'Exit Strategy' (Stanford Law and Economics Olin Working Paper #542) by Mark A. Lemley and Andrew McCreary
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In Silicon Valley, the most important thing to think about when starting a company is how you’re going to end it. The venture capital funding model that dominates the tech industry is focused on the “exit strategy” — the ways funders and founders can cash out their investment. While in common lore the exit strategy is an initial public offering (IPO), in practice IPOs are increasingly rare. Most companies that succeed instead exit the market by merging with an existing firm. And for a variety of reasons, innovative startups are especially likely to be acquired by the dominant firm in the market, particularly when they are venture funded.
In this paper, we argue that this focus on exit, particularly exit by acquisition, is pathological. It leads to concentration in the tech industry, reinforcing the power of dominant firms. It short-circuits the development of truly disruptive new technologies that have historically displaced incumbents in innovative industries. And because incumbents often buy startups only to shut them down, intentionally or not, it means that the public loses access to many of the most promising new technologies Silicon Valley has developed.
There has to be a better way. We suggest a number of ways to break the cycle of acquisition by incumbents, including changing the incentives that favor acquisition over continued operation, finding other ways to fund startups or to allow venture capital firms to cash out without an acquisition, and changing the antitrust laws to focus on who is acquiring startups. These solutions won’t fix the problem of today’s entrenched tech monopolies. But they will allow the next generation of companies that might displace the tech giants to make it to market.
