To kick off this series, I figured a good place to start is with the acquisition business model. This has become one of the more popular business models for web services. The reason this works is because there are big companies (ie. Microsoft, Google, Yahoo, etc) that are acquiring startups at an alarming rate. Like any business model, basing your company on the sole idea of being acquired is risky. If done right however, it can be a very lucrative approach to a startup business.

Overview

The name pretty much explains the ultimate goal of this business model: being acquired. So how does this model actually work? Everything the business does is to maximize outside appeal and internal value. Doing this will insure your startup receives the best offers possible.

When beginning a startup, it is important to lay extensive groundwork. This comes in the form of a solid business model. Even if your startup is marketed toward an acquisition, your startup still needs to have a marketable business plan. This business plan should say how the acquiring company is going to make money with your product. This could be through advertising in the product or marketing it as a free and pro version. These will be covered in the coming weeks. When looking at any startup for possible acquisitions, the acquiring company wants to minimize its risk of making a bad investment. Showing them that your startup has a solid business plan will help minimize any perceived risks. Once the business plan is completed, it is time to develop your product.

Developing a solid product is the most important part of any business model. The acquisition model is no exception. If nothing else, you need to spend more time on product development than with other models. This is attributed to the overall approach of your business, and that is to be bought out. Companies want to know that the product they are getting will come at a minimal impact to their current product line. They do not want to spend additional time to re-engineer your product because it was originally poorly designed. This is so important that many companies will walk away from an offer due to poor product design. This means that when designing your product, keep in mind things like scalability and performance. I spoke about these two in regards to Ruby on Rails, but it honestly applies to any language. Product documentation is also a plus in acquisition, but it’s not really a make or break component. The majority of companies would rather hire some of the original engineers rather than spending additional funds to train someone.

Now that you have a high level overview of this business model, let’s take a look at the advantages and disadvantages.

Advantages

• Highest Reward
  • If your startup is bought out, then you have spent a minimal amount of time and maximized your profit. Buyouts in other industries can take a few years to happen. Luckily the software industry is unique in the fact that buyouts commonly happen within the first year of the startups existence.
• Minimal Market Risk
  • Developing your product and launching your product is pretty quick. The hard part comes after the product is launched and surviving the after the initial buzz wears off. If you are lucky enough to sell off your product, you do not have to deal with this difficulty. However, if you can survive this, your startup is now worth even more money in an acquisition.
• Moonlighting Approach
  • This is one of the few business models I can think of that are easily done by moonlighters. Being able to keep your current job and do your startup on the side is very appealing. It provides supplemental income to your startup and helps to minimize individual risk. The reason moonlighting is possible is because the startup requires less time doing managerial activities.

Disadvantages

• Lower % of Success
  • Relying on an outside company to buyout your startup is not easy. Your product must be very impressive, compelling, and original. Making an improved version of an existing product has a much lower percentage of a successful acquisition than an original product.
• Job Security
  • Once the acquisition is complete, there is no guarantee you will still have a job. The only people who will potentially keep their positions are those who founded the company, primarily the CEO.
• Victim of Market
  • If the market changes, it puts your entire startup at risk. Either the economy could go into a recession where companies are not looking for acquisitions, or your product is not favorable in the market. Your startup is at the mercy of the economy and the community. If the community shifts elsewhere, or your product loses buzz, you can watch the offers either going down significantly or disappearing all together.
• Community > Quality
  • The quality of your product is not as important as the size of your community. If you take a look at any acquired company in recent years they are not usually the ones with the best product, but rather, they had the largest community surrounding them. All this means that your market appeal has to be staggering if this business plan will work to its full potential.

Conclusion

Building your startup in hopes of an acquisition may seem idiotic, but is has been very successful for many Web 2.0 services. Even if your startup does not end up being acquired, you should have your back covered with the business plan you present to interested companies. I will cover these alternative business plans in the coming weeks. Also considering the current state of the market and with companies acquiring startups like wildfire, the acquisition business model is the most appealing for my side projects and companies. What is your opinion? Are the risks worth the reward?