When deals fall apart

Last week, after I put the newsletter to bed, word began to emerge from various news sources that the OpenAI-Windsurf deal was in trouble. At that moment, we had no idea what that meant. But we would soon learn that OpenAI had walked away from the deal, a move that would set off an odd chain reaction of events.

For starters, Google reacted swiftly, using its cash hoard to acquire key Windsurf talent for $2.4 billion. That included CEO Varun Mohan, company co-founder Douglas Chen and several members of the company’s research team. It was a nice chunk of change for those who benefited, but not everyone did. The remains of the company, including the 150-person team not included in the Google deal, were cast aside, at least at that moment. It wouldn’t take long, however, for Cognition to scoop up what was left.

It’s worth noting that Cognition paid the remaining Windsurf employees, based on their vesting schedules, and the agreed upon purchase price for the company’s assets. Although the sale price wasn’t shared, it’s a fair guess that it was substantially lower than the Google deal. The speed at which this deal pivoted was startling and a lot of people from investors to customers to employees had to be wondering what just happened. Customers in particular have to wonder what this all means to them going forward.

This story has plenty of drama, and the aftermath has abundant twists and turns. Yet, the narrative of a deal falling apart is one we've seen many times before.

I’d call that a bargain

When folks go to work for startups, the founders attract them to their companies with dreams of building something great and maybe making some money along the way. There is an implicit and explicit agreement that if it works out and the company is successful, employees with equity stakes could come away with a nice nest egg. 

In the case of OpenAI and Windsurf, a straightforward, old-fashioned acquisition would have meant a big payout for many who helped build a product that in just four years already boasted $80 million ARR (annual recurring revenue).

Let’s be clear that nobody is guaranteed anything in the startup employee payout calculus, but in the case of Windsurf’s key employees, they walked away with most of the spoils and the rest of the company got much less.

The same goes for companies buying a startup’s services. Startups offer the advantage of providing innovative products and services that bigger companies might not be able to come up with, but the risk is that the company could be sold or go out of business. It’s a trade-off many buyers are willing to make in the name of innovation.

Then there are the investors, the folks who risk real cash to support promising companies with the hope that they will pay out some day. Realistically most don't, but suddenly the new Acquihire Model is throwing up roadblocks to more substantial payouts.

As Bloomberg’s Parmy Olsen wrote recently, “The phenomenon has been great for tech giants who can remove potential rivals more cheaply, but it’s left venture capital investors in a rut with fewer returns than they would have expected from a traditional sale or even an initial public offering.”

The regulators strike back

Some have suggested that the way this went down was due to overly aggressive regulation, and Google simply skirted the rules to get the deal done. Putting aside the fact that Google is already dealing with a massive antitrust case related to its search and advertising business, the alternative would be letting large companies buy up whatever they want without having to answer to anyone, an outcome I don’t think many people want. Big companies could simply use their market clout and a bigger wallet to remove every competitor. That’s probably not a great outcome for startups, who would have an increasingly hard time competing against giants, no matter how good their products are.

A couple of years ago, we saw regulators scuttle a much larger deal when Adobe tried to buy Figma for $20 billion, a $10 billion premium over its prior valuation. It was an enormous amount of money, but it seemed clear from the start that Adobe, which had a similar but much less popular product, wanted to use its size advantage to take a competitor off the board and own the superior product. 

As my former TechCrunch colleague Alex Wilhelm wrote pulling no punches, “If Adobe wants to deal with the competitive threat that Figma represents to the company — something that we can infer from the $10 billion premium that Adobe is willing to shell out for the smaller concern — it should do so by building something that can compete.” 

Apparently regulators agreed and put up enough obstacles to kill the deal. Weep not for Figma though. It got a nice consolation prize: staying independent, collecting a $1 billion exit fee and building a solid company, one that recently filed for an IPO.

Plaid faced a similar fate when Visa tried to buy it for $5.3 billion in 2020. Once again, regulators snuffed out the deal for competitive reasons, and the startup still ended up doing OK. In fact, the company raised $575 million this year at $6.1 billion, a valuation higher than the Visa offer. Yes, it was well below its peak 2021 valuation of $13.4 billion, but back then everyone tended to be overvalued.

Deals fall apart for so many reasons, some we never hear about, but the outcome of an exit matters to the employees, customers and investors, who all have a dog in this fight. Those employees who bought into the vision and worked long hours should be rewarded for their commitment if there’s an exit. Cognition did its best to honor that commitment. Meanwhile, the founders took the big money and ran, probably letting a lot of people down.

Investors who took actual financial risk likely walked away with far less money than they would have gotten had the company exited in a straight sale, and Windsurf customers ended up big losers too with a tool they like getting split up among two companies in a complex and confusing arrangement. 

Sure, you can blame the regulators if you like, but in the end, Google skirted the regulatory process by throwing big bucks at a small group of core employees, and the rest of the stakeholders were left to pick up the pieces.

~Ron

Featured photo by Abby Savage on Unsplash