The phenomenon of “beach money exits” — startup founders accepting large but low-ball offers to sell — is a pertinent threat to venture capital investors, according to VC researcher Matthew Wansley.
“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,” wrote Wansley, a professor at Yeshiva University’s Cardozo School of Law, in a forthcoming paper for the Journal of Corporation Law.
“Beach money exits have remained a hidden problem,” he explained, “because VCs have an incentive to declare an acquisition of one of their portfolio companies a success, even if they privately disagreed with the decision to exit.”
Even when company backers want to wait for a better buyout bid, founders often have the power to override investors and compel the sale, Wansley argued. VCs may have the power on paper to veto such transactions, but using that power may mean losing the cooperation of founding executives. Their involvement is often critical to a company’s continued success after it has changed hands.
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It’s impossible to put a number on the frequency of beach money exits, the paper noted, because identifying them requires insight into boardroom negotiations.
But existing research has established founders are more risk-adverse than investors in selling decisions, and Wansley’s work detailed how contract law and social norms empowers these leaders to make suboptimal deals for their own companies.
“Beach money exits destroy value if the new owners of the assets are unable or not motivated to extract as much value out of those assets than the old owners would have been,” the professor wrote. “The inefficiency of a beach money exit is the opportunity cost of what the startup might have become had it remained independent.”
Venture capital’s business model explains “why VCs hate beach money exits,” he continued. “Startups that return 10-times are hard to find. A startup with an early acquisition offer that represents a 2 to 5-times return may sound like a success to laypeople, but to VCs, a beach money exit is a missed opportunity to hit a grand slam.”