Color, a photo sharing app that launched in August of 2010, has the unpleasant distinction of having raised $41 million before it even launched, by far one of the largest sums bestowed on any software company prior to them acquiring a single customer. Its technology, a location based social network that automatically found and shared photos with relevant people nearby, was hyped by every tech blogger who had the good fortune of enjoying early access to the product. And of course, after launching, the product was roundly reviled and sunk like a stone.
It's a marketplace that encourages risk
News broke yesterday that Color was shutting down, followed by the news the Color was not shutting down, followed by the news that Color was being acquired by Apple for at least $10 million, followed by the news that no, Apple was just paying $2-5 million for the company's engineers. While the companies actual fate is still uncertain, Apple paying somewhere between $2-5 million for what's left of Color actually makes perfect sense.
If you're more interested in phones than founders, you might be thinking, "Wait a minute, why pay $5 million for employees from a company that is about to fold? Why not just wait for Color to collapse, then hire whoever you want at the market rate?" Outside of Silicon Valley, by which I mean the tech industry, that would probably be the case. But there is a very odd and particular logic to what is known in the biz as the acqui-hire: the act of purchasing a dying company for its employees.
UNC law professors John Coyle and Gregg Polsky recently published one of the first academic papers on this topic. They break the Silicon Valley ecosystem down into three parties: the talent, the investors and the tech titans with cash on hand. Each one has their own set of incentives and a complex game has evolved to ensure a maximum benefit for all parties.
Everyone wants to be an entrepreneur
Engineers want to be entrepreneurs, because being seen as a leader elevates you from just another skilled coder to a very valuable commodity. Venture capital investors are willing to back risky ideas from unproven founders because betting on the next Mark Zuckerberg is the best way to make big returns on your capital. And companies like Apple and Google are sitting on huge mountains of cash during an era of historically low interest rates. What they want more than anything is great talent.
The rule of thumb is that only one or two out of every ten startups will succeed as a business. Only one out of a hundred will be a real home run. With the rest, the ideas like Color that seem great on paper but fail to catch on in the real world, an acqui-hire is often the best solution for all parties. The founders and employees get to say they were acquired by an Apple, Google, or Facebook. This is a badge of honor. The same goes for the investors, who get to make back some of their investment, or perhaps break even. The big companies get a team of people who have worked together to build a product and can be leveraged into a larger organization, in this case a photo-sharing feature that would be terrific if native on iOS.
Yes, there are other reasons to buy failed companies: cool tech, trademarks, patents and IP. Some of these may be part of the deal for Color. Or this may simply be a raid on talent, in which none of Color's assets go to Apple, and the investors simply keep whatever is left in the bank and wind the business down. But analyzing the logic behind the reported deal is helpful for a broader understanding of how the startup scene works and why. Is it the best system? From the viewpoint of purely rational markets, no. But when the primary value is disruptive innovation, a cycle that encourages bold, risky thinking and keeps the tech titans on their toes could be seen as one of America's enduring economic advantages.