Analysis: Venture Capitalists Aglow Over Microsoft-Yahoo

Analysis: Venture Capitalists Aglow Over Microsoft-Yahoo

A combination of Microsoft and Yahoo may create new dealmaking opportunities for venture capitalists seeking to fund or sell technology start-ups.

The combined entity could be even hungrier for acquisitions as it races to catch up with Google in the lucrative markets of online advertising and search tools, venture capitalists said. The deal could also create a wave of new start-ups by departing Yahoo employees.

Furthermore, the emergence of a stronger, well-heeled and aggressive competitor would actually help drive up prices for start-ups, even though the $45 billion merger would also eliminate a potential suitor for such companies.

Yahoo could bring a culture of bold acquisition strategies and entrepreneurship that would benefit Microsoft, a company with a reputation of being slow and conservative on the acquisition front.

"It's an opportunity for Microsoft to change their behavior pattern and improve their ability to compete," said Mike Kwatinetz, general partner at Azure Capital Partners. "If they do that well -- and maybe this acquisition will push them toward that change -- there will be a huge positive for Microsoft and the start-up community."

Although Yahoo has been an active acquirer, typically buying up small start-ups, its stock price has recently plunged and it lags behind Google in search engine market share, owning about 23 percent compared to Google's 58 percent.

If Yahoo were to remain independent, it could continue to lose market share and its financial horsepower, thus making it a less aggressive acquirer, said Bryan Stolle, partner at Mohr Davidow Ventures. "It's better to have two strong combatants," he added.

For venture firms, which make financial bets on promising start-ups and hope to recover their investments through a sale or an initial public offering, aggressive companies drive up deal prices. In recent years, firms made more money by selling companies rather than taking them public.

Despite the U.S. economic downturn, venture capitalists are gung-ho about mergers and acquisitions -- especially of tech companies they support -- partly because of the appetite of large publicly traded companies.

At a venture capital conference last December, executives from Microsoft, Cisco Systems Inc and IBM Corp said they were bullish on acquisitions this year, expecting to do between 10 and 20 deals apiece.

Some venture capitalists also said there might be a wave of new start-ups by departing Yahoo employees if Microsoft's bid for Yahoo succeeds.

"A lot of new companies are going to get formed out of this," said Steve Baloff, general partner at Advanced Technology Ventures. "It will create a more fertile entrepreneurial environment as talent hits the market."

At last week's Demo 2008, a conference where entrepreneurs show off their latest innovations, many venture capitalists bemoaned the lack of big ideas, saying the products on display were little more than add-ons to existing technologies.

Employees at Yahoo, known for its more entrepreneurial work culture, may also leave to pursue their own interests because the slow process of merging would put plans on the back burner, said Sanjay Subhedar, co-founder of Storm Ventures.

"Some of the ideas that people want to push in larger organizations take time to bubble up," he said.