Antitrust is in the news to an extent that it has not been for a generation. Senator Klobuchar (CALERA), senators Lee and Grassley (TEAMS Act), and, in a series of bi-partisan bills, various members of the House of Representatives all seek to rewrite antitrust law. In particular, these bills aim to limit merger activity that is focused on acquisitions of smaller companies by larger technology companies, with the proposals ranging from presumptions of anticompetitive effects to outright prohibitions.
In a new working paper, we focus on the often overlooked implications of a change in antitrust law for venture capital, start-ups, and exits for investors. The currently proposed bills, we argue, would chill venture capital and corporate venture capital investing because the primary exit method – acquisitions – would be limited. For hardware, software, biotech, finance, certain industrial applications, and other industries and businesses that are essentially built on acquisitions, such a change would fundamentally diminish the ability to innovate by changing business models and where firms allocate risk. Whether to make or buy and other fundamental choices would change by making it difficult and in some cases nearly impossible to pursue M&A-related exits. the incentives for investors to sell companies. The even greater danger is that entrepreneurial value and innovation might be destroyed) in the economy generally.
Our paper addresses these potentially negative implications of proposed antitrust legislation in general and focuses in particular on the venture capitalists (VCs) that fund the entrepreneurial ecosystem. First, the paper reviews how antitrust merger law currently works and how proposed legislative changes to antitrust may threaten the innovative VC-backed ecosystem that has made the United States the center of global innovation across many different industries. Accompanying this review are some empirical observations. Second, recognizing that understanding innovative entrepreneurial activity calls for a deep appreciation of those who back it, the paper provides an overview of the entrepreneurial ecosystem and the motivations of VCs. In so doing, it identifies the drivers of entrepreneurial innovation and explains why changes to merger law may threaten them.
Finally, the paper concludes that changes to merger law may diminish the benefits of the entrepreneurial ecosystem and U.S. innovation. The connections between mergers and those benefits are clear. Because a target firm is often a strategically complementary asset to the acquiring firm, the merger may lead to reduced transaction costs and asymmetric risk. The merger may also enable learning by doing, encourage knowledge transfers, reduce information leaks, improve investment coordination, and create R&D synergies. Mergers can also help companies adapt quickly to competitive threats from larger firms: Adding new products or features through acquisition can be less costly and time consuming than creating them from scratch.
We present a discussion of liquidity events, with a focus on M&A activity, through the lens of investors, founders, and their ability to deliver and benefit from consistent innovation. The focus of the current discussion is on the entrepreneurial ventures being acquired and the viability of their innovation. We highlight a related view that has to do with the health of the VC model as a whole, shifting attention for the specific ventures that are to be acquired and taking the broader view of the VC firms that funded those ventures and the firms’ ability to back other innovative ventures.
M&A plays a crucial role in the health of the VC ecosystem. We highlight this for two important reasons. First, many of the first-time funds launched in the last couple of years focus on inclusion and diversity, having been raised by investors of diverse backgrounds. Moreover, the new cadre of investors make it their mission to support founders of diverse backgrounds. As a result, smaller new funds often pursue innovation in sectors or places that have been neglected in the past. This suggests that acquisitions play a crucial role in the health of the VC ecosystem. This may be particularly so for first-time funds, where the time and ability to execute a deal can unlock the ability to raise a follow-on fund and further advance diversity and inclusion in the entrepreneurial ecosystem. Thus, a change in merger law may threaten such inclusion and diversity efforts.
Second, to the extent that incumbent acquirers may be precluded or delayed from accessing the broader universe of entrepreneurial ventures (because M&A has been limited or closed off), the entrepreneurial ecosystem may end up with “walled innovation gardens.” One concern is that such an approach effectively creates these walled gardens where only pre-selected startups can reach and win incumbents’ attention. This runs the risk of stifling innovation (for incumbents) and can also affect scale-up opportunities (for start-ups) and compensation for 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, may miss out on other and perhaps better innovations. For entrepreneurs, it implies that many would be unable to scale or sell their companies, especially if the trade-sale (sale of a venture-backed business) route is blocked. Finally, for VC funds, the shift of incumbents’ resources towards corporate-venture builders can decrease the availability of capital and the prospects for future funds in two ways: first, a decree ase in the number of established corporations that can serve as limited partners and, second, a decrease in M&A activity.
The world of entrepreneurship is complex. There is a history of poorly thought-out legal rules that negatively affect business growth and innovation. The proposed change in merger presumptions, motivated by the desire to increase the number of tech firms, will instead reduce M&A-exit opportunities for founders and VC investors, decrease the number of new VC funds, and may have a disproportionate impact specifically on the social-based investing that is aimed at increasing sustainability and diversity and that plays a large role in many first-time funds’ investment decisions. Limiting the number of companies that can make acquisitions through a proposed change in merger law constrains the ability of new ventures to exit. It also potentially chills incentives for such firms to scale up because they may be punished for being too. The costs in terms of reducing entrepreneurial exits are too great to justify a change in merger law.
This post comes to us from professors Gary Dushnitsky at London Business School and D. Daniel Sokol, currently at the University of Florida’s Levin College of Law but soon to be joining USC Gould School of Law and the USC Marshall School of Business. It is based on their recent paper, “Mergers, Antitrust, and the Interplay of Entrepreneurial Activity and the Investments That Fund it,” available here.