Innovation & Startup Ecosystem at Risk: Revamping the U.S. M&A Regulatory Framework

By SBE Council at 5 July, 2022, 1:50 pm

ICYMI – M&A Regulatory Revamp: Is the Innovation Ecosystem at Risk?

In case you missed it, on June 28 in Washington, DC, Concurrences Review hosted a timely event called “M&A Regulatory Revamp: Is the Innovation Ecosystem at Risk?” Hosted by the Small Business & Entrepreneurship Council (SBE Council), Seyfarth, and the Small Business Roundtable, expert panelists provided important insight into what’s at stake with regard to potential regulatory changes and proposed legislation, given M&A’s importance to supporting startups, small business growth, driving innovation, and the positive impact on the overall U.S. economy and its competitiveness.

You can find a recording of the event here.

Below you will find key insights and quotes from the experts and speakers who joined us for this event.

The Importance of M&A to Startups and Small Businesses

“M&A activity is very important activity for our economy, our competitiveness, and for the vibrancy of the U.S. economy. As Congress considers and debates competition legislation to help us better compete with China and across the globe, preserving what we have with regard to policy and incentives is a very important piece for them not to forget…potential rule changes and legislative proposals could upend a system that is working rather well in incentivizing small businesses and startups to create and develop amazing innovations that are then connected to the scale and resources they need – in this case an acquisition – that can bring that innovation to its full potential and to the benefit of many consumers. ” – Karen Kerrigan, president & CEO, Small Business & Entrepreneurship Council

“I can’t begin to tell you with 35 years of emotion how critical it is to keep the M&A highway without speed bumps and toll booths and unencumbered pathways to exit. Our small businesses across the country, many that are not venture backed, are relying on a pathway to exit and many of them are relying on exit via merger and acquisition, and in particular Davids selling to Goliaths. If we take away or make too encumbered their pathway, the unintended consequences are severe. This is not just a policy issues, but a community issue, it’s a wealth creation issue. In the non-venture capital world, almost no non-venture backed companies will find their way to the public markets, their exit either is to sell to their employees, or sell to a larger company or a competitor.” – Andrew Sherman, Partner, Seyfarth

“The most common positive outcome that can happen to an entrepreneur is that they go through some M&A type of acquisition, and the least of the most common outcomes is that they go into the public markets. The reason is that the public markets have become more and more hostile over the years to small and medium-cap companies.” – Jeff Farrah, General Counsel, National Venture Capital Association (NVCA)

“We as founders would have loved to scale our first company, but there were not resources available for that. Many entrepreneurs see that they can’t scale unless they become part of a larger company. I have seen my friends who sold their companies to bigger companies to then see what really great things can be done once you have more resources at your disposal. And they are thrilled at what has become of their products. They have been able to build large business units and increase the number of jobs that are associated with what they have built. Acquisitions have a real role in making this happen.” – Bettina Hein, Founder, Juli, Serial Entrepreneur

“Many entrepreneurs don’t regard themselves as scalers and growers of companies. They regard themselves as founders, as entrepreneurs, as establishers and that’s what they love to do – found companies and establish them and work to get them on their feet and sell, and go out there and do it again.” – John Dearie, President, Center for American Entrepreneurship

“A robust M&A system drives the startups that drive the innovation that we all benefit from. For startups not in the big ecosystems like Silicon Valley, M&A becomes the only feasible exit and is critical to building [local] ecosystems and economic growth.” – Nathan Lindfors, Policy Manager, Engine

“The U.S. economy is very much a small business economy. And the big jump in new business applications and self-employment is moving in the right direction. Acquisitions are a key option for entrepreneurs, as our latest startup survey showed 13% want to be acquired. Going public is very expensive and not an option for the vast majority of these startups.” – Raymond Keating, chief economist, Small Business & Entrepreneurship Council

Value Creation and Benefits of M&A

“Research shows that a prominent feature of the current startup ecosystem is the frequency with which entrepreneurs purposely develop new technologies targeted at acquisition by established firms for incorporation into incumbent system and products. And many innovative firms aim to to attract buyers in an attempt to gain access to the resources of an incumbent firm and propel development of their products and services.” – Maureen Ohlhausen, Partner, Baker Botts, Washington D. C., former Commissioner and Acting Chairman, Federal Trade Commission

“There’s been more recognition of what we’ve termed the recycling effect..once individuals go through an acquisition of their company, they don’t just go sit on a beach for the rest of their lives with their piles of cash, and live out their days and do few things. Because of the nature of who entrepreneurs are, they are very dogged people that want to solve problems… they tend to go on and form new companies. So you see these serial entrepreneurs that continue to do more great things and create economic activity. Even those who don’t become repeat entrepreneurs, they tend to go back to the entrepreneurial ecosystem in additional ways. They’ll take the capital they’ve made and become angel investors, and invest in the next generation of companies. A lot of them go on to become venture capitalists.” – Jeff Farrah, General Counsel, National Venture Capital Association (NVCA)

“Founders that exit don’t leave and live on some yacht in the Mediterranean. What they do is stay in the ecosystem and become investors in startups and mentors. They open incubators and become the anchor of that community. When founders sell their startup, they generally join the acquiring firm to oversee integration or maybe stay longer.” – Nathan Lindfors, Policy Manager, Engine

“Complimentary assets…most businesses are not going to massively scale up on their own – you need to have compliments. It’s very difficult for these very small companies to scale up, they’ll never be the next Medtronic. But they are a really great piece that if you can integrate these two things together, you are unlocking a lot of value that’s going to help consumers and society as a whole.” – Daniel Sokol, Professor, Carolyn Craig Franklin Chair in Law and Business, Affiliate Professor of Business, Marshall School of Business, USC Gould School of Law

“There are technologies that will reach technological glass ceilings if they are not turned over through acquisition or licensing or joint ventures – but more typically acquisition – in order to harvest them into their most mature state.” – Andrew Sherman, Partner, Seyfarth

The “Killer Acquisition” Myth. The FTC’s Data Void and the Need to Focus on Evidence

“The prospect of acquisition strongly incentivizes startups to innovate, and the RFI’s explicitly suggest that large firms should more often be blocked from acquiring startups is not supported by market evidence over the last two decades.” – Maureen Ohlhausen, Partner, Baker Botts, Washington D. C., former Commissioner and Acting Chairman, Federal Trade Commission

“If you say that you really want to understand the venture ecosystem and you literally do not have a subscription [to Pitchbook] that provides you with the data of that venture capital ecosystem, it’s kind of incredulous to say that you are going to monitor this entire ecosystem to look for harm when you don’t understand the ecosystem. This is horrifically bad.” – Daniel Sokol, Professor, Carolyn Craig Franklin Chair in Law and Business, Affiliate Professor of Business, Marshall School of Business, USC Gould School of Law

“Much of the rhetoric around this issue focuses on the fear that large technology companies will acquire startups not to grow them or to improve them, or improve their offerings through synergies, but to eliminate them from the market. However, these so-called ‘killer acquisitions’ are rare and even less likely to occur in the tech industry than in other industries.” – Maureen Ohlhausen, Partner, Baker Botts, Washington D. C., former Commissioner and Acting Chairman, Federal Trade Commission

Unintended Consequences of Intrusive M&A Intervention and Changes

“One thing that may surprise a lot of people is that the [NVCA] members expressing the most concern about all the antitrust proposals tend to be disproportionately regional, medium-sized or even smaller venture capital firms. And the reason for that is that the companies in their back yard that they tend to invest in and help grow don’t tend to grow to the size that allows them to go onto the public markets. So, these regional funds disproportionately rely on M&A activity, and they look at what’s going on on Capitol Hill, and in the FTC and DOJ, and they have a lot of alarm.” – Jeff Farrah, General Counsel, National Venture Capital Association (NVCA)

“If you can’t grow via acquisition, what’s the alternative? You basically create a walled garden of innovation. You are making all that innovation internally and you’ve basically shut out everybody else.” – Daniel Sokol, Professor, Carolyn Craig Franklin Chair in Law and Business, Affiliate Professor of Business, Marshall School of Business, USC Gould School of Law

“Many funds that have been started in recent years have much more of a DEI mission. There are many more funds where the VCs are diverse groups, so if you change the rules now there is going to be a disproportionate impact on women VCs, on minority VCs. So, if we change the rules now think of the unintended consequences. You are going to hurt the VCs that are investing – and not just the VCs themselves – but the investments they make oftentimes tend to be more diverse groups that haven’t gotten investments before.” – Daniel Sokol, Professor, Carolyn Craig Franklin Chair in Law and Business, Affiliate Professor of Business, Marshall School of Business, USC Gould School of Law

“[FTC Chair Kahn] has said publicly, I want these [warning letters] to stop anti-competitive M&A. The problem, of course, is how do you define anti-competitive M&A? We’re looking at an FTC that seems incredibly hostile to the notion of mergers and acquisitions having any pro-competitive benefits at all. So, when you are a company looking at the regulatory space, you know that you’ll be seeing an uphill battle. And you might believe that your deal is good, it’s pro-competitive, it’s good for your users, its good for your investors and will contribute to the economy in all great ways, but you’re looking at a path that is 12 months, 18 months of incredibly difficult advocacy in front of the agency. And very expensive advocacy getting outside counsel, costing millions of dollars, only to see the result that you’re hoping for 18 months down the line, if at all. So, again it’s actually one of the objectives of the FTC to slow down M&A, which is frustrating. It is one of the engines of growth we have in the U.S. and one of the primary exit strategies for small companies that brings new products and ideas to market.” – Kellie Kemp, Senior Counsel, Competition & Litigation, UBER

“The bulk of a small business owner’s net worth is tied up in these companies. They may have limited retirement savings and limited net worth, and their net worth is tied up primarily in the company – the illiquidity of the company. If you take away the liquidity of the possibility of a sale you are greatly impacting not only wealth creation in this country, but job creation, and you are creating a much higher chance of disengagement by employees and a lack of innovation. We will not be able to stay competitive as a country if we take away or make too encumbered the pathway to exit. The cost of regulation in M&A is already significant.” – Andrew Sherman, Partner, Seyfarth, Washington D. C

“If you change the rules and say everything is a ‘killer acquisition” to a nascent competitor, then guess what? You can’t have a merger system that works. You shut off the entire merger system.” – Daniel Sokol, Professor, Carolyn Craig Franklin Chair in Law and Business, Affiliate Professor of Business, Marshall School of Business, USC Gould School of Law

“There is more recognition that this ecosystem exists and it is very fragile, and changes could disrupt it. The recycling effect of this ecosystem, of involvement and people collaborating, is something that our country has done. Not every country in the world can say that. We are very fearful this will be disrupted.” – Jeff Farrah, General Counsel, National Venture Capital Association (NVCA)

“Every time you make these new regulations, big companies find a way to profit from that, and the lawyers and consultants. What I see as an entrepreneur regarding these regulatory and legislative proposals is that they are going to make ‘big tech’ more successful being they are the ones that can afford the lawyers and consultants. Those costs are passed down to me, the entrepreneur, and push the price of my company that I created even further down as it acts as a quasi-tax on my entrepreneurial labor.” – Bettina Hein, Founder, Juli, Serial Entrepreneur

The “Platform Competition and Opportunity Act” (PCOA)

“They [the entrepreneurs] are beyond concerned. It’s fair to report they are terror stricken by what this legislation could potentially mean for them. Particularly PCOA, that would explicitly restrict acquisition of smaller companies by larger companies. They have both principal concerns and basic disagreements with the draft of the legislation, specifically that mergers are inherently anti-competitive and anti-innovation. What the entrepreneurs know and what they will tell you is that not only is this not true, but acquisition is absolutely essential to the entrepreneurial and innovation ecosystem.” – John Dearie, President, Center for American Entrepreneurship

“It is effectively a ban on acquisition by the four or five large tech platforms in this country.” – Jeff Farrah, General Counsel, National Venture Capital Association (NVCA)

“If the proposed merger and acquisition legislation goes through, the M&A route will close. They’ve already closed the IPO route. It’s not that there aren’t problems, it’s not that abuses don’t happen and there are changes to the regulatory scheme I think we would support that get at real issues. But specifically restricting the ability of small companies in an arbitrary way to see or merge in a way that’s not at all targeted, but also shifts the burden of proof in unfair and difficult ways just does not support entrepreneurs.” – Bettina Hein, Founder, Juli, Serial Entrepreneur

“Fully half of the companies in our survey see a merger or acquisition as their ultimate goal. So, they are deeply concerned about anything that might disrupt that. Fully, three-quarters of the companies [in the survey] said they would strongly oppose anything that restricts their ability to sell their business to a larger business down the road.” – Todd McCracken, President, National Small Business Association

“Though they are being pushed as antitrust bills, in fact it’s not antitrust as we know it but more regulatory policy-competition type set of bills. These are antitrust in name only. If it is regulation, people have to come clean. And then we can ask the basic questions – What is it we are trying to do? What motivates the regulation? I am not against regulation if you can express clearly what’s the purpose of regulation and why we need it. Is there something that the antitrust laws are not doing? Why not ban other companies that are serial acquirers? Why just the big four or five?” – Daniel Sokol, Professor, Carolyn Craig Franklin Chair in Law and Business, Affiliate Professor of Business, Marshall School of Business, USC Gould School of Law

“By making the acquisition process much more complicated and expensive, the Act [PCOA] would increase the cost – the regulatory cost and burden – of the acquisition. Acquirers would pay for that cost by reducing the price their willing to pay for an acquired company. So, the people who are going to get stuck – with the increased cost of acquisition – would be the entrepreneurs trying to monetize the value of what they have created over years of hard work.” – John Dearie, President, Center for American Entrepreneurship

“PCOA would have precisely the opposite effect it is intended to have. It is clearly aimed at the larger digital platforms, and the whole purpose is to reduce the capacity of the large firms to acquire companies. The concern among entrepreneurs is that by making the acquisition process so expensive and so complicated, so complex, that only the largest companies have the resources and lawyers necessary to navigate the complex new rules. It would have the effect of deepening and widening the competitive moat around the large incumbents because smaller competitors won’t be able to clear the hurdles of the regulatory burden and costs associated with the new regulatory landscape. It’s a reasonable concern because we’ve seen it before with Sarbanes-Oxley, which was aimed at large corporations and one of the unintended consequences was the cost of complying with Section 404.” – John Dearie, President, Center for American Entrepreneurship

Policy Do’s and Don’ts

“So, to the extent the agencies do plan to introduce modifications, the revised guidelines should preserve a flexible analytical framework that allows a fact-specific, case-by-case assessment in lieu of broad presumptions that could inadvertently harm innovation.” – Maureen Ohlhausen, Partner, Baker Botts, Washington D. C., former Commissioner and Acting Chairman, Federal Trade Commission

“To protect the startup culture that is so essential to fueling innovation and economic growth, the agencies should avoid creating a climate that is presumptively hostile to the acquisition of nascent competitors. I hope whatever revisions we see to the guidelines recognize the importance of the innovation cycle. And I hope any revisions to the guidelines are able to allow it to continue.” – Maureen Ohlhausen, Partner, Baker Botts, Washington D. C., former Commissioner and Acting Chairman, Federal Trade Commission

“We regularly ask startups what’s going on in your ecosystem. What are the policy issues that you are facing? And no one has ever said explicitly ‘antitrust.’ Or, we really wish Google couldn’t buy us. No one says that. What they do tell us if that we can’t expand into California because there is an onerous privacy standard. We need a federal privacy standard where we don’t have to go state-by-state and spend tens of thousands of dollars to figure this stuff out. We need better access to capital. We need support and institutions in our communities to help us do these things. We need not to be opened up to frivolous lawsuits for patent trolling and other intermediary liability issues. These are the things people talk about. These are the principal barriers. For startups, all policy is competition policy.” – Nathan Lindfors, Policy Manager, Engine

“Most innovation in our economy comes from small businesses, comes from startups, comes from these fast-growing firms. It is through innovation we increase our productivity, and it is where all of our economic growth comes from. So, this is fundamental to the strength of our economy and we have to get this right and we shouldn’t be taking unnecessary risks.” – Todd McCracken, President, National Small Business Association

“What not to do? Blanket bans, there is no economic basis for them. Overly harsh restrictions – such as we’ll just ban technology companies. But what is a technology company? Every company across the supply chain is going through digital transformation. It’s not so clear what’s tech vs ‘non-tech.’” – Daniel Sokol, Professor, Carolyn Craig Franklin Chair in Law and Business, Affiliate Professor of Business, Marshall School of Business, USC Gould School of Law

“There’s so much tumult in the economy right now, and many things that need to be fixed – supply chains, inflation, new business creation, labor shortages and the skills gap. There is a whole host of things that Congress can focus on that can really help the startup ecosystem and small businesses at this point in time. Including access to capital. There is much to be done to strengthen the ecosystem…but why are we doing things [revamping M&A regulation] that will make us less competitive, less innovative, and then [Congress] will have to fix the problem it causes with something else?” – Karen Kerrigan, president & CEO, Small Business & Entrepreneurship Council

The Importance of Regulatory Certainty to Innovation and Investment

“When you have this type of regulatory uncertainty, it’s more difficult for people to invest because they don’t know if they are going to get their money out. This is not just a U.S. issue. We are actually seeing the experiment naturally playing out in Europe affecting U.S. companies because sometimes acquisitions that would clear the U.S. are being challenged in distinct states and at the European level hurts investment.” – Daniel Sokol, Professor, Carolyn Craig Franklin Chair in Law and Business, Affiliate Professor of Business, Marshall School of Business, USC Gould School of Law

“We don’t want certainty because the rules are stupid. We want certainty because the rules allow for some amount of predictability that weigh real antitrust concerns with the other aspect, which is the value creation aspect that benefits the venture capitalists, the entrepreneurs and indeed society overall.” – Daniel Sokol, Professor, Carolyn Craig Franklin Chair in Law and Business, Affiliate Professor of Business, Marshall School of Business, USC Gould School of Law