Dan’l Lewin, Corporate Vice President, Strategic and Emerging Business, Microsoft Corporation

Courting Startups: Our Global Strategy

Should we invest in startups? That was the question I posed at the beginning of this column series in October 2005. My answer then and now is the same. Yes, but not in the traditional way a venture capital firm does. We invest our resources, people, and of course technologies in startup companies worldwide — working with VCs to enable innovation and accelerate the software ecosystem. In some cases, we acquire companies that help us accelerate our product roadmap and align with customer needs.

In fact, during our last fiscal year, we acquired nearly three times as many startups as we did the same period a year earlier. So what’s up? Why all the deal making? Clearly, market dynamics come into play. There’s consolidation going on, and a realistic, pragmatic IPO market. While it may turn out to be one of the busiest years for IPOs since the tech crash, there’s still cautious optimism in the market and a requirement for sustainable performance. In fact, Morgan Stanley’s Mary Meeker says winning technology companies today must have (among many other things) a large market opportunity (better to have 10% and rising of a $1 billion market, then 100% of a $100 million market.) In addition, newly created regulatory hurdles are causing trepidation in the market. Some companies are even doing trial runs on their road shows, testing the company pitch with investors and bankers just to gauge the reaction before the real event.

But for us, there is another reason why startups are a target of interest and have always been. We see acquiring companies as a natural and pragmatic way to satisfy our market and customer needs, to acquire inventive new technologies, creative people, and to integrate them into our product and solution roadmap. See Pick of the Crop article in the Wall Street Journal, Online. But you may be surprised to learn of the market areas we targeted and our sweet spot for investments.

You could say we’re on a roll, and we don’t see it letting up anytime soon. Bruce Jaffe, head of Microsoft’s Corporate Development group, a close partner organization to my responsibility, says that they have the biggest pipeline of potential deals — ever.

This column explores our acquisition strategy. We’ll talk about our appetite for acquisitions and the payoff for entrepreneurs and investors alike.

Three Quarters of a Billion Dollars— A Nice Round Number

Here are the digits worth noting: For the fiscal year 2006 which ended on June 30th, we bought 21 companies for a total of approximately three quarters of a billion dollars. That compares with just 9 companies in the prior fiscal year, valued at approximately $250 million. (See Microsoft acquisitions by year here.) Most of our acquisitions tend to be technology-based private companies. About one-half of the companies we acquired in the last year were not VC-backed, but rather backed by founders and angel investors, a growing trend with serial entrepreneurs. I think it’s also indicative of why CEOs choose M&A as opposed to an IPO. Clearly, the regulatory market (Sarbanes-Oxley, and other new generation regulations such as HIPAA, Gramm-Leach-Bliley, etc.) is causing CEOs to rethink exit strategies. I hear time and time again from high networth CEOs and venture capitalists that the personal exposure associated with taking a fledging startup public is significant and oftentimes leads them toward acquisition as a more palatable outcome. Not surprisingly, M&A activity soared in 2005, the best year since 2000, and experts say 2006 could easily be a record year for deals.

From our point of view, here are some additional insights about our interest areas from our latest round of acquisitions:

  • One-third - based in Silicon Valley, or California.
  • One third - international acquisitions, British game developer Lionhead Studios, digital asset management company iView Multimedia, and mobile search technology provider MotionBridge, based in Paris are examples.
  • Most of our acquisitions were made by our Platform, Products and Services division, but we also made several important acquisitions in Entertainment and Devices, as well as in our Business Division.

A Globetrotting Strategy — A Different Kind of Investor

We’re courting great companies wherever they may be. And, in fact, we’re counting on our relationships with VCs worldwide to help us deepen our dialogue with the portfolio companies we should consider. We’re not just buying infrastructure, or management/technology talent, or security products; we’re buying lots of stuff in the gaming segment too, distribution content and more. Further, as web standards and services become mainstream, and all large players adhere to those standards, our platform investments will evolve, including Window Live, content and distribution relationships, SaaS, and more. And this, in turn, will likely stimulate our appetite for more acquisitions — looking for the areas where this makes the most sense.

In general, we make acquisitions for one or all of the following reasons:

  • People power and expertise (great engineering teams and operating managers)
  • Technology advantage (adding a new incremental innovation to an existing product line, or planned product)
  • Time-to-market benefit (sometimes the market moves so fast that it makes sense for us to buy rather than build a new technology/approach … i.e. compliance, legal, audit, and security requirements as a result of Sarbanes-Oxley)
  • New market/opportunity — disruptive or new channel innovations (As just one example, Teleo got us deeper into the VoIP space.)

Our acquisitions are based on more than revenue or profits. Since we already have strong brand recognition, great sales channels, partners and existing product lines, we look to how we can leverage acquisitions into our existing customer base and distribution channels for the highest returns. Early on, we do our best to identify great engineering teams and unique technology. We form partnerships, help startups build on our platform, introduce them to VCs and more. Acquiring them sometimes happens, but it is not necessarily the ultimate goal.

Whom Did We Target? The Usual Suspects.

Many of the companies we acquired, naturally, had ongoing relationships and partnerships with Microsoft in one way or another. That’s what I mean by targeting the usual suspects. It’s important to note that working with partners and VCs around the world, we continually refine and update a very clear framework of where we are making our development investments, where we see customer direction and need, and where we see opportunity to partner for mutual benefits and transparent insight into MSFT platform roadmap. Our goal is always to be a fair, transparent partner.

Here are the 21 acquisitions we made in FY06:

You can see from this list, we’re acquiring a wide range of businesses — particularly as the industry moves forward with the programmable web and IP addresses found everywhere — from light bulbs to Nike’s. The surface area for software and solutions is amplifying our business model. And that is making us more acquisitive.

Henry Chesbrough in his book, “Open Innovation: The New Imperative for Creating and Profiting from Technology,” said it best. He believes that the modern corporation of today must have permeable walls relative to licensing in and licensing out. In fact, I believe this is the new business model for growth. Companies’ new ideas will come from a variety of sources, not just pure internal R&D.

We’ve always licensed in, and of late, have begun to license out, given the depth and breadth of our research and development efforts. Microsoft’s IP Ventures licenses and spins out these leading-edge technologies to entrepreneurs, start-ups, and corporations as a way to both recoup a portion of our R&D investments and encourage new business investments and economic development. More on this soon.

It may surprise you to know that Microsoft in the '90s was the most acquisitive software company in the industry: midway into the new millennium, we may once again be ending this decade as the most acquisitive in the business. In fact, if you’re a startup company with promising technology, we’re ready to deal.