Today brought an article in the WSJ about some weakening in angel and follow-on investing in the face of heavy deal flow, and a similar theme by Jason Calacanis in his Launch blog.  Jason’s point #11 suggesting that it’s time for some teams and companies to combine their efforts is consistent with activity I am seeing in my daily travels in the Austin tech community.

The logic behind such combinations may be abundantly clear, the bigger question is how to get them done.  It’s easy to do M&A work on companies with real numbers; you can identify the synergies, cut overlapping expenses, leverage respective strengths, and arrive at a mathematical solution as to how much the respective parties bring to the table.  You can even get fairness opinions to back up your position.  If the social issues between the respective leadership teams can be resolved, then the rest falls into place.

However, if you are combining two companies that have great stories but don’t yet have great numbers, things get more complicated.   (Two, by the way, is the ideal number; 3-ways are nearly impossible to accomplish happily.)  Deals that are meant to be are certainly still doable, but here are some aspects to consider:

1.  Start with the social issues.  If the respective teams genuinely like each other, have the capacity to agree on a shared vision and a more specific product road map, and there is a bona fide complementary role for every key person who wants to continue, you may proceed.  If not, it’s probably time to get back to work on something else.

2.   Examine the idea from the customer perspective.   Beware of unintended consequences where customers and/or distribution channels may not easily be converted to the combined entity for one reason or another.   I got in the middle of a deal which did have real numbers in the 90’s (a rarity for that time), and the mere intimation of that combination frightened off the largest customer we had.  We survived that, but clearly we had a customer who didn’t want to see any changes as to who was in charge. 

3.  Consider carefully the investor perspective.  If one or both entities is still burning cash and reliant on continuing investor support, the Golden Rule comes to the fore.  Whoever is writing the checks has to be sold on the deal and has to agree to keep writing them.  If the companies are being combined with a view to the next round, then particular care needs to be taken toward assuring that the resulting entity is attractive to investors at a valuation that is better for all.  If the companies are, for the moment, fully funded, the existing investors still need to be consulted so that they have a chance to buy into the fairness of the deal and remain happy and supportive.

4.  Agonize over relative valuations.  If the managers, customers, and investors all seem to align, there’s still the hard part of hammering out a deal that makes everyone equally please or equally upset.  Both parties will have hockey stick projections, so forget those.   You can look back at actual cash invested as a starting point, but there can be arguments as to whether that cash was invested to create forward value or not.  Cohesive technical teams have some intrinsic value; just look at how many companies Google buys just for the talent.  Signature customers can add to one side or the other.   Unique management skills can make a difference.  There are many other intangibles to consider, but both parties will come down to reasoning such as: “Am I likely to make more money via this combined path than by staying independent and risking whatever dilution may come from financing that standalone strategy?”

5.  At the end of the day, it boils down to alternatives.  The economic times and the financial markets may force you into decisions that are not exactly what you had scripted in your mind when you hatched your company, but these decisions may be your only lifeline to remain in the game.   Do you want to go back to a real job?  Perhaps, or possibly your significant other is lobbying for that.   Or, can you stay the course and develop an true entrepreneurial career?  You don’t have to retire on your first deal in your 20’s; bunting as part of a bigger game-winning strategy will give you more turns at bat than if you always swing for the fences.   (Excuse the corny metaphors.  Just a bit of homage to the baseball playoffs.)

I’ll keep following this story and watching for successful “storied deals” as opposed to numbers-based deals.  We may indeed have gotten to where lean startup theories are producing too many companies that are just too lean to stand on their own, and a phase of some consolidation may be a healthy thing for all.

<image of Longhorn bunt from ESPN>