Don’t destroy entrepreneurship with ill-conceived antitrust legislation

Start-ups are the lifeblood of innovation in the United States. Venture capital-funded start-ups disproportionately produce technological innovations. However, the Senate’s proposed American Innovation and Choice Online Act (AICOA), which has once again been the subject of Senate hearings and focuses on “self-preferences” by big tech firms, may have unintended negative consequences on technology purchases by to the companies covered by the bill. and companies that may be covered in the future. These consequences include a reduction in exit opportunities for tech founders and venture capitalists to cash in on successful exits. This would hurt American innovation at precisely a time when we need innovation to solve global problems, including health, financial inclusion, and small business growth.

AICOA severely limits the usual vertical integration in technology, as in many other areas of the economy—what some have derided as “self-preference.” What does this mean? The bill does not define the term, leaving it to apply to a wide range of business practices, whether good or bad for competition. Imagine that, unlike antitrust law, where a plaintiff must make an initial showing of anticompetitive effects, under AICOA, the burden is on the target company to demonstrate that something would not happen with most of the conduct covered by the draft. law. Worse, the bill’s language is vague at best and unrelated to existing case law or doctrine, increasing business risk for companies even beyond those covered by the bill.

Why does this matter for entrepreneurship? AICOA would curtail acquisitions not only of companies covered by the bill, but also of companies trying to grow their market capitalization. Many companies’ business models are based on “self-preference”, which in many cases creates value for companies and consumers. For example, for decades many retailers and supermarkets have done this in their own stores and virtual shelves with their own private labels. Much of the “personal preference” creates economies of scale and increases startup value through product innovation and improvement. Without the ability to “self-prefer,” companies will be less willing to acquire new businesses and technologies. The combination of weaker incentives to purchase together with the inability to use contractual self-preferences will reduce scope economies and integration efficiency.

Perversely, AICOA will make it harder, not easier, for new companies to enter against existing technology companies, as competition in digital platform markets is often based on differentiation from existing products and services. This can come from covered companies making acquisitions to compete with each other.

Big tech companies need tech start-ups to drive innovation because start-ups are complementary assets. This means that an online food delivery company that sells tacos and burgers might want to acquire an existing online delivery business that sells beer because, as most people know, beer and tacos or burgers are complementary. Why acquire rather than build capabilities in-house? Because internal growth takes more time and is riskier, while the tech startup, by definition, is willing to take higher risks for higher returns. The online beer delivery company may not be able to grow on its own, but it might be better off as part of a larger company that has more access to cash, R&D, better online payment systems, and more factors. Together, a combined online beer and tacos company creates more value than two separate beer and tacos companies. The same can be seen with many tech deals, such as Apple’s acquisition of Shazam in music streaming.

If big tech companies can’t vertically integrate, it will significantly impact their incentive to acquire startups and thus damage the entire venture capital-backed ecosystem. Most successful exits happen not through IPOs, but through acquisitions. In previous work, we have identified that deal value has increased significantly since 2006, while IPOs have decreased significantly since the late 1990s. Without a well-functioning M&A system, there will not be a successful exit for many enterprises.

In addition, the easy exit for start-ups through acquisition provides an important signal to the market regarding the pricing of similar deals. As with real estate listings, the more comparable the sales in technology, the more accurate the pricing will be in seed funding rounds. Moreover, large buyers mean multiple bidders. As anyone who has bought and sold real estate knows, the more bidders there are, the higher the value you can get when you put up the for sale sign. However, AICOA would reduce precisely these types of market behaviors far beyond covered companies, as there would be fewer offers (which translates into lower prices for entrepreneurs selling their companies) as well as fewer comparable sales to to determine the price. Starting a small business thus becomes less desirable.

Antitrust law may need to be reformed, but AICOA would hurt rather than help the entire tech ecosystem at precisely a time when technology is offering more to the economy in the form of new tools for small businesses and pushing inflationary pressures through supply chain efficiencies. Antitrust reform efforts should focus on identifying problems and proposing solutions that address the way markets work so that intervention can create more value than harm.

Dr. Daniel Sokol is the Carolyn Craig Franklin Professor of Law and USC Gould School of Law and USC Marshall School of Business Professor of Law and Business.