In 1986, pharmaceutical giant Eli Lilly acquired Hybritech, at the time a seven-year-old San Diego, California-based biotechnology firm. Shortly after the acquisition, the CEO and the CFO of Hybritech left Eli Lilly to start their own venture capital firm. This venture capital firm funded several start-up ventures created by former Hybritech employees. In total, Hybritech directly or indirectly spawned 13 biotechnology companies in the San Diego area. Thus, this single acquisition created a surge of entrepreneurial activity for the region.
This example illustrates a general phenomenon: acquisitions and initial public offerings (IPO) of nascent, start-up companies in a geographical region increase the founding rates of other new companies in the same region. In other words, a geographical area with a steady stream of successful start-ups that either get acquired or go public will beget other start-ups. Setting up such a virtuous circle increases the level of entrepreneurship in the region and in turn boosts the economic health of the region.
Thus, from a policymaker?s standpoint, entrepreneurship can be catalysed by factors that enable IPOs and acquisitions of young, start-up companies. For example, a takeover code that facilitates rather than inhibits takeover of firms can be such an enabling factor. Similarly, corporate tax changes that reduce the tax burden imposed on such transactions can play an enabling role.
The executive and senior technical ranks of successful start-up organisations include individuals who have a high potential for repeat entrepreneurship, particularly in businesses that involve technically sophisticated products and production processes. Moreover, these are the individuals best equipped to create new ventures. Yet, the lack of financing often acts as a spoiler for such employees, with latent entrepreneurial aspirations.
Acquisitions and IPOs represent ?liquidity events? for the senior executives and researchers in a start-up firm. Before the acquisition or the IPO, these executives hold stock in a privately held, early stage start-up company. Given that this stock is not a liquid asset, IPOs or acquisitions typically represent the first opportunity for insiders to extract significant financial gains from their participation in the start-up. When the start-up?s stock begins trading on a public market, high-level employees are able to sell their shares after the lock-up period expires. Thus, insiders? ownership stakes become liquid assets following the company?s transition to public status.
Similarly, if an established, publicly listed firm acquires the start-up, executives and researchers in the start-up get to convert the stock they held in the start-up to the publicly listed acquirer?s stock. Therefore, as in the event of an IPO, liquidity also follows a publicly traded firm?s acquisition of the privately held start-up.
These liquidity events stimulate entrepreneurial activity in a geographic area because they weaken the financial bonds that tie senior executives and researchers to their current employers. The cash that company leaders get from selling their stock can be used to subsidise the creation of a new venture, or give them time to raise more capital. Thus, the inflow of cash removes an important hurdle in the pursuit of other entrepreneurial opportunities.
High visibility IPOs also enhances the career opportunities for members of the firm?s management team. Leading a new venture to a successful liquidity event sends a compelling message about a manager?s abilities in the uncertain world of entrepreneurship. Venture capitalists, for instance, feel more comfortable sponsoring entrepreneurs with a track record of success. Therefore, the likelihood that an entrepreneur can attract the resources to build a strong company increases once he or she has previously led an organisation to an acquisition or IPO. These entrepreneurs will be better able to mobilise capital, and may have a greater incentive to depart from their current employer because of the structural changes created by a recent liquidity event.
The author is assistant professor of finance at Emory University, Atlanta, and a visiting scholar at ISB, Hyderabad