Trading Up

When a startup is sold, in part or in full, it is just a trade. As a country that is entirely dependant on trade for our prosperity we should understand this better.

You build a startup to test an idea,
and then you build a company to execute the idea.

— Spencer Fry

A startup is a phase, not a destination.

A startup is created to develop a new product (or service). The goal is to eventually sell that product for more than it costs to make.

But the more fundamental product of many startups is the company itself. The goal is the same: to sell that product for more than it costs to make.1

This is a challenging idea for a few different reasons:

Firstly, not every startup is built to be sold.

For example, consider the Nishiyama Onsen Keiunkan in Hayakawa in Japan, which was a startup in the year 706 and is still operated today by the same family. There have been 52 generations of owners. So far none of them has considered an exit strategy.

As Natasha Lampard wrote, reflecting on this family: 2

I imagine they focused, not on an exit strategy, but on an exist strategy, a strategy built on sticking around; a strategy not for a buy-out, but for a handing down, a passing along.

I wonder what decisions we would make differently if we inherited the work we do?

I wonder what decisions we would make differently if our duty was to pass on the work we do?

Those are great questions. What does it mean to be a good ancestor? There are different ways to create value in the long term, and one of them is to be an owner rather than a trader.

Secondly, very few startups are able to be sold.

In fact, it’s a mistake to think that a founder can just choose to sell their company on demand, at anything more than a fire sale price. That’s not normally how it works in my experience: companies are bought. It’s hard to create a product or service that anybody want to buy and, likewise, it’s hard to build a company that anybody wants to buy. If you are able to create a company that is growing fast enough and/or making enough profit then it’s likely you can find somebody who will be interested in owning a piece of it, if and when you choose to look.3 But, only if!

Thirdly, we seem to get very confused about how to feel about local companies that are sold to international buyers …

How you know you made the right decision to sell your business:
Half of the reckons are “you sold too soon!” and the other half are “how is it possibly worth that much?”

🔄 Exit == Investment

Ownership is complicated.

It’s useful to remember that every sale is also a purchase.4

For every founder or investor you hear describing their “exit” there is a new owner on the other side of that transaction making a purchase.

Sometimes the thing being sold is the whole company. Sometimes it’s only a portion of the company (what we more commonly call: capital raising). In both cases the existing owners are trading shares in the startup for capital. In both cases the company is being sold. The only real difference is where the new capital ends up - when taking investment the money is typically invested in the company itself to fund future growth, but when a company is acquired the capital is paid directly to the founders and investors and in many cases to the wider team involved as well.

In this way it makes no sense for us to celebrate when startups raise capital from international investors but worry about companies being “lost” to overseas owners when startups are sold outright. Those are two versions of the same transaction.

However, despite this, we tend to be quite absolutist: we consider a company started in New Zealand a local company, right up until the day it is acquired, at which point it becomes a foreign company.

Perhaps some examples would help to demonstrate the flaws in this?

Consider Vend and Seequent, who each announced their acquisitions on the same day in March 2021.

I was one of the initial investors in Vend, so have some insight to the details. The first time a share of Vend was sold to an international buyer was in 2011, when Point Nine (based in Berlin in Germany) led the first substantial investment round. This pattern was repeated multiple times, as over the following years Square Peg (based in Melbourne in Australia), Valar Ventures (based in San Francisco in the USA) and Qualgro (based in Singapore) all led subsequent investment rounds. And those are only the lead investors, there were many other smaller investors based all around the world (including some in New Zealand!) who contributed more than $70 million of capital during this time to fuel the growth (which is a fancy way of saying: paid for payroll and rent). By my rough calculations at the time of the “sale” to Lightspeed in 2021 just over 50% of the shareholders by value were based in New Zealand.

So, when was Vend actually sold? 🤔

I wasn’t an investor in Seequent, so don’t know their story so well, but did note that at the time of their acquisition the NZ Herald reported they were 75% owned by Accel KKR (a private equity fund based in the US), who announced their investment in 2018. Seequent started with one employee in 2004, and grew to over 430 employees by the time it was acquired, with ~170 of those positions based in New Zealand.

So, when was Seequent “lost” to New Zealand?

The important number in each of these exits is not the headline sale price, or even the portion of capital that was returned to New Zealanders, but rather the gains or difference between the amount invested and the amount returned. That’s much more difficult to calculate from the outside looking in, so it is very rarely reported.

But, if our goal is to recycle capital then we should probably be more accurate in how we think about that flow of capital.

Perhaps part of the reason we feel conflicted in these situations is that we are all naturally proud when a company started in New Zealand grows to be successful. We enjoy being part of the same ecosystem.

We feel a wide and collective ownership of these companies that do well, even though actually the ownership of each individual company is limited and private. Often it’s a mixture of local and international investors and local and international staff. A sale is usually a good outcome for most if not all of those people.

We are seemingly happy to gift public money to help companies grow, but when a company is acquired the value created from that growth flows mostly to the private owners.

🏉 Don’t pass it, kick it

All of this assumes “we” are always the sellers.

Maybe the biggest challenge to how we think and feel about this question will be when companies that we consider to be local companies start acquiring rather than being acquired.

Actually, this has already happened. 😀

Also in March 2021, at the same time as some in the media were debating the “loss” of Vend and Seequent, Xero announced two international acquisitions of their own in quick succession - firstly Planday based in Denmark and then Tickstar based in Sweden.

What did these transactions mean for the startup ecosystems in Denmark and Sweden? Did they lose? Did we win? What was the transfer of value in these transactions (in total Xero paid ~NZ$285million for these two companies + possibly another NZ$46million based on future performance)? Did either of these startups become a New Zealand company following their acquisition? What about Xero itself? Does the fact they now have some of their team based in Scandinavia make them more or less of a New Zealand company?

When we find “ourselves” on the other side of the transaction like this the weakness of our thinking about sales is exposed.

(I put “ourselves” in scare quotes there, because of course Xero itself is partly owned by shareholders based all over the world, so thinking of them as a 100% Pure New Zealand company is also flawed)

When a company is sold, in part or in full, it is just a trade. The local owners who are selling are importing capital. As a country that is entirely dependant on trade for our prosperity we should be able to get our heads around this idea.

Some rare companies, like the onsen in Hayakawa, are family heirlooms. Some other startups are pets: we enjoy their company and they make us happy for as long as they survive. But, many others are livestock that are raised for a purpose. That’s fine. We don’t need to feel bad about being the farmers in this metaphor. What we sell is not a rare and scarce resource, like land. We retain the expertise to make more! What we receive in return is helpfully one of the inputs we need to continue to farm.

A large amount of the capital that is invested in startups, especially in the critical early-stages, is itself the exhaust of previous startups.

Every single founder I know who has grown a great business and sold it has gone on to reinvest a significant portion of the proceeds of that exit into new early-stage ventures. And in many cases large amounts of their time and experience to go with that.

Repeated over multiple generations it has the potential to contribute significantly to our collective wellbeing. We’re already seeing evidence of this. This is how we will grow our ecosystem. This is how we have grown our ecosystem. It’s happening.

We need to level-up. Our long-term ambition should be to become international investors ourselves. If we are successful in growing a thriving ecosystem, eventually we will be the ones investing in startups based elsewhere around the world; our companies will be acquiring startups based in other countries; our superannuation funds will be investing in venture funds elsewhere. Of course, all of those things are already happening too, albeit at a small scale, but we just don’t tell those stories well.

For reasons I can’t explain, we prefer to see ourselves as victims of global capital markets and think that the solution to this is to try and barricade ourselves off. That’s a losing strategy.

It’s actually quite a simple choice we have:

  1. We can continue to grow our economy by trading companies for capital, and encourage more serial founders and investors to recycle the money and expertise that is created in the process; or
  2. Discourage successful founders from taking offshore investment or selling to offshore buyers.

Choose one.

We need to stop worrying about retaining ownership of startups. We need to stop getting angry when a startup is sold. We need to describe the outcomes we want from our startups and then find the optimal mix of local and international ownership that helps us achieve those.

  1. Credit to Nat Torkington for being the first person I saw to put that collection of words together in that particular order. It’s an obvious idea, as soon as you hear it. ↩︎

  2. Source: An Exists Strategy, Offscreen Magazine

    Natasha also delivered a wonderful version of this as the closing talk at Webstock in 2015↩︎

  3. Entire PhDs could be written in the definition of “enough” in this context, so I won’t get bogged down by that now. But for reference I’ve written elsewhere about how to think about valuing your startup in an investment round, which may be useful. ↩︎

  4. Something that always makes me laugh is when a share price drop on the public markets is described as a “sell off”. There is no warehouse where shares that are sold are kept waiting to find a buyer - every share sold is bought by somebody else. ↩︎

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