Does it always pay to be the market leader upstart?

Today, two Techstars companies were acquired, MadKast and Intense Debate. Techstars is the Y-Combinator-like incubator program that gives small seed stage investments to take young entrepreneurs and their ideas from an idea in most cases, to a full-fledged prototype. Both upstarts barely got off the ground before they were acquired, a strong testament to the Techstars network, and the value add of the startups themselves.

One of the intersting things that I’ve started to notice lately is that the supposed market leader wasn’t the one that was acquired. I’ve seen this with Jaiku and now with Intense Debate and Madkast. For Intense Debate, Disqus was seen as the market leader among the Techmeme crowd, followed by JS-Kit. Disqus seems to have quite a bit of the A-list crowd installing their comment plug-in to enhance their community. Rarely have I heard much about Intense Debate, other than the mentions that they are the “other” company in the space. To be fair, they are very, very early in the process, and they don’t have the VC endorsement that Disqus has, with Union Square Ventures. I would probably install one on my blog, but I don’t get enough visitors to even warrant that : ) 

The interesting thing about Automattic’s (makers of WordPress) purchase of Intense Debate is that conventional wisdom says that you acquire the market leader, and that the entreprenurial team should aspire to be the market leader in their space, even if that means the only way to do that is to raise boatloads of money. But what additional value would Automattic have received by acquiring Disqus?  They would have probably paid an order of magnitude more for Disqus than for Intense Debate, in my opinion, just in the same way Google would have paid substantially more for Twitter than for Jaiku. Disqus has the VC investment, so they’re probably looking for a more substantial return on the $500M investment they received, whereas Intense Debate has just $15M in funding (from Crunchbase). If Intense Debate was acquired for a couple million bucks, or even a couple million bucks cash and stock in Automattic, it would be a nice return on investment in a short amount of time. Something they can throw in the bank, earn a little interest, and think about their next startup, where they can get boatloads of funding, because they were previously successful in a startup in a short amount of time. Maybe then it makes sense to try for the home run after having some personal financial security.

Perhaps this is the anomoly more than the norm, but for first time entrepreneurs against better funded competitors, perhaps the next strategy is just to continue to create substantial value, keep expenses low, reject large capital infusions, and create an awesome product. On the flip side, if I were Automattic, it makes perfect sense to acquire someone like Intense Debate, where I have the distribution model to make their plug-in more widely distributed, instead of paying 2 to 3 times what I would have paid Disqus. Instead, I use that extra money to help the newly acquired team figure out ways that redefines it’s product, to encourage people to switch from Disqus to Intense Debate/Wordpress.

It’ll be interesting to see if this trend develops more in the future, but it appears that entrepreneurs have many more opportunities to be candidates for strategic acquisitions, if they minimize the capital they take, at the expense of not being able to increase headcount and potential distribution channels. I wonder if someone has a chart that illustrates for every dollar in VC they raise, what is the corresponding pay-out they’d need in a liquidity event to earn the same amount without VC. If the founders of Intense Debate all received a million bucks from Automattic, how much would they have had to sell for if they had raised a million bucks? Would the market have even tolerated that type of expected payout? I know you can do the VC method to back in to this number or some simple back of the envelope math, but it would be interesting to see a chart that showed the direct relationship.

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