Competition laws could be a death knell for startup mergers and acquisitions
Technology entrepreneurs and innovations yet to be imagined are in the crosshairs of misguided antitrust legislation. Antitrust policy is under the microscope from both political parties.
The Biden administration’s Executive Order on Promoting Competition in the American Economy lays the groundwork for the first-ever antitrust regulations for technology companies and internet platforms, and proposed legislation by Sens. Amy Klobuchar (D-Minn.) and Josh Hawley (R-Mo.) would rewrite antitrust law. Both bills and the order seek to limit merger activity focused on acquisitions of smaller companies by larger technology companies, with their proposals ranging from presuming anticompetitive effects to outright prohibitions.
However, these proposals likely will have unintended consequences that would hamper innovation and entrepreneurship. The result is that certain potential deals will never leave the boardroom and others will be abandoned because the risks of antitrust intervention are too high.
For deals that do move forward, many will be challenged under more stringent merger laws. Such a change in the law will fundamentally alter the ability of U.S. companies to innovate in the technology sector, and result in collateral damage across a wide range of traditional industries such as biotech, consumer goods and finance, along with sustainability-focused or previously neglected sectors.
Investors and founders must be able to realize returns on their investments and efforts, commonly referred to as ‘entrepreneurial exit,’ or they will not take the risk of investing in startups and commercializing emerging technologies. Without the ability to exit, neither founders nor investors will be able to reap the gains of entrepreneurial value creation. If the proposed legislation becomes law, it will foreclose many merger and acquisition exits and thus lessen the incentives for founding and growing a business. It therefore makes investment in innovative ventures less likely since founders and investors cannot reap the rewards of a relatively timely exit at high valuations. When certain potential acquirers can no longer make acquisition bids, venture capital investors will lose the ability to make significant returns and funding to the entrepreneurial ecosystem may wither.
For the past two decades, acquisitions have constituted the most common entrepreneurial exit for U.S.-based VC-backed innovators. Not only do acquisitions account for the larger number of liquidity events, but they also cover a wide range of low and medium valuations. Why do larger companies acquire smaller ones? Most often, it is to unlock the power of complementary assets. That is, to combine the novel product or service from the startup with distribution channels, manufacturing capabilities, marketing prowess and regulatory expertise of the acquirer. These combinations are key to successfully and rapidly introducing innovation in the market, as has been demonstrated in numerous industries. But the proposed legislation would block a lot of the value creation through complementary assets that a combined company post-merger offers.
A change in merger rules also hurts efforts at diversity and inclusion. Many first-time VC funds introduce investors of more diverse backgrounds. Moreover, the new cadre of venture capitalists make it their mission to support founders of diverse backgrounds. As a result, smaller new funds often pursue innovation in companies, sectors or geographies that have been neglected in the past. Yet, it is these funds and companies that may be most affected by a decrease in rewarding acquisitions.
The proposed legislation may also change the structure of innovation. To the extent that large incumbents are precluded or delayed from accessing the broader universe of entrepreneurial ventures, legislation may create ‘walled innovation gardens.’ Within those walls, new ideas may be cultivated but only pre-selected startups can reach and win incumbents’ attention. This runs the risk of stifling innovation (for incumbents) and also can impact scale-up opportunities (for startups) and compensation and longevity of the VC funds that backed them.
For incumbents, the risk is that they draw from a limited pool of innovators and, therefore, miss out on other/better innovations beyond the focal pool. For entrepreneurs, it implies that many would be unable to scale or sell their companies, especially if the acquisition route is blocked. Finally, for VC funds, the shift of incumbents’ resources towards corporate venture builders can decrease capital availability and the prospects of future funds in two ways: first, a decrease in established corporations as an important source of limited partners in their funds, and second, a decrease in M&A activity.
The world of entrepreneurship is complex. There is a history of poorly thought-out legal rules negatively impacting business growth and innovation. The proposed antitrust legislation imposing limits on mergers by incumbent firms, motivated by a desire to increase the number of tech firms competing, will instead reduce M&A exit opportunities for founders and the VC investors who back them. It may also decrease the number of new VC funds founded, and could have a disparate impact specifically on social-based investing relating to sustainability and diversity that plays a large role in many first-time funds’ investment decisions. Policymakers should think carefully about these likely impacts before endeavoring to rewrite U.S. antitrust laws.
Gary Dushnitsky is an associate professor of Strategy and Entrepreneurship at London Business School. He also serves as a senior fellow at the Mack Institute for Innovation Management at the Wharton School of the University of Pennsylvania. His work focuses on the economics of entrepreneurship and innovation. He explores the shifting landscape of entrepreneurial finance, exploring such topics as corporate venture capital, crowdfunding and accelerators.
Daniel Sokol is a professor of Law and affiliate professor of Business at the University of Florida. He focuses his teaching and scholarship on complex business issues from early stage start-ups to large multinational businesses: entrepreneurship, compliance, innovation, antitrust, M&A, and digital transformation.
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