Recent Research: VDOs should pick investment partners with exit-tinted glasses

Forthcoming research suggests venture development organizations, that is, those publicly-supported nonprofits that combine risk financing with expert technical assistance to grow local innovation-based startups, should give careful consideration to the exit histories of the venture capitalists they partner with to move the VDO’s portfolio firms through seed and series A investment rounds. Who those VCs know and have worked with to achieve successful exits previously through acquisitions or IPOs, in many cases, may be more important than the VC firms’ zip codes or assets under management.

The path to a successful exit for each high-growth startup will vary; for example, exiting from the startup phase may take many forms, including staying an independent private company, becoming a publicly traded business through an IPO, or being acquired by a larger firm. The last two paths in that list are the most common for equity-financed innovation startups, with acquisitions being the much more prevalent of the two. 

A new working paper by Maryann Feldman, et al. would indicate part of the VDO’s due diligence process when seeking VC investment partners for first and second stages of financing should consider the nature and success of the companies that acquired the VCs’ previous holdings.  Does the investor have previous experience with larger companies that would make the most appropriate targets for the startup’s eventual or likely acquisition, if that is a viable exit strategy?

The findings in Gathering Round Big Tech: How the market for acquisitions reinforces regional inequities in the U.S. are built on an exploration of the nature and characteristics of 846 firms acquired by the seven largest American digital platforms — Amazon, Alphabet [Google], Apple, Microsoft, Facebook, Oracle and Adobe — from 2001 and 2020.

Like much of the innovation economy, the digital startups acquired by Big Tech are clustered in the country’s largest tech hubs, led by Silicon Valley, original home to 34.4 percent of the acquired, trackable businesses in the dataset. The other major hubs of New York, Boston, Seattle and Los Angeles account for the sources of an additional 19.6 percent of the companies.  Nine metro areas collectively sourced 8.4 percent of the balance of the U.S. acquired startups and 25 metro areas each had one target firm.

Only half of the U.S. startups acquired by Big Tech had received venture capital investments. The rest were financed by “businesses founders, angel investors and other entities such as banks and wealth and investment management firms.” Even within Silicon Valley-based startups, VCs had invested in only 54 percent of the acquired firms.

The statistical analysis determined being in Silicon Valley has a positive and statistically significant effect of a 17 percent increase on likelihood of acquisition. The location of the VC investor within Silicon Valley, however, was not found to have any “discernable effect on whether the acquirer is a Big Tech.”

The value of VC investors — and it is important for the point of this article — is that if the investor had been an early backer of one of the Big Tech companies, the startup had a statistically significant effect of increasing the likelihood of acquisition by 16 percent, “essentially the same as the effect of a Silicon Valley location for the target.” 

If this finding holds beyond the acquisition behavior of the seven largest digital platforms in the U.S., one might conclude the private social network of VC investors may be an important asset for overcoming geographic distance for VDOs when seeking larger corporations as acquirers for portfolio firms.  Scouting and attracting VC investors with relevant connections to the specific products or technologies within startups that are supported by VDOs to grow regional innovation economies might yield better outcomes than other policy tools commonly used to cultivate risk capital from investors with less useful networks.

Gathering Round Big Tech: How the market for acquisitions reinforces regional inequities in the U.S can be found here.