Divide and Conquer: Mastering the Art of Spin-Outs
Unleashing Your Inner Elon
Every founder with a stroke of success gets a twinkle in their eye at the thought of running an incubator. It's like a modern-day Willy Wonka running a factory of innovation instead of chocolates … and without the questionable child labor.
Founders see lots of opportunities, but they are limited in the bets they can take because of limited attention, money, and resources. This is especially true in today’s environment – where money is scarce.
Usually, when founders come up with a great idea, a cool technology, or an interesting innovation, it often dies. Not like a heroic death in a blockbuster movie, no, it just... fizzles out. At best, it hangs out in the company, making it a little better, like that office plant that's seen better days but still brightens up the room.
Not every company can be Amazon, popping out billion-dollar businesses (like AWS) like a magician pulling rabbits out of a hat. Even Amazon in 1998 was more like a struggling street performer than the grand illusionist it is today. But what if we could find a way to perform our own magic trick and breathe life into ideas that might otherwise join the ranks of forgotten office snacks?
What if there was a way to breathe life into an idea that would otherwise wither on the vine? That's where the idea of spinning out companies comes in, a concept as real as my love for dad jokes.
There are start-ups that actually spin out companies to help them thrive. And that is not fake news.
Spinning out a company allows you to:
(1) Focus more on your core business (like finally focusing on that diet you've been talking about)
(2) Give the new idea a chance to thrive because there will be people solely focused on it (sort of like sending your child to a boarding school)
(3) Raise additional money (that you don't have to fund from your balance sheet) … like getting someone else to pay for your kids education
So I forgot to introduce myself. My name is Auren and I am the CEO of SafeGraph and I’m a GP at Flex Capital. I have a lot of experience with spin-outs and thought I’d outline them here because there is basically NO information on them.
The Four Horsemen of Spin-Outs (IPDA)
Now, let's talk about what I like to call "The Four Horsemen of Spin-Outs" (IPDA). And no, IPDA isn't a new craft beer you missed out on, it's a handy acronym for the types of spin-outs: Incubation, Product, Division, or Acquisition.
Incubation Spin: An Incubation Spin is like a baby chick just hatching from its egg; an idea born within your company that's still super early. These ideas come about because it is either a product that your company needs or something that could be a complementary product to yours.
Product Spin: This is a product or service that you have already built internally where your company is the only customer. You realize that other companies could benefit from this product. You already have code, engineers, and the first customer (you). It's like making a fantastic homemade salsa and realizing your friends might enjoy it too. You've got the recipe, the ingredients, and the first taster (you).
Division Spin: You have a product or division that is generating revenues but it is not part of your core offering and would have a better chance of growth on its own or part of another entity.
Acquisition Spin: There is a company you acquired that is no longer part of your core thesis. This spin rhymes with the Division Spin but can be easier to do because there might be a way to sell it back to the founders of the acquired company. This spin is like regifting an unwanted Christmas present.
Let's Explore Some Spin-Out Success Stories
Now, let's talk about some real-world spin-outs. Here at SafeGraph, we've spun out four companies – all different kinds of spins, like a DJ on a turntable.
Veraset was the first company we spun out (a good example of a Division Spin). At the time, Veraset was a $10M ARR profitable division that was unfortunately being overlooked within the larger company. Despite not needing any financial capital due to its profitability, it required renewed focus, attention, and a team that was directly incentivized by its success. In 2019, we brought on board a new CEO and spun the company out into an entirely separate entity. By 2023, Veraset had merged with a larger corporation, marking the successful completion of our first spin-out.
Emboldened by the success of Veraset, we decided to act as an incubator for our next spin-outs. In 2020, we fostered two innovative ideas, both apt examples of Incubation Spins, which we believed would flourish better as standalone companies. One concept centered around automating SDRs and the other focused on recruitment.
The challenge, however, was that we didn't have any internal members to manage these new companies. So, we embarked on a mission to recruit founders for each one. Ensuring the founders held the majority of the equity was a crucial strategy to keep them motivated. We raised $2M for the SDR company and $500k for the recruitment venture. The ultimate success of these companies remains to be seen, but they were able to find product-market fit swiftly, as the original ideas stemmed from issues that SafeGraph was confronting (if SafeGraph was facing these problems, probably a lot of other companies are too).
In an Incubation Spin, you generate a promising idea within your company that isn't directly related to your core business. You then spin it out, secure external funding, and become its first customer. Today's economic climate makes procuring external funding a significant hurdle. It's typically easier to raise funds when there's an established company with a product, a customer base, and a team familiar with the problem at hand, as is the case with a Product Spin.
Starting in 2020, SafeGraph built a huge marketing motion to get our data in the hands of academics. This was extremely successful for us - resulting in over 300 academic papers using the SafeGraph data. But it was also a big cost center - we had 3 full-time people staffing it and it was not core to our product or mission. So in 2022 we spun out our academic research program into a new company called Dewey Data (a Product Spin). Our VP Marketing, Evan Barry, left SafeGraph to become CEO of Dewey. We raised $1M seed capital (even in Fall 2022, we were able to raise the seed funding fairly easily) to operate the company. Six months later, Dewey is working with SafeGraph and dozens of other data companies – and is even profitable already.
OK. I get it. SafeGraph is a weird company that sometimes spins out other companies. Are there any other examples of that?
The answer is yes. This happens more often than people think and sometimes these spin-offs can become more successful than the main company. Spin-offs have generated hundreds of billions of equity value, and can be a great way to capture value while maintaining the focus on the core business. The grass is always greener on the other side, and spin-off ideas could be seen as “shiny objects” - especially if these ideas arise in periods of high stress or when a business is struggling. Having someone focused on “the distraction” can be a great way to still run the experiment, be a part of it, and grow an amazing business. To draw the parallel with incubating a business, the trade-off with spin-offs is that you need to accept that someone else is going to take credit for their success.
“One of the things I realized about myself is that I am so enamored with and have so much fun doing the zero to one invention process that I am okay if other people ultimately get the credit”
-Jack Abraham on World of DaaS
Crunchbase is also a great example of a Division Spin. It was originally conceived as part of TechCrunch. TechCrunch was ultimately bought by AOL which was bought by Verizon. So it was sitting as a sub of a sub of a sub and not getting the attention it needed. In 2015, Santi Subotovsky (VC extraordinaire who was the Series A investor in Zoom), GP at Emergence Capital, convinced AOL to spin out Crunchbase into a separate company. AOL would continue to be a major owner – and Emergence led a $7M Series A into the company (I put in $100k into that round) and he recruited the amazing Jager McConnell as CEO.
Crunchbase is now a thriving data company that has raised over $100 million since 2015. This was a great outcome for everyone involved – AOL, Emergence, the Crunchbase employees, and the Crunchbase users (who get a much-improved product).
One of the most successful spin-outs in history is Blackrock – which spun out of Blackstone in 1994. Larry Fink (still the CEO today) founded Blackrock as part of Blackstone in 1988. Today, Blackrock manages over $8 trillion (yes, trillion!!) in assets. And this is an example where the spin-out is more valuable than the parent – as of this writing, Blackrock has an enterprise value of ~$100 billion and Blackstone has a market cap of ~$75 billion.
Sometimes an acquired company is no longer strategic to the acquirer and it could have much bigger shareholder value as an independent entity. PayPal was acquired by eBay in 2002 and continued to grow massively. A dozen years later, it made a lot more sense to operate PayPal independently and eBay made the final separation in 2015 (Acquisition Spin).
But I’m Just a Start-up – How Do Spin Things Out
Spinning out companies is a bit like juggling flaming swords, while riding a unicycle, blindfolded. So, naturally, it helps to have a seasoned partner to guide you. A partner like Emergence Capital did with Crunchbase, or as Flex Capital is doing now. They don't just toss money at you; they also provide legal aid, help you recruit, and whisper sweet nothings in your ear.
Thinking of doing the spin-out tango solo? Well, make sure you have a legal team in place that doesn't just talk the talk. At SafeGraph, we're fortunate to have an arsenal of senior executives, seasoned in the deadly arts of finance, legal, tax, operations, and HR. If you're not as lucky, maybe consider a scrappy, entrepreneurial legal resource. They're like the Indiana Jones of law, minus the whip (OK … some of them even come armed with whips). And don't forget a solid operations person to untangle the logistical spaghetti that comes with more employees.
The Spin Out Carousel Doesn't Always Go Round
Just like trying to assemble IKEA furniture, things can go sideways. Incubation Spins often end up like a misassembled Kallax shelf – especially since they don’t come with instructions or even an Allen wrench.
Some spins might make you question whether it's worth the headache. Spinning out means people are switching teams, and managing that change requires the diplomacy skills of a Middle East peace negotiator with stale hummus.
There's no magical crystal ball that tells you when to spin out. Amazon could have spun out AWS, but then we might have ended up with "Amazoff". Sometimes it's better to keep the businesses together, especially if you can finance it internally. In the tax world, losses from new ventures can help balance out the gains from your profitable ventures.
And Now for the Most Important Part… the Team
The most important thing is the team leading the new company. They need to be so amazing that they make unicorns look like donkeys. They have to be properly incentivized too, of course. You can't just pick any old Joe from the core business and expect them to run the spin. If you're going to poach someone from the core business, they need to be so extraordinary that their coffee break ideas are better than most people's best work. But remember, that means the core business loses a superstar, and might need to hold auditions for their replacement.
Spinning out like Jedi Master
If starting a company is like jumping off the roof of a skyscraper and assembling the parachute on the way down, then spinning out a company is like bungee jumping off the same skyscraper, but this time, you're knitting the bungee cord as you plummet towards the ground, all while juggling flame throwers
Remember, spinning out isn't always the right dance move. Sometimes, it's better to keep your dance troupe together.
Just ensure you're prepared for some dizzying spins, some stumbling twirls, and even the occasional faceplant (I prefer the bellyflop). With the right team, you'll dust yourselves off, fix any dislocated limbs, and get back to the dance floor, ready to spin out a startup that's more dazzling than a disco ball at a '70s dance-off.
Like this? Follow me: @auren on Twitter.
Special thanks to Mario Moscatiello, Kristi Allen, Rajal Patel, and Jeff Lu for their insights and edits. And special thanks to Parker Ence, Geoff Prince, Sage Litsky, Ravi Patel, Nicole Berger, Ross Epstein, Dave Fitzgerald, Felix Cheung, Jason Richman, Evan Barry, Stefans Keiss, Zaki Mahomed, and others for joining us on these adventures.