The startup market: exit strategies and entrepreneurial choices

For an innovative idea, the path to commercialization begins in the moment a startup is created. But how long this journey will last is hard to predict. In many cases, technology startups devise strategies to be acquired by large incumbents in the industry during the idea development phase when the technology has yet to be perfected. In other circumstances, startups go into stealth mode, aiming for a late exit, initially seeking financing but only revealing themselves to potential buyers at a later stage in the game. In still other cases, startups adopt flexible strategies, immediately scouting for funding but then opting for a late sale.

Given the high failure rate for technology startups, choosing the wrong exit strategy or timing for the deal is a critical issue that can seriously jeopardize the survival of the company. In deciding when to sell, startups have to face a trade-off: selling early minimizes mistakes in scaling up and errors in execution, but diminishes the value of the sale; selling late increases the chances of finding a better offer by generating more competition among buyers, but this strategy also entails a higher risk for the company’s survival.

In a recent study , we developed an analytical model to delineate the exit strategies for startups.

Transitioning from the initial phase (invention) to the final one (innovation) requires scale-up and execution capabilities that not all startups have, and that differ from one startup to another. Compared to consolidated companies, startups are more prone to make mistakes in this complicated development phase. For instance, they might hire the wrong people, or develop the product for the wrong market or for too may markets, or they could run out of money from their initial investment. In light of all this, a delayed exit could be very risky. What’s more, startups have limited resources, which could be earmarked either to attempt an immediate exit (when they only have a patent or a prototype), or to develop and sell an invention later on (with a functioning technology or a viable product in hand). So the timing of the sale is influenced by the interactions between buyers and sellers, and depends on environmental factors that play a part in determining the value of the startup captured by each side.

Our study demonstrates that a key factor in terms of timing of a sale is how much effort startups have to make from the outset to solicit offers, or in contrast how much they can focus on business development. What’s more, since the most valuable resources for a startup are the capabilities of the founders, organizations with capable managers can wait to go to market, while less capable management teams are forced to make this move right away.

There are also other factors that can impact the decision on exit timing. To this end, our study shows that startups are more likely to make a late sale when they have plenty of venture capital and weaker protection in terms of intellectual property. The same is true when it’s expensive to develop “absorptive capacity” (i.e. the capacity to understand, develop and integrate nascent technology). But the exit timing for startups is not contingent on economic considerations alone. Other factors may come into play as well. For example, entrepreneurs like to be in the driver’s seat to develop their idea, so they may prefer to keep control of the company longer, delaying a sale without maximizing profits.

Turning to potential buyers, they can participate in the initial offer only if they have sufficient absorptive capacity, which actually leads to less competition and a lower purchase price. What’s more, fewer participants means less likelihood to find a good match between the startup and the buyer, which would place at serious risk the future survival of the company. In this sense, for a startup, every circumstance that reduces the number of buyers who participate in the initial market constitutes an incentive to delay the sale.

Entrepreneurs who prefer to remain in charge tend to sell late and fail more often. The message here is that startup founders need to have exceptional self-awareness, setting aside any sense of self-importance; with proper foresight, they should carefully consider whether to continue running their business themselves or entrust it to someone who has the resources to scale up.

Any number of large incumbents are always paying close attention to the startup market (Apple’s purchase of Siri is a perfect example). So, the sale of a startup in the end is a big deal for the entire innovation market, which is constantly driven to come up with new ideas and technologies.