Competition laws could be a death knell for startup mergers and acquisitions

Technology entrepreneurs and as yet unimaginable innovations are in the crosshairs of a failed cartel legislation. Antitrust policy is being scrutinized by both political parties.

The Biden Administration Executive Order to Promote Competition in the American Economy lays the foundation for the first antitrust regulations for technology companies and internet platforms and suggested legislation from Sens. Amy KlobucharAmy KlobucharBiden’s raid on misinformation reveals partisan divisions over content reform Biden Appoints Big Tech Critics to DOJ Antitrust Role The White House Sees A Cool Fight With Facebook MORE (D-Minn.) And Josh HawleyJoshua (Josh) David HawleyPoll: Trump leads the 2024 GOP area code, followed by Pence, DeSanti’s US dollar administration to pay for congressional infrastructure plans The White House sees a cool battle with Facebook MORE (R-Mo.) Would rewrite antitrust law. Both bills and the resolution aim to limit merger activities that focus on the acquisition of smaller businesses by larger tech companies, with proposals ranging from anti-competitive effects to outright bans.

However, these proposals are likely to have unintended consequences that would hamper innovation and entrepreneurship. The result is that certain potential deals never leave the boardroom and others are abandoned because the risks of antitrust intervention are too high.

For businesses that move forward, many are challenged under stricter merger laws. Such a change in the law will fundamentally change the ability of US companies to innovate in the technology sector and lead to collateral damage in a variety of traditional industries such as biotechnology, consumer goods and finance, as well as sectors that are sustainability-oriented or previously neglected sectors.

Investors and founders must be able to generate returns on their investments and efforts, which is commonly referred to as an “entrepreneurial exit,” or they do not run the risk of investing in startups and commercializing new technologies. Without the opportunity to exit, neither founders nor investors will be able to reap the profits of the company’s added value. If the proposed law becomes law, it will prevent many mergers and acquisitions, reducing the incentives for starting and growing a business. This makes investments in innovative companies less likely, as founders and investors cannot reap the rewards of a relatively timely exit to high valuations. When certain potential acquirers become unable to submit tender offers, venture capital investors lose the opportunity to generate significant returns and funding for the business ecosystem can wither.

Over the past two decades, acquisitions have made the most common corporate exit for US-based VC-backed innovators. Acquisitions not only make up the greater number of liquidity events, they also cover a wide range of low and mid-range valuations. Why do larger companies acquire smaller ones? In most cases it is about unlocking the power of complementary assets. That means combining the new type of product or service of the startup with sales channels, manufacturing capacities, marketing competence and regulatory know-how of the buyer. These combinations are the key to a successful and rapid market launch of innovations, as has been shown in numerous industries. But the proposed legislation would block much of the added value from complementary assets that a combined company will offer after the merger.

Changing the rules of merger will also harm diversity and inclusion efforts. Many first-time VC funds Introduce investors from different backgrounds. In addition, the new cadre of venture capitalists has set itself the task of supporting founders from different backgrounds. As a result, smaller new funds often innovate in companies, sectors or regions that have been neglected in the past. However, these funds and companies may be hardest hit by a decline in profitable acquisitions.

The proposed legislation can also change the structure of innovation. To the extent that large established companies are excluded or delayed from accessing the wider universe of entrepreneurial ventures, legislation can create “walled gardens of innovation”. Within these walls, new ideas can be cultivated, but only pre-selected startups can reach and win the attention of established companies. This carries the risk of stifling innovation (for established companies) and can also affect scale-up opportunities (for startups) as well as the compensation and longevity of the VC funds that have supported them.

Established companies run the risk of drawing from a limited pool of innovators and therefore missing out on other / better innovations outside of the focus pool. For entrepreneurs, this means that many cannot scale or sell their companies, especially when the acquisition path is blocked. Finally, in the case of VC funds, the relocation of incumbents’ resources to corporate venture builders can reduce capital availability and prospects for future funds in two ways: first, a decline in incumbents as a major source of limited partners in their funds, and second, a Decline in M&A activity.

The world of entrepreneurship is complex. There is a history of poorly thought out legal regulations that have a negative impact on business growth and innovation. The proposed antitrust law, which limits mergers of incumbent companies, motivated by a desire to increase the number of competing tech companies, will instead reduce M&A exit opportunities for founders and the VC investors they support. It could also reduce the number of start-up VC funds and, in particular, could have very different effects on socially-based investing in terms of sustainability and diversity, which plays a large role in the investment decisions of many first-time investors. Policy makers should carefully consider these likely implications before venturing into rewriting US antitrust laws.

Gary Dushnitsky is Associate Professor of Strategy and Entrepreneurship at the London Business School. He is also 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 changing landscape of corporate finance and examines topics such as corporate venture capital, crowdfunding and accelerators.

Daniel Sokol is Professor of Law and Associate Professor of Business at the University of Florida. He focuses his teaching and his scholarship on complex business issues from early-stage start-ups to large multinational companies: entrepreneurship, compliance, innovation, antitrust law, M&A and digital transformation.

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