Acquisition Restrictions & US Startups: A Threat to Innovation

The Growing Scrutiny of Big Tech

For a considerable period, genuine bipartisanship has been rare in Washington. However, a shared focus has emerged among both Democrats and Republicans: increased examination of large Big Tech corporations.

Regulatory Efforts and Their Potential Impact

Numerous hearings have been conducted by congressional committees, and legal challenges alongside proposed legislation aimed at regulating privacy and data collection practices have been initiated. The consequences of these potential reforms for emerging companies and the venture capital firms that support them remain uncertain.

A specific area of heightened antitrust investigation – limitations on company acquisitions – poses a substantial risk to the vitality of the entrepreneurial landscape. Policymakers should therefore proceed with careful consideration before implementing such changes.

Concerns Regarding Acquisition Restrictions

Restrictions on acquisitions could significantly hinder the entrepreneurial ecosystem. This is because acquisitions often represent a crucial exit strategy for startups and a key source of returns for investors.

• Acquisitions provide financial incentives for innovation.
• They allow successful startups to scale rapidly.
• They foster a dynamic market where new ideas are rewarded.

Limiting these opportunities could stifle innovation and discourage investment in new ventures. A cautious approach to regulating acquisitions is therefore essential to preserve a thriving entrepreneurial environment.

Acquisitions: A Cornerstone of the Startup Landscape

Within the startup world, particularly for ventures supported by venture capital, there are fundamentally three potential outcomes: operating as an independent entity – frequently culminating in an Initial Public Offering (IPO), undergoing a merger or acquisition, or facing bankruptcy. While every effort is made to succeed, the unfortunate reality is that the majority of startups, exceeding 90%, ultimately fail.

However, the successes that do emerge often have a substantial impact, as demonstrated by companies like Moderna and Zoom, which provided critical solutions during the recent pandemic.

The IPO Dream vs. Acquisition Reality

Entrepreneurs typically begin their ventures with a strong aspiration of eventually establishing a self-sufficient, publicly traded company. Nevertheless, an IPO proves unattainable for most. The path of entrepreneurship is inherently difficult, and the progression from a nascent startup to a public company is a feat accomplished by a relatively small number of businesses.

As highlighted in Silicon Valley Bank’s 2020 Global Startup Outlook, most founders don't anticipate a public market exit. Consequently, a significant 58% of startups anticipate being acquired. Data from NVCA-Pitchbook on acquisitions and IPOs corroborates this founder sentiment regarding likely exit strategies.

Acquisition-to-IPO Ratios

In 2020, the ratio of acquisitions of VC-backed companies to IPOs stood at approximately 10:1, with 1,042 venture-backed companies being acquired compared to 103 entering the public markets.

Some suggest that the prevalence of acquisitions today is driven by anti-competitive practices of established technology companies. However, Patricia Nakache of Trinity Ventures, in her testimony before the Senate Judiciary Committee, noted that acquisitions have “been commonplace in the U.S. since before the dawn of the modern venture capital industry.”

Interestingly, current trends indicate fewer acquisitions relative to IPOs than in previous years. The average acquisition-to-IPO ratio since 2004 is approximately 15:1. This shift occurs amidst increasing difficulties in bringing smaller companies public, which has reduced the overall number of publicly listed companies.

The Positive Impact of Acquisitions

Acquisitions play a vital role in maintaining a healthy startup ecosystem. Entrepreneurs who achieve liquidity through the sale of their companies frequently embark on new ventures, founding innovative companies and often becoming angel investors or venture capitalists themselves.

Furthermore, acquisitions are instrumental in generating returns for VC funds. This allows VCs to secure new funding and invest in the next wave of entrepreneurs. This “recycling effect” is a key factor driving economic dynamism and should be encouraged.

Key Benefits of Acquisitions

• Entrepreneurs gain liquidity and can reinvest in new ventures.
• VC funds are replenished, enabling further investment in startups.
• Innovation is fostered through the continuous cycle of funding and creation.

Potential Impacts of Acquisition Regulations on Entrepreneurship

Acquisitions play a vital role in the business landscape, yet proposed antitrust reforms introduce substantial alterations to their governmental assessment. Two key pieces of legislation driving this change are Senator Amy Klobuchar’s Competition and Antitrust Law Enforcement Reform Act (CALERA) and Senator Josh Hawley’s Trust-Busting for the Twenty-First Century Act.

These legislative efforts stem from concerns that established companies proactively eliminate emerging competitors. However, both proposals risk hindering startup innovation and overall competition, rather than fostering it.

A central element of these bills is the restriction of acquisitions by organizations exceeding a $100 billion valuation. Specifically, Hawley’s bill advocates for a complete prohibition on acquisitions by companies of this size if they “lessen competition in any way.”

Klobuchar’s bill proposes a significant shift in the legal burden of proof during acquisition reviews. Currently, the U.S. government holds the responsibility to demonstrate anti-competitive effects; this bill would transfer that obligation to the acquiring parties. They would then be required to prove the acquisition does not “create an appreciable risk of materially lessening competition” to avoid being blocked.

Both of these proposals carry potentially adverse consequences for companies supported by venture capital.

Consider first the breadth of these proposed regulations: While a $100 billion company represents considerable size, this threshold encompasses a much wider range of businesses than just the large technology firms frequently discussed in antitrust debates. Approximately 150 companies worldwide are valued at $100 billion or more, with over 80 located within the United States. This extends potential scrutiny to diverse acquirers like Estee Lauder, John Deere, Starbucks, and Thermo Fisher Scientific.

Furthermore, the legal criteria established by these bills present significant challenges. Klobuchar’s proposal creates uncertainty for startups regarding permissible acquisition activity, while Hawley’s bill effectively halts a substantial number of transactions. This is particularly problematic given that acquirers typically seek companies that enhance their existing operations. Many of the most active acquiring companies also operate in multiple sectors, inherently competing with other businesses.

In conclusion, the legislation put forth by Klobuchar and Hawley threatens to disrupt a crucial component of the U.S. startup ecosystem. Acquisitions provide essential liquidity, enabling participants to pursue new ventures and contribute to the creation of improved companies. Slowing this process would be detrimental, especially when increased entrepreneurship is critically needed.

Acquisitions are a key mechanism for injecting capital and fostering innovation within the startup community.

Understanding the Proposed Legislation

• CALERA (Klobuchar): Shifts the burden of proof in acquisition challenges to the acquiring companies.
• Trust-Busting Act (Hawley): Proposes an outright ban on acquisitions by companies valued over $100 billion if they lessen competition.

These changes could significantly alter the landscape for venture-backed companies seeking exit strategies.

The Impact on Competition

Restricting acquisitions could inadvertently stifle innovation by limiting opportunities for startups to be integrated into larger organizations. This could lead to a decrease in overall competition.