits.