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Early investors can forecast future of startup companies


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Success comes in many forms.

For a movie, it could be box office numbers or critical acclaim. In academia, it might be publishing research or helping students land dream jobs after graduation. New research from the University of Washington shows there are also multiple ways start-ups can be successful. Early investors often predict which route they will take.

“In the entrepreneurial world, we hear a lot about corporate exits because that’s when the founders and investors make money,” said study co-author Emily Cox Pahnke, an associate professor of management and organization at the University of Washington Foster School of Business.

“In most industries, both acquisitions and IPOs, or IPOs, are great exits. But what it takes to achieve them is different. Our research shows that different patterns of collaboration between venture capitalists lead to different types of exits for the companies what they invest in.”

When a venture capital firm, or VC, invests in a startup, it often does so with other VCs as part of a syndicate. VC syndicates share knowledge and resources as they work to guide their startup towards a successful exit strategy, be it an acquisition or an IPO.

The study, recently published in the Academy of Management Journalfound that companies whose VCs invested with other VCs they had worked with in the past were more likely to exit through acquisition.

Acquisitions can be a form of quick exit where a company is sold to a larger company. In contrast, less prior collaboration between VCs in a syndicate increases the likelihood of a company going public. Surprisingly, researchers found that the same collaboration patterns that increase the likelihood of an IPO also increase the likelihood of a company going out of business.

Using Crunchbase, a database of startups and investors, the authors looked at US-based startup companies backed by VCs. They found that past collaborations between venture capitalists could help predict a startup’s future outcome.

The researchers analyzed the initial funding and results of more than 11,000 companies launched between 1982 and 2014. They supplemented the Crunchbase data with manually collected third-party sources and identified 71,624 funding rounds involving 20,142 investors.

In the paper, the authors provided two examples to illustrate how prior collaboration affects exit type. Gridiron Systems and Carbonite were both VC-backed companies that provided digital data storage. Gridiron’s VCs had co-invested in at least two previous companies. Conversely, none of Carbonite’s VCs had co-invested before. Gridiron Services was acquired in 2013 and continues to specialize in storage technology. Carbonite went public in 2011 and has now expanded its services to other markets.

In an acquisition, a startup is bought entirely by another company that takes on a controlling ownership interest. While the shares of the founders and investors become fully liquid, control of the company is also transferred.

“In order to assist in an acquisition, investors need industry-specific knowledge,” said Pahnke. “They need to be able to agree on certain outcomes faster and act faster. Finding a good suitable buyer requires industry links. Having worked with a number of investors in the past reduces the chance of conflict that slows down ​you, and you are much more likely to agree on the outcomes you want and have ties to the industry.”

In an IPO, a company’s shares are offered for sale to the broad market of equity investors. The management team often stays in place, and founders and investors typically gain partial liquidity.

“If you don’t know each other, if you haven’t worked together, you’re much more likely to have conflicts that slow you down,” Pahnke said. “You’re also more likely to consider a much wider variety of information and alternatives. While it takes longer, you’re probably going to get those kinds of complex results, like an IPO, where you don’t have to rely on a specific buyer.”

Pahnke said IPOs are riskier than acquisitions. In an acquisition, the founders and early investors know the exact amount they will receive and when the transition will take place. But when a company goes public, founders and early employees usually can’t sell their stock for a period of time. If stock prices fall, founders and investors may not make money.

“In acquisitions, founders typically only stay with the acquiring company for a limited time,” Pahnke said. “Founders can go further and do something else. With an IPO, the management team will probably hang around for a while.”

Pahnke said she hopes this article will help broaden the definition of success.

“There are trade-offs between working with people you know and people you don’t know that lead to different kinds of success,” she said. “It’s not that anyone is bad or good. They are only qualitatively and quantitatively different.

“As researchers, we provide unexpected insights that are only visible when you map a large number of collaborations over time. For entrepreneurs and investors alike, our research suggests that you need to think carefully about who you work with – and who they have worked with in the past. have worked – help you achieve different kinds of success.”

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More information:
Dan Wang et al, The past is the prologue? Venture-Capital Syndicates’ collaboration experience and start-up exits, Academy of Management Journal (2021). DOI: 10.5465/amj.2019.1312

Provided by the University of Washington

Quote: Early Investors Can Predict the Future of Startup Companies (2022, June 10) retrieved June 10, 2022 from https://phys.org/news/2022-06-early-investors-future-startup-companies.html

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