Congress has stepped up its focus on large technology platforms. The current emphasis is how our nation’s antitrust laws can be changed to address the power of these companies. One of the proposed solutions is restricting or forbidding acquisitions of smaller companies, which would hurt VC-backed companies due to the importance of acquisitions to the startup ecosystem. Instead of making the startup ecosystem collateral damage in this fight, Congress should encourage the creation and growth of new companies across a broad range of industries. This is the most effective way to increase competition in the U.S. economy.
What Washington Wants From Big Tech
The House of Representatives Judiciary Committee recently passed the Platform Competition and Opportunity Act (H.R. 3826), which is effectively a ban on acquisitions by Apple, Alphabet, Amazon, and Facebook. The bill made it out of committee but with “no” votes from three key Democrats – Representatives Zoe Lofgren (D-CA); Eric Swalwell (D-CA); and Lou Correa (D-CA)—and all but a few Republicans. Other prominent acquisition restriction bills include the Competition and Antitrust Law Enforcement Reform Act from Senator Klobuchar (D-MN) and the Trust-Busting for the Twenty-First Century Act from Senator Hawley (R-MO).
New Antitrust Analysis
I have written in TechCrunch about how the proposals from Senators Klobuchar and Hawley would harm the entrepreneurial ecosystem. Recently, two academics, Professor Daniel Sokol of the University of Southern California and Gary Dushnitsky of the London Business School, released a new report that raises serious concerns with legislation that restricts or bans acquisitions. It offers a compelling look at the data to underscore why acquisitions are a vital part of new company formation. In addition, the report delivers four key lessons that policymakers should consider before moving forward with acquisition restrictions.
1. Acquisitions are vital to the entrepreneurial ecosystem
The congressional debate around antitrust and acquisition restrictions is heavily tilted toward how reforms will impact large tech companies. NVCA has championed the perspective of VC-backed companies and encouraged policymakers to consider how changes in the law would impact growth companies. The report underscores the importance of acquisitions in this way:
Without the ability to exit as well as having that ability reduced by having one major off-ramp closed off (i.e., acquisition), neither founders nor investors will be able to reap the gains of the appreciation in the valuation of the business. Increasing difficulty in entrepreneurial exits for founders and investors makes future investment in such ventures less likely, since founders and investors cannot reap the rewards of a timely exit at acceptable valuations.
Policymakers should heed this warning and recognize that undermining acquisitions would send a discouraging signal to founders and early employees who in many cases need an acquisition to realize the value of their company. After all, often the stock these company builders hold is illiquid, and the sale of a company is the only opportunity for entrepreneurs and their investors to realize value from their creation.
2. Some deals will die in the board room
As NVCA has engaged with Members of Congress on acquisitions, a common refrain is that under certain proposals the parties to an acquisition will still have an opportunity to make their case to the government that a deal is pro-competitive. But Professors Sokol and Dushnitsky argue that “certain potential deals will never leave the boardroom and others will be abandoned because the risks of antitrust intervention are too high.” In other words, companies will never reach the point where a case is made to the government about competition concerns.
Policymakers must appreciate that many growth companies are not well-positioned to endure months or years of uncertainty and costs in a legal or regulatory process if at the end of the process the government might slam the door on the transaction. That is an unfortunate outcome for entrepreneurs who are motivated to engage in entrepreneurial activity due to the potential for a lucrative exit.
3. IPOs have dropped precipitously, making acquisitions more important
For venture-backed companies there are effectively three outcomes: standalone company (often via initial public offering); merger or acquisition; or bankruptcy. Company failure is the most common outcome, but the success stories are often hypergrowth companies with an outsized impact on innovation, competition, and job creation. Many entrepreneurs and their investors begin the company building process with the hope of creating a standalone, public company. But building a public company is incredibly hard—and has gotten harder—as evidenced by the significant drop in IPOs.
Professor Jay Ritter of the University of Florida has presented alarming evidence of challenges in the public markets for small capitalization companies. The number of IPOs per year post-2000 has dropped by more than half relative to the preceding two decades. Companies going public are older than they used to be – the average age of a company undergoing an IPO in the last decade was about 10.7 years as compared to 7.5 years in the 1980s and 8.5 years in the 1990s. Far fewer small capitalization companies go public: between 1980-2000, companies with less than $50 million in annual sales made up about 50 percent of IPOs; post-2000 that number has dropped to about 25 percent.
Given these public market dynamics for VC-backed companies, now is a particularly troubling time for policymakers to foreclose or limit acquisitions as an exit opportunity for entrepreneurs and their investors.
4. Acquisition restrictions hurt the health of the startup ecosystem
Members of Congress love to tout the benefits of entrepreneurship, be it Moderna that created a COVID-19 vaccine, Zoom that enabled communication during the pandemic, or many other innovative solutions that stepped up to meet society’s challenges. But what some fail to understand is these companies are only possible because of a healthy entrepreneurial ecosystem that is impacted by public policy. Restricting acquisitions of VC-backed companies would harm this ecosystem and the broader economy. The report from Professors Sokol and Dushnitsky concludes that acquisition restrictions will particularly harm first-time venture funds that rely on acquisitions, as well as corporate venture capital activity that has become an important source of capital for founders.
The outlook is uncertain for legislation that stifles acquisitions. NVCA will continue to work with policymakers as they consider changes to antitrust laws to ensure that startups and scaleups are not harmed in the process. Those in the entrepreneurial ecosystem should inform policymakers of the importance of acquisitions. It is not always intuitive that attempts to thwart larger companies would impact smaller ones, but it is a point that policymakers are sensitive to once presented with the evidence. Like other policy debates, it is important that the venture community and entrepreneurs speak with one voice to protect the vibrant entrepreneurial community that sets our country apart.
Jeff Farrah serves as General Counsel at NVCA, where he advocates before Congress, the White House, and agencies for pro-entrepreneurship policies and leads in-house legal matters for the association. He loves working at the intersection of venture, public policy, and the law. Jeff concurrently serves as Treasurer of VenturePAC, the political action committee of NVCA.