Exit Junkies: When Equity Stifles Innovation

Startups and venture investors share a problem; “exit dependence.”  Equity investors can’t sustainably invest in startups without exits, because exits are how those investors get paid.  They must be able to sell their equity (i.e. stock) at a higher value through a merger/acquisition or IPO.  No exit, no returns.  There must be a “liquidation event.”  Startup funding is hooked on exits.

History makes a good argument for equity investing.  Venture capital has created more than 12 million jobs and over $2.9 trillion in corporate revenue since 1970 (and that’s just in the US).[1] Although the venture capital industry recently posted negative 10-year returns, $6.36 in corporate revenue was created for every dollar of venture capital invested between 1970 – 2008.[2] Meanwhile the average return for angel investor groups as of 2007 was 2.6 times the invested capital within 3.5 years (approximately a 27% IRR).[3] Not too shabby.

While a great start, exit dependence underpins why only around 1% of US startups attract equity investment in the first place, and that’s within one of the most stable, liquid, best understood securities markets in the world.  Entrepreneurs in most other nations have it far, far worse.

To the extent that economic vitality depends on innovation, innovation depends on equity investment, and equity investment depends on exits… there is a problem.  Exits are scarce.

In the heyday of 1991 – 2000, less than half of VC-funded companies had an exit.[4] Those were the good times.  In 2009 there was approximately 1 exit for every 10 deals funded (10%).[5] In other words, only around 1% of startups attract equity investment, and among them only around 10% equate to actual exits.  One tenth of one percent.

According to the University of New Hampshire’s Center for Venture Research, even those companies that did have IPOs between 2001 and 2007 had to wait an average of 10.9 years (when backed by angel investors) or 14.4 years (when backed by VCs).[6]

That’s a long time for investors to hold their breath, especially since most investments fail to exit at all.  According to the ACA, “the most sophisticated angels make at least 10 investments to make a return on their investment, counting on one or two to provide nearly all of their return.”[7]

Who has the stomach for all that, especially in today’s economy?  Turns out, fewer and fewer investors do.  Overall, angel investments were down 8.3 percent in 2009 from 2008 while angels more often shied away from riskier seed and start-up deals: new first sequence investments were only 47% of angel investments in 2009, a significant decline from the two prior years.[8]

The point is this: equity investing has been a tremendous benefit to society.  No argument there.  However, inherent structural limitations have made it unsuitable for all but approximately one tenth of one percent of startups nationwide.  What about the other 99.9%?  Surely at least some of the 99.9% have potential to make profoundly positive impacts on communities, economies, customers, employees and commercial ecosystems.  Is there a way to invest in them too, without requiring an exit?

This question is not an armchair triviality, it is a global alarm.  Exits rarely happen, making them a thin instrument upon which to hang the future of startup innovation worldwide.  Is there a 12-step program to cure our exit dependence?  Or… is our creativity so stunted – our addiction so complete – that we can’t fathom alternatives?  Are we destined to be exit junkies forever?


Thomas Thurston, President, Growth Science International, LLC

Bruce Pascoe, Visiting Researcher, Growth Science International, LLC

[1] Joint study by the National Venture Capital Association and HIS Global Insight, Venture Impact: The Economic Importance of Venture Backed Companies to the U.S. Economy, (2009)

[2] Joint study by the National Venture Capital Association and HIS Global Insight, Venture Impact: The Economic Importance of Venture Backed Companies to the U.S. Economy, (2009)

[3] Wiltbank & Boeker, Returns to Angel Investors in Groups, (November, 2007)

[4] http://venturecapital.doodig.com/2010/02/02/venture-capital-and-entrepreneurial-success-the-exit-funnel-and/ (Accessed June 22, 2010])

[5] See National Venture Capital Association & Thomson Reuters, Venture-Backed Exit Activity Shows Improved Signs of Life in Q1 2010; All-time Record for Venture-backed M&A Exits; Nearly All Venture-backed IPOs Trading Above Offer Price, (April 1, 2010); see also PricewaterhouseCoopers/National Venture Capital Association, MoneyTree Report; Total U.S. Investments by Year Q1 1995 – Q4 2009, (January 2010)

[6] UNH Center for Venture Research, Angel Investors, VCs Look At IPOs Differently, (http://www.unh.edu/news/cj_nr/2009/july/lw22cvr.cfm) (Accessed June 21, 2010)

[7] Angel Capital Association, The Value Of Angel Investors And Angel Groups, (http://www.angelcapitalassociation.org/data/Documents/Public%20Policy/Federal%20/Value%20of%20Angels%20FAQ%202009R.pdf), (Accessed June 22, 2010)

[8] UNH Center for Venture Research, The Angel Investor Market In 2009:  Holding Steady But Changes In Seed And Startup Investments, (http://wsbe.unh.edu/files/2009_Analysis_Report.pdf) (Accessed June 21, 2010)


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