Working Paper: NBER ID: w24350
Authors: Ashish Arora; Andrea Fosfuri; Thomas Roende
Abstract: Most technology startups are set up for exit through acquisition by large corporations. In choosing when to sell, startups face a tradeoff. Early acquisition reduces execution errors but later acquisition improves the likelihood of finding a better match since in the early market, there are fewer buyers because early acquisition requires costly absorptive capacity. Moreover, the buyer’s decision to invest in absorptive capacity is related to the startup’s decision about 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 if the timing of exit is a strategic choice, i.e. startups have to commit to whether to exit early or late. Too few startups are sold early, and too few buyers invest in absorptive capacity. Paradoxically, venture capital aggravates the inefficiency. However, if 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: startups; exit timing; entrepreneurial exit; absorptive capacity
JEL Codes: L26; O34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strategic choice of exit timing (D25) | market dynamics (D49) |
| number of buyers investing in absorptive capacity (E22) | probability of early sales (C69) |
| commitment to an exit strategy (G34) | late sales (L81) |
| small number of buyers (D41) | larger gap between social value creation and private value capture (D46) |
| early acquisitions are less frequent (G14) | inefficiently late exits (G14) |
| venture capital availability (G24) | reduce early acquisitions (D25) |
| tactical choice of exit timing (C41) | excessive early acquisitions (G34) |
| accepting too many early offers (D44) | over-investment in absorptive capacity by buyers (E22) |
| early deals (L14) | negative externalities on late buyers (D62) |