Microsoft-Yahoo combo could mean one fewer exit for upstarts

In the world of Internet investing, there are generally two get-rich exit strategies: acquisition or initial public offering.

Since the dot-com bust, the prospects of a consumer Web public offering have dropped considerably, despite Google's multibillion-dollar hit and the hype over Facebook. That's why many angel investors and some venture capitalists look to meaty acquisitions by Yahoo, Google, and Microsoft to reap their financial rewards.

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But if Microsoft and Yahoo join forces, as many suspect they will, that means there's one fewer buyer of start-ups or midsize companies ideal for acquisition. That's at least the buzz among some venture capitalists and angel investors during a relatively quiet time in the merger talks.

"I'd prefer a healthy Microsoft and a healthy Yahoo again competing against Google because it keeps a more vibrant acquisition market," said Geoff Yang, a general partner at Redpoint Ventures, a backer of companies such as Wiki company JotSpot (bought by Google), Right Media (bought by Yahoo) and Sidekick maker Danger (being bought by Microsoft).

As everyone analyzes whether a Microsoft-Yahoo merger makes sense, behind the scenes, investors and start-ups are questioning how the landscape may change without one of Silicon Valley's regular acquirers and a potentially more distracted duo. (In the last six months, for example, Yahoo has bought three companies backed by Redpoint, according to Yang.) Yahoo, Google, and Microsoft--and to a broader extent, Viacom, News Corp., Liberty Media, and InterActiveCorp--buy a handful of companies annually as a way to stay on top of the latest technology trends and bring on new talent.

Just look at their track records.

Since September 2001, Google has bought an estimated 60 companies ranging in price from $500,000 to $3.1 billion. (Wikipedia has recorded 51 Google acquisitions and investments in that time, but a few companies undoubtedly didn't make the list, given the search giant's low-key acquisition strategy.) In the last seven years, Google has bought an average of just fewer than nine companies annually.

Google's tried-and-true acquisition strategy is to buy young companies with a good idea and talented engineers. Only five of those Google acquisitions were for more than $100 million, including last year's whopping $3.1 billion DoubleClick deal, which is still pending. The meatier deals, from older to most recent, were Applied Semantics ($100 million), DMarc Broadcasting ($102 million), YouTube ($1.65 billion), FeedBurner ($100 million), and Postini ($625 million).

In the last 10 years, Yahoo has acquired an estimated 57 companies, according to records kept on Wikipedia, but that number is likely lower than the total too. Yahoo's acquisition price tags have typically been higher than Google's, with roughly 15 buyouts at more than $100 million.

One of its largest was $5.04 billion for Broadcast.com at the height of the dot-com bubble. The Internet company typically buys several small companies, along with a few larger acquisitions annually. Other notables include Overture Services in 2003 ($1.63 billion) and Delicious in 2005 (unknown sum).

In the last 12 years, Microsoft has bought more than 100 companies, according to Wikipedia records. That number could be higher, but at that rate, its annual average is comparable to Google's. Over that time, Microsoft hasn't focused on buying small Silicon Valley companies--last year, for example, it was noted for buying ad agency Aquantive for $6 billion and wireless-phone service Tellme for an estimated $750 million. But it seems to be shifting that strategy of late.

This year, three of its four acquisitions have been private companies from Silicon Valley, including two virtualization software makers, Calista Technologies and Caligari, along with Palo Alto-based Danger, creator of the T-Mobile Sidekick.

If Microsoft gets its wish with Yahoo, the company could tighten the purse strings or continue on its start-up acquisition strategy. "It just may be that Microsoft's increased focus on start-ups offsets the loss of Yahoo," said one Silicon Valley executive, who asked to remain anonymous.

One other potential issue for investors is a slowing economy. Venture capitalists say a weakened economy could squeezer mergers and acquisitions, or cause valuations of private companies to fall. Investors would likely look to add money to the promising companies in order to weather any slump.

Some angel investors suspect that smaller acquisitions, in the range of $10 million to $20 million, will likely continue in the event of a Microsoft-Yahoo merger. What will get harder to negotiate are the acquisitions in the range of $100 million to $300 million, some investors suspect.

Reactions outside Silicon Valley are mixed. Yoav Andrew Leitersdorf, managing partner of European-based YL Ventures, said a merger seems appropriate for the two companies so that they can better compete with Google. But a merger could spell trouble for firms like his, which makes seed investments in young companies for less than $3 million to build them up to valuations of between $20 million and $80 million for acquisition.

"Both corporations are very active acquirers at all valuation ranges, and both make investments in small start-ups on a global basis," Leitersdorf said. "A merger means one fewer potential investor or exit partner to court and negotiate with, which could result in reduced levels of investments and exits, or at the very least, reduced valuations," he added.

That said, a successful Microsoft-Yahoo marriage could put pressure on Google's search and advertising business, and that, in turn, could benefit start-ups with cutting-edge technologies, he said. Google and Microsoft would both be looking for new competitive tools.

Yang of Redpoint Ventures also chose to be positive. "In the absence of (three healthy rivals), two healthy players are better than one."