Silicon Valley’s dirty little startup secret

In San Francisco cafes and bars, even on the street, I overhear people talking about their startup ideas, business plans, and goals. And there are tons of incubators, Angels, wannabe Angels, VC firms, making investments in startups.

And there’s lots of money being made, especially among the Super Angels, the incubators such as Y Combinator, the micro-VCs, and people such as Jeff Clavier, Dave McClure, who have made fortunes selling startups to larger companies. Sometimes startup teams can go from seed to exit in under a year.

For the investors, making dozens of $10K to $25K seed investments, can be tremendously lucrative.

Just one $25 million payday from the sale of a startup will more than cover an Angel investor’s loss from a hundred dud $25K investments – which is a loss of just $2.5 million. The risk to reward ratios are off the charts, which is why so many want to be Angels.

And there’s no shortage of startups looking for seed investments. They are told that they must have a business plan, they must address market opportunities of at least $1 billion in revenues; industry sector expertise is important; do the team members have prior experience? Are there enough tech leads in the team?

We are repeatedly told that these, and many other factors, are important to investors.

But aren’t most of those “factors” BS? Take a look:

The plan is to sell these tiny businesses to larger companies in the shortest time possible.

But in the vast majority of cases, the buyers aren’t interested in the startup’s business, they are acquired for their engineering talent alone.

For example, this morning Seattle-based Geekwire announced an exclusive story:

Amazon buys TeachStreet

Amazon.com has acquired TeachStreet, the 5-year-old online marketplace that matches students and teachers.

It’s an interesting story, does this signal Amazon’s push into educational markets? Will it take TeachStreet’s technology and scale it across its massive cloud infrastructure?

Nope. Geekwire’s John Cook reports:

This is looking very much like a “talent acquisition.”

TeachStreet will be shut down on February 15th. Teachers who use the service will be able to export their class listings, and the company is offering a number of alternative services where teachers can market their classes.

This happens time and time again. Mark Zuckerberg has said it many times, Facebook acquires companies mostly for their talent. Google does it too, all the giants do. They buy the startups and close the business.

Twitter recently bought Summify (a few weeks after it was featured in SVW) and closed it down. Apple bought LaLa and closed it down. There are hundreds of startups acquired every year and their services or products are closed down.

This might seem like an expensive way to recruit engineers but there are many benefits such as removing potential competitors, which helps maintain the status quo. The giant companies have a lot invested in the status quo because they collectively have the most to lose from its disruption.

Plus, they have agreements not to poach staff from each other. So where else can go? Startups are by far the best hunting ground for new talent.

So, do we really have a startup boom? Or is it a masquerade, a proxy for a battle between the Internet giants for top quality engineers?

And is it really that expensive to recruit in this way?

A giant Internet company such as Amazon can leverage the output of a software engineer far more efficiently than a startup. The value of code is proportional to the scale of its use. The same code can be used to provide a service for one hundred people or ten million.

Building scale is hard, very hard. But if you already have scale, then you have the means to leverage the work of software engineers across a vast realm of business opportunities. So even if an Amazon or a Google pays out a couple of million dollars per engineer, it can monetize their productivity better than any startup because of the tremendous global scale of their platforms.

There are other benefits too: The acquisitions are usually made in stock, which is a far better reward for employees than using stock option grants, which have an uncertain upside at mature companies due to slow stock price growth.

Plus, corporations can bind engineers to two-year agreements or more, as part of the acquisition terms. This limits staff churn, which is a huge problem in finishing important projects when job markets re tight.

My advice to young engineers is don’t worry too much about your business idea and bootstrap your own venture with three pals.

Produce some great code, create and launch a service, then shop it around as a demonstration of your talent. Shop it through the guys that run the incubators – their prime value is their contacts at the Google, Facebook, etc. They know how to sell startups and they’ll sell yours for a fee.

Your venture will show that you can work well in a team; it shows initiative; and the rigors of the startup life demonstrate that you aren’t a bunch of lazy nine-to-fivers, and are able to crack your own whips to get work done when it needs to be done. It’s a self-selecting process that filters out those that say they can, from those that do.

Silicon Valley’s dirty little secret is that the startup boom is mostly a disguised jobs fair that directly benefits the big corporations. Occasionally, an innovative startup makes it past this stage but it has to be so bad that no one wants it — not even for its team. It’s from among those ugly ducklings that the swans of the new age emerge: FB, Goog, Twitter, Yahoo! and others — no one wanted them at first, then they couldn’t get enough of them.