Expert Panel: If It Ain’t Broke… The Unintended Consequences Of Changing Merger Rules
As Congress considers changing merger rules, remember the current system works well for startups. In fact, now is the best time to be an entrepreneur: U.S. startups raised $69 billion from investors in Q1 of 2021—41% more than the previous record.
CCIA recently hosted experts from the fields of law, entrepreneurship, and economics, including A. Douglas Melamed, Professor of Stanford Law School; D. Daniel Sokol, Professor of University of Florida Levin College of Law; Parag Shah, Founder and CEO of Vemos; and Susan Woodward, Founder of Sand Hill Econometrics and former SEC Chief Economist.
Moderated by Trevor Wagener, Director of Research and Economics of CCIA, the panel discussed why undermining the mergers and acquisitions cycle would have serious, negative consequences for entrepreneurship and innovation.
— Venture capital provides the nutrients that allow new businesses to grow.
— Maintaining the consumer welfare framework is crucial to the continued success of the U.S. venture ecosystem.
— Acquisitions are a key exit strategy for entrepreneurs, and create value for the entire ecosystem.
— Making acquisitions more difficult would crush the innovation pipeline.
Venture capital provides the nutrients that allow new businesses to grow.
Entrepreneurs turn to venture capital to transform their ideas into working businesses, said Susan Woodward, founder of Sand Hill Econometrics and former SEC Chief Economist. “Entrepreneurs will come up with an idea [and] they might rustle up a little bit of money from friends and family to rent an office and print some business cards. And then they go around knocking on the doors of the venture capitalists trying to raise some real money. They’re typically looking to raise one or two or five million dollars as a first round of funding and usually, at the time of this first round, they only have an idea. They don’t have a product. They don’t have any customers. They don’t have any revenue.”
Investors are looking to make a return within five to ten years, said entrepreneur Parag Shah, founder and CEO of Vemos. “Investors, which are typically now required at some level—whether angel or venture capital—they are looking to invest for that same reason. How do we get a return of our dollars within a short period of time? And when I say short, I’m saying anywhere between five and ten years. And get a multiple on our money through an acquisition.”
Investing in early stage companies is an inherently risky proposition, with an aggregate exit multiple of only about 2.5x, said Woodward. “Now, among the acquisitions that are a success—there are some quite interesting successes of course—and of course, I believe that the reason people think overall that venture capital is such a money making-machine is because they only read about the successes in the newspapers. They don’t read all of the details on the failures.”
— “The total exit value for all the companies that have exited for venture capital is about $1.7 trillion. And this is over the period 1990 to 2020 Q1. And the amount of money that was invested in them was about $700 billion. And so that gives us an exit multiple of about 2.5, which is a good rate of return if you take it over 10 years, but it’s not the 10 times your invested value that a lot of people like to talk about.”
Maintaining the consumer welfare framework is crucial to the continued success of the U.S. venture ecosystem.
The consumer welfare standard is “perfectly capable” of addressing anticompetitive harms, said A. Douglas Melamed of Stanford Law School. “I think, with some degree of conviction, that the attack on the consumer welfare standard is a complete red herring. It is a rhetorical device that is used by the populists to discredit antitrust law in pursuit of a very different objective. If you’re focusing on economic welfare, the consumer welfare standard —which, by the way, is really nothing more than a badly named determination that that’s what antitrust law is about, economic welfare—is perfectly capable of addressing non-price harms, innovation harms, quality harms, and harms in buy-side markets, including labor markets.”
Breaking up platforms—which benefit consumers and provide unprecedented cheap and efficient ways for startups to scale—would be detrimental to entrepreneurs, said Shah. “I think that, for startup entrepreneurs, leveraging these current platforms are very, very critical to our success.”
— “When you look at the amount of wealth that’s been generated by entrepreneurs over the last decade, it’s because their ability to scale on these platforms is so much more cost-effective and fast when before that was not the case. So when you look at it breaking these platforms up, it’s very concerning to entrepreneurs like me because people don’t understand what it takes to build on a particular platform.”
Acquisitions are a key exit strategy for entrepreneurs, and create value for the entire ecosystem.
Acquisitions are a way for founders to earn a return on their investment—one they often use to start or invest in other businesses, said D. Daniel Sokol, Professor of University of Florida Levin College of Law. “What about the founders? They want their money too. And here’s the beautiful thing about the current system. When there is robust M&A it’s not like the founders say, ‘I’m 32 and I’m retiring and in the next set of years I’m going to do absolutely nothing.’ No. They end being serial investors, serial founders. They either start their own VC fund or their own Angel fund or they start another venture with a lot of their money.”
When companies acquire businesses that provide complementary assets, innovation is more rapidly introduced to the market, Sokol added. “So when you benefit from an innovation, not just a novel product or service, but the complementary asset basically allows for speeding up and successfully introducing innovation to the market, which allows for better commercialization. We’ve seen this across a lot of traditional industries — the traditional typesetter industry, biotechnology, even solar industry.”
Entrepreneurs are far more likely to achieve a return on their investment via a sale than by waiting to go public, showed Woodward. “Only 1% of the companies who succeed in ever getting venture money succeed in going public after a first round. That’s 1%. One in 100.”
— “So when we look at the outcomes, and in the American database we have about 35,000 companies, and only 13,000 of them are still alive now. So the others have exited. And over those companies 11% have done an IPO; 35% have shut down [as] worthless; and 54% have been acquired.”
Companies need a valuation of at least $100 million to go public, and few startups get there, Woodward added. “It’s a huge mistake for any company to even consider going public at a valuation of under $100 million. I mean, it’s out of the feasible set. And so that means that out of our over 11,000 acquisitions, we’ve only got 1,700 companies who could have conceivably done an IPO—and even then, it’s very [nerve-wracking].”
Making acquisitions more difficult would crush the innovation pipeline.
Removing the possibility of an exit through merger would make innovation more risky and less financially attractive, Sokol continued. “You basically say the free market—through free agency—is shut off to you so what does it mean? More internal growth. It means a longer pipeline to get to success, number one. Number two: it’s a little difficult for these companies because they’re the ones now responsible. They’re taking on a lot more risk for each one of these ventures.”
— “So we’ve actually added risk to existing companies, number one. Number two: it’s just going to be a longer process for us to get the value creation that we would get from acquisitions.”
Bringing the entrepreneur’s perspective, Shah pointed out that shifting the burden of proof to the acquiring firm would cause negative ripple effects through the innovation ecosystem. “And when you put the burden on [startups], now they’re having to extend a lot more resources to go through an acquisition which, again, affect entrepreneurs like myself and the entire ecosystem because innovation doesn’t happen in a line. It happens in a very squiggly way, where we’re all trying things, failing repeatedly over and over and over again, until something magically works.”
— “It’s something that requires a lot of iterations. And if we’re not able to produce the iterations, we’re not going to see the innovation that we’ve seen over the last decade for sure, definitely over the last 20 to 30 years. We’re going to see, in my opinion, way less competition. And we need more competition. And those iterations and those acquisitions create more innovation and more competition that is bettering everybody’s lives and is creating more wealth for more players in this economy.”