Beach Money Exits

Abstract

The capital structure of fast-growing startups makes them vulnerable to value-destroying acquisitions. Founders in early-stage startups own a large fraction of their company’s equity, which gives them powerful incentives to deliver growth. But there is an underappreciated downside to tying founders’ net worth so tightly to one risky, illiquid asset. When a fast-growing startup receives an acquisition offer for less than its expected value, founders may push their board to take it. Founders may prefer an exit that would diversify their risk and give them financial security for life — beach money — to the uncertain prospect of even greater wealth later. Venture capitalists contract for the right to block this kind of acquisition, but their veto threat will not be credible if the startup’s continued growth requires the founders’ cooperation. Corporate law may not provide a remedy either because the source of a founder-director’s apparent disloyalty is difficult to prove: the subjective value they place on an otherwise legitimate payout. These beach money exits impose a hidden tax on innovation. When an acquirer’s bid is lower than a startup board’s estimate of the expected value of remaining independent, an acquisition may transfer control of the startup’s assets to a business that will put them to a less productive, and possibly anticompetitive, use. The difficulty of preventing these inefficient acquisitions reveals the limits of private ordering.

Keywords: startups, acquisitions, venture capital, corporate law, contracts

JEL Classification: K22, K12