A better formula for starting -- and selling -- an ad tech company.
As a serial entrepreneur who's started a few companies in the ad technology space, I get a lot of requests for advice about starting companies. This is also a byproduct of my current job, which involves much work with ad tech acquisitions. Given events of the past few months, the venture and start-up communities are hungrily looking at advertising as a place to invest.
So today, some advice for both investors and entrepreneurs who are looking at advertising and trying to figure out what to do.
Honor the Ecosystem
Most people starting companies believe they'll succeed by disrupting the ecosystem. They look at a value chain to see where they can cut a major player out of the mix and capture its value.
In advertising, the focus is often put on disintermediating the ad agency. It's been tried many times, and it never works. People who don't work in advertising erroneously think an agency is a creative production shop. Agencies play a huge, valuable, and constantly evolving role in the advertising ecosystem. They also have immense power and are not to be trifled with. They're not just creative shops. They provide a wide range of services, including strategy, creative, media planning, media buying, marketing analytics, and many others.
Rather than try to disintermediate agencies or other players, look at market inefficiencies in the advertising ecosystem. Where can you provide value? How can you make things easier for companies in this space? Where can you provide transparency for things that are opaque? Those are the ways technology companies have succeeded in the space.
The Entrepreneur's Formula
Back in the day, a formula was widely used to figure out how to make millions as an entrepreneur. It went something like this:
The problem with this formula is most of the time, it doesn't work well for entrepreneurs. It's very hard to get acquired for $100 million. And it's hard to meet the formula's requirements.
It also pushes the founders' ownership percentage relatively low. And God forbid you don't sell the company in the first three to five years, because the VCs will typically have dividend payments that grow over time, eating into company ownership. Investors are always paid before anyone else. The amount the company must be sold for so founders and employees see a return is quite high by that point.
Say you're the founder of a company that followed the above formula. By the time you get through series C, you personally own 5 percent of the company, and you've taken $25 million in funding across three rounds. Here's how it works:
Technically, you're now a millionaire. But you must pay capital gains on this money at a pretty high rate. So now, you're not a millionaire.
Let's think about this with a new formula:
What happens in this case?
Right about now, you're thinking, "Wait a second, Eric. Are you saying it's in the entrepreneur's best interest to sell his company early for less money? That seems wrong. Shouldn't you try to build a big company with a complex product set that solves big problems?"
No. The new world we live in is very different. You're better off building a small company that solves a small to medium-sized problem that's very technically complicated. Before joining a big company, I erroneously assumed these guys had so many resources that nailing small technology problems was a no-brainer. I've found, however, big engineering teams are focused on solving big engineering problems. Big companies suffer from the same problems small companies do: they never have enough resources to do everything they need. The difference is the big guys have money to acquire companies to speed their time to market.
Most startups try to solve the whole problem. They build really fast with a small engineering team and a large marketing, sales, and operations team. The engineers hardcode everything and don't keep the code open, don't document the code, and insert all sorts of crazy open-source widgets into their technology. Often, the engineering is outsourced to another country, and founders give very little thought to ensuring security on the other end of the pipeline.
When a big company comes along and does due diligence on the technology, it finds security holes, spaghetti code (define), lots of technical problems that have to be mitigated prior to the acquisition, and lots more that have to be solved later. And if the start-up created an entire operating platform, there's likely a ton of redundancy between the acquirer's and the startup's platforms.
And the outsourced development that sounded like a great idea? Let's just say if you haven't visited the team building your product and have no idea what type of security and source code management they've used, you might have some trouble. If you're trying to sell your technology to a big company, it probably isn't great that every developer in Eastern Europe or Asia has access to bits of your source code. It's better to build an engineering team locally that's a strong asset and adds value to the acquisition price. It's hard to find talented engineers at a big company who have experience in advertising technology. Startups have better luck recruiting engineers, and they can gain valuable years of experience building a version one or two ad technology that makes them more valuable.
The biggest pieces of advice I have, then, are:
Meet Eric at ClickZ Specifics: Online Video Advertising on July 19 in New York City.
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