Accounting rules and the future of web startups

I love Paul Graham’sessays. Although longer than my usual reading allows the best way to read them is to star them on my google reader and read them later on the plane when I have downtime. He’s got a latest piece on the future of web startups. Dave’s got a summary but I think the main point is the “barrier to entry” is so much lower (costs, risk, etc.) that there will be a lot more startups than before. I have 3 important but different points than the ones either Dave or HipMojomake.

1. When I was at Cisco (1995+) we used to joke that Cisco purchased companies more often than we went grocery shopping. The times were good. You could buy companies with stock (Cisco’s stock was a huge premium then) and not have to worry about it. Not so any more. More companies are acquiring in mostly cash and some stock. Why? Accounting rules. Its just not possible for a lot of companies (save Google and a few others) to acquire companies for cash consistently. FAS 128 makes it difficult.

Previously, companies were required to amortize
goodwill over a long time (40 years), and this non-cash expense reduced
reported (GAAP) EPS. FAS 142 eliminates amortization and institutes an
annual impairment test. This article will briefly review the potential
impact of these changes on reported earnings. We expect the changes to
start impacting earnings by the end of 2001. 

2. The BIGGEST hurdle in doing acquisitions is the “integration” the day after. If as Paul suggests lot more companies get acquired, this creates a HUGE strain on the acquiring company. Regardless of whether you are acquiring 2 person startup or a 2000 person organization, the integration is tedious, complex and often time consuming.

3. Sourcing and having a acquisition “champion and owner“. The real power of the acquisition is after the combined entity has something valuable together (as in 1+1=10). Even at Mercury we did about 7+ (2 were extremely successful) acquisitions in 3 years and getting an executive to “own and champion” the acquisition is difficult. Not because they don’t want to do it, but more because they have a day job. Keeping the role of champion outside of the organization that wants this acquisition done is also a problem.

So, I agree the costs of starting a company are lower now, but also think if you do get a downturn the “opportunity costs” for any individual working for a $200K job at Google versus $60K + bread + water is too high. People will go back to the “safe bet” when the market does (and it will) turn for the worse.

I agree though that these are best times for entrepreneurs.