Working Paper: CEPR ID: DP12724
Authors: Ashish Arora; Andrea Fosfuri; Thomas Rønde
Abstract: Most technology startups are set up for exit through acquisition by large corporations. In choosing when to sell, startups face a tradeoff. Early acquisitions reduce execution errors but later acquisitions improve the likelihood of finding a better match because there are fewer buyers in the early market as early acquisitions require costly absorptive capacity. Moreover, the decision of buyers to invest in absorptive capacity is related to the decision of startups on the timing of the exit sale. In this paper, we build a model to capture this complexity and the related tradeoffs. We find that the early market for startups is inefficiently thin when the timing of exit is a strategic choice, i.e. startups have to commit whether to go early or late. Too few startups are sold early and too few buyers invest in absorptive capacity. Venture capital paradoxically aggravates the inefficiency. Instead, when the timing of exit is a tactical choice, i.e., startups can choose to go late after observing the early offers, there are too many early acquisitions and too much investment in absorptive capacity by incumbents.
Keywords: entrepreneurial exit; markets for technology; absorptive capacity
JEL Codes: L26; O31; O33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Strategic Choice of Timing (C41) | Investment in Absorptive Capacity (E22) |
| Investment in Absorptive Capacity (E22) | Early Market Inefficiency (G14) |
| Venture Capital Availability (G24) | Fewer Early Acquisitions (G34) |
| Flexibility of Startups (M13) | Excessive Early Acquisitions (G34) |
| Excessive Early Acquisitions (G34) | Over-Investment in Absorptive Capacity (E22) |