The issue
The proportion of software startups that are acquired instead of going public has grown over the last few decades. Big Tech, with large cash reserves, as well as other large enterprises, buy up smaller companies as a way of acquiring innovation or human capital, stopping competitors or maximising growth. For many venture capitalist-backed startups, this is now seen as a viable exit strategy.
Is such acquisition good for a healthy software market? Does it promote new players or stifle exciting disruptors? Should promising startups be allowed to flourish, so one day they list publicly? Should Big Tech, which intensifies the issue, be blocked?
Meta, Google, Apple, and Amazon, as well as others, have often purchased upstart innovators to stay ahead. The latest wave focused on generative artificial intelligence (AI) is no exception. Yet there isn’t much research that can help us understand the challenge, until now.
This is why Luise Eisfeld, Assistant Professor of Finance at HEC Lausanne has collected new data and built a dynamic model of startup entry, with the working paper, ‘Entry and Acquisitions in Software Markets’, now shaping how academics and policymakers think about competition in the digital sphere.
By applying the model to the data, which encompassed 20,000 companies, Eisfeld found that if all startup acquisitions were blocked entirely, the entry of new startups might decline by as much as 20 percent. These were the preliminary results. This is because venture capitalists and investors are more likely to invest if they think the company will be purchased for a profit. The research also shows that blocking mergers between established industry players and more mature startups might increase entry. This is because investors would feel that their activity is less likely to be hindered by Big Tech.
Why it’s important
Regulators in the U.S and Europe, have ramped up their fight against anti-competitive behaviour by the Big Tech giants. Already the European Commission has opened up a probe into the behaviour of Apple, Alphabet and Meta. This comes in the wake of the EU’s Digital Markets Act, which is a sweeping new law aimed at ensuring fair competition in the bloc’s tech industry. The big question now is whether there should be a review on mergers or a stricter regulatory regime that controls market behaviour more generally.
What the professor has to say
The vast majority of startups, particularly in the EU, are now acquired, very few go public. Many anticipate that they will be bought up in the future. This drives them to enter the market in the first place, this is also what motivates venture capitalists to fund them.
The model shows that if Big Tech firms are the ones acquiring startups, this may deter entry. Whereas acquisitions in general, which can also be done by smaller firms, encourages entry. Merger policies need to balance these two opposing effects. A case by case acquisitions review is therefore essential, with a big focus on the activity of Big Tech firms.
Conclusion
The research has gotten a lot of attention by policymakers, including the Competition and Markets Authority in the UK, raising many questions. As a society do we want more startups to be acquired by Big Tech, with only a few, new publicly listed firms? Or do we want a larger startup ecosystem, with many more firms that have the potential to grow and go for IPOs? If we want the latter, then we need to reduce the regulatory barriers that startups face when they want to become a publicly listed company, and also nurture startups to grow much faster and larger.
