Are Exit Strategies Hurting Innovation?


During the Think Tank that I participated in at Dell World, the topic of conversation turned to startups.  Specifically, how do startups drive innovation?  As I listened to the folks around the table like Justin Warren (@JPWarren) and Bob Plankers (@Plankers) talk about the advantages that startups enjoy when it comes to agility, I started to wonder if some startups today are hurting the process more than they are helping it.

Exit Strategy

The entire point of creating a business is to make money.  You do that by creating a product that you can sell to someone.  It doesn’t have to be a runaway success.  So long as you structure the business correctly you can make money for a good long while.  The key is that you must structure the business to pay off in the long run.

Startups seem to have this idea that the most important part of the equation is to build something quickly and get it onto the market.  The business comes second.  That only works if you are playing a very short game.  The bad decisions you make in the foundation of your business will come back to bite you down the road.

Startups that don’t have a business plan only have one other option – an exit strategy.  In far too many cases, the business plan for a startup is to build something so awesome that another larger company is going to want to buy them.  As I’ve said before talking about innovation, buying your way into a new product line does work to a point.  For the large vendor, it is dependent on the available cash on hand.  For the startup, the idea is that you need to have enough capital on hand to survive long enough to be bought.

Looking For A Buyer For The End Of The World

There’s nothing more awkward than a company that’s obviously seeking a buyout from a large vendor that hasn’t received it yet.  I look at the example of Violin Memory.  Violin makes flash storage cards for servers to accelerate caching for workloads.  They were a strategic parter of HP for a long time.  Eventually, HP decided to build those cards themselves rather than rely on Violin as a supplier.  This put Violin in a very difficult position.  In hindsight, I’m sure that Violin wanted to be bought by HP and become a division inside the server organization.  Instead, they were forced to look elsewhere for funds.  They chose to file an initial public offering (IPO) that hit the initial target.  After that, the parts of the business that weren’t so great started dragging the stock price down, angering the investors to the point where executives are starting to leave and lawsuits look likely.

Where did Violin go wrong?  If they had built a solid business in the first place they might have been able to keep selling along even though HP had decided not to buy them.  They might have been able to stay afloat long enough to find another buyer or file an IPO when they have a more stable situation with earnings or expenses.  They might have been able to make money instead of losing it hand over fist.

The Standoff

The idea that startups are just looking for a payday from a larger company is hurting innovation.  Startups just want to get the idea formed enough to get some interest from buyers.  Who cares if we can make it work in reality?  We just have to get someone to bite on the prototype.  That means that development is key.  Things like payroll and operating expenses come second.

In return, companies are becoming skittish of buying a startup.  Why take a chance on a company that may not be around next week?  I’d rather spend my time on internal innovation.  Or, better yet buy that failed startup for pennies on the dollar when they liquidate due to inability to manage a business.  Larger companies are going to shy away from startups that want millions (or billions) for ideas.  That lengthens the time that it takes to innovate, either because companies must invest time internally or spend countless hours negotiating purchases of intellectual property.

Tom’s Take

Obviously, not all startups have these issues.  Look at companies like Nimble Storage.  They are a business first.  They make money.  They don’t have out-of-control expenses.  They filed for an IPO because it was the right time, not because they needed more money to keep the lights on.  That’s the key to proper innovation.  Build a company that just happens to make something.  Don’t build a product that just happens to have a business around it.  That means you can continue to improve and innovate on your product as time goes on.  It means you don’t have to look for an exit strategy as soon as the funding starts running dry.  Then your strategy looks more like a plan.

3 thoughts on “Are Exit Strategies Hurting Innovation?

  1. Tom a couple of points:

    The drive for an exit strategy comes from two places. The first,and biggest. driver are the VC firms. Their whole business strategy is to invest in startups and get the money out either by selling the startup to a bigger company or by selling off their shares after the IPO. They can then reinvest the funds in the next startup. Since tech firms almost never pay significant dividends that’s only way the VCs can give the investors in their funds a return on their investment. Unlike private equity firms VCs don’t charge management fees to their portfolio companies.

    The other driver is a lack of respect for slower growing businesses that don’t have the potental to make their owners billionaires. As you walk around VMworld or a similar event there are lots of little booths with companies that do $30 million in software business and net their owners $250,000-$3,000,000 a year. The problem is you can’t be a storage vendor at that scale.

    Finally re:Nimble they just had a very successful IPO and I agree unlike Violin where the CEO’s incentive to get millions of shares if there was an exit made it a company built for exit not the long term you’re mistaken when you say they’re making money. They lost almost $30 million in the last 9 months.

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