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Many lawmakers are eager to curb the power of the biggest tech companies: Amazon, Apple, Facebook, and Google.
But some of their proposals could actually hurt the smaller businesses they are supposed to protect, venture capitalists warned CNBC.
VCs are particularly concerned about Congress’s efforts to limit mergers and acquisitions through dominant platforms. Some of these proposals would work by shifting the burden of proof in merger cases to these companies to show that their businesses do not harm competition.
While proponents argue that such bills would prevent so-called killer acquisitions, where big corporations leverage potential rivals before they can grow – Facebook’s $ 1 billion acquisition of Instagram is a common example – tech investors say they are are more concerned about how the bills buy the market for startups and discourage further innovation.
Of course, venture capitalists and the groups they represent have an interest in keeping a relatively easy route to getting out of their investments. A trading group that represents VCs, the National Venture Capital Association, has venture arms from several big tech firms among its members. (Comcast, the owner of CNBC’s parent company NBCUniversal, is also a member.)
However, their concerns highlight how changes to antitrust law will affect well beyond the largest companies, and how smaller players may have to adapt if they are passed.
Why startups are acquired
When venture capitalists invest in a start-up, their goal is to get a high return on their expenses. While most startups fail, VCs rely on the minority to have enough exits to justify their remaining investments.
There are two ways to exit: through an acquisition or through an IPO. If one of these events occurs, investors can get at least some of their money back and, at best, reap big profits.
According to the NVCA, around ten times as many startups exit through acquisitions as through IPOs. Venture capitalists say this number shows the importance of keeping the merger path clear.
The top 5 tech firms aren’t the only ones making tech deals. Amazon, Apple, Facebook, Google and Microsoft account for about 4.5% of the value of all tech deals in the US since 2010, according to public data compiled by Dealogic.
Reform proponents have pointed to some acquisitions, like Instagram’s through Facebook, as examples of companies selling before they have a chance to become independent rivals to larger companies. But VCs say this is often not the case.
“They all think that one day they could be publicly traded, but the reality is that for most of these companies it is not realistic to grow the size and scale to survive the public markets starting today,” said Michael Brown. General partner at Battery Ventures.
While going public is often the goal, VCs can be impractical for startups for a number of reasons.
First, some startups may simply not have a product or service that will function as a stand-alone company over the long term. This doesn’t mean that their technology or talent isn’t valuable, just that they could be most successful in a larger company.
Kate Mitchell, co-founder and partner at Scale Venture Partners, gave the example of a company called Pavilion Technologies that made predictive technology for manufacturers and agriculture and sold it to manufacturing company Rockwell Automation in 2007.
“This is a company that just couldn’t escape the pace,” she said of Pavilion. “Because they were selling to large factories around the world, we couldn’t figure out how to sell the technology cheaply.”
It’s still a useful technology, but it needs the infrastructure of a larger company to keep accelerating, she said. After Rockwell acquired it, it was added to their offering and several employees stayed for years.
Sometimes a takeover is the last resort before bankruptcy and at least helps investors get some of their money back.
“It is better that they are sold for 80 cents a dollar than that they go bankrupt,” she said.
Additionally, going public can be difficult. The IPO process is expensive, and VCs said that small-cap companies often struggle in the public market, in part due to a lack of analyst coverage of such companies.
Clate Mask, co-founder and CEO of venture-capital-funded email marketing and sales platform Keap, said greater merger restrictions on the largest companies would likely “change the mindset for startups.” But the shift wouldn’t be between getting and buying and going public. Instead, he said, it might encourage entrepreneurs to think harder about raising venture funding at all.
“When you have capital behind you, you can think and act differently,” he said, adding that with that support, entrepreneurs can take more risks.
Loss of investment and innovation
Several VCs told CNBC they were concerned about the trickle-down effect that merger restrictions for the largest companies would have on the entire entrepreneurial ecosystem.
They fear that institutional investors who support VCs – such as foundations and pension funds – will put their money elsewhere when companies no longer have enough viable exit routes. In turn, venture capitalists have fewer resources to provide to entrepreneurs who may see fewer reasons to take the risk of starting a new business.
Ultimately, it is about innovation losses, which the legislature wants to ward off with merger restrictions for the largest buyers.
“If you limit the potential for exciting rewards and returns on investments, entrepreneurs could spend their time elsewhere,” said Patricia Nakache, general partner at Trinity Ventures.
Nakache said limiting the ability of the largest tech companies to make acquisitions could actually deter entrepreneurs from building companies that compete with their core businesses. That’s because many business owners like to have a backup plan that includes potential buyers when they can’t go public. Given the greater uncertainty about whether the big tech companies might be potential buyers, they could try to build deals outside of the core offerings of the biggest players, she said.
VCs also warned that without the biggest players in the mix, sales prices for startups would drop significantly.
But outside of the industry, some believe these concerns won’t be as bad as VCs fear.
“These types of laws, when they work as intended, will generally have a more competitive marketplace, so there will be more potential buyers,” said Michael Kades, director of markets and competition policy at the nonprofit Washington Center for Equitable Growth. “I understand if you’re at VC today, you’re worried about the next few years, or what your business may get, but increasing the number of potential business buyers … also means it’s still a very thriving one.” Market for these types of acquisitions, just not through dominant companies. “
Bhaskar Chakravorti, dean of global business at Tufts University’s Fletcher School, said while venture capitalists are likely right that acquisition prices could fall under new merger restrictions, entrepreneurs will still have an urge to innovate.
“Ultimately, people will adjust, and yes, some of the reviews, some of the tenders might be stunted. Some of the acquisitions might cost ten or 20% less,” he said. “But in the end, I don’t think it’s going to make that much of a difference because entrepreneurs take ideas, build them, put teams together, and venture capital needs a place.” invest.”
Kades agreed that good ideas are likely to get funding even if the biggest companies can’t bid or have a harder time making an acquisition. Restricting mergers between these companies is about “trying to limit the anti-competitive premium,” he said.
Move capital
VCs also fear the new rules could accelerate the shift of venture investing outside of the US
Mitchell said while other countries, including Canada, have incentivized entrepreneurs to get and stay within their limits, regulations under consideration in the U.S. will deter them.
“We’d make it difficult to be an entrepreneur in her country right now at a time when everyone else is trying to make it attractive,” she said.
According to the NVCA, the US share of global venture capital has fallen from 84% to 52% over the past 15 years. So lawmakers shouldn’t rest on their laurels that US venture capital can compete with the rest of the world under new arduous regulations, argue VCs.
But Chakravorti didn’t think the merger laws would spur investment outside of the U.S. as many alternatives are worse.
“There are very few alternative locations,” he said. China exits would come with increased scrutiny, and Europe is known for a clumsy approach to business regulation.
However, should stricter merger laws be passed, he should consider throwing a broader net for potential buyers when the time comes to get out of an investment. That could include more international buyers than he would otherwise consider.
Nakache said should merger reforms pass, she might consider investing more in startups whose potential buyers would not be affected by the law. For example, if corporate platforms like Salesforce or Oracle fail to meet the threshold for more stringent merger enforcement, VCs could shift their spending from areas like search and social media to software as a service.
Open to some reforms
Some of the VCs interviewed by CNBC felt that existing antitrust laws were appropriate, but others admitted that reforms outside of mergers could be beneficial.
Restrictions on platforms that use the data they collect to compete with companies that rely on them are an example that could help improve the playing field if done right, Nakache suggested.
Mitchell said the most helpful change would be to create more consistency in how antitrust laws are enforced, especially from one government to the next.
Mask, the CEO of Keap, said he wasn’t against Congress taking action to curb the power of big tech companies, but most entrepreneurs recognize that these companies are “good for the ecosystem” as a whole.
“These big tech companies are helping to drive much of the momentum for the entire sector,” he said. “And I think it’s also a great thing to let them break up in an extremely aggressive way.
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