Regulatory risk: Political headwinds
A heavy hand on tech takeovers will be counter-productive.
Big tech companies buying start-ups has been a thorny topic of late. There are some big upsides to a healthy acquisitions market. For lots of start-up founders, "getting acquired" is something they've worked towards since day one. It's the "exit" – the holy grail where their years of sleepless nights, subsistence salary, and unsustainable stress pays off. Founders, investors, and – usually – most of the company's employees finally get to see a financial return for their equity and hard work.
Elon Musk was a product of the sell and re-invest cycle.
It's also great for the country, as high-growth young firms account for a huge chunk of the new jobs created in our economy. Those jobs are well-paid, high-value technology and business roles – invariably, these are the jobs our kids want to get. Entrepreneurs building second or third companies with capital from a previous exit typically expand their businesses much faster, fuelled by this virtuous cycle of "exit and reinvest". It's a tremendous generator of employment and value for the economy.
Acquisitions are good for the acquiring company, too. When developing new technologies, features, and markets (which we can loosely describe as research and development for these purposes), tech companies use a mix of "build" and "buy" – either dedicating internal resources to create the product, or buying a company that has already built it and developed a user base. "Buy" has been very popular over the past 20 years, particularly in Silicon Valley.
So why is this a thorny topic? What are the downsides?
Sometimes the "buy" philosophy has the effect of enhancing the market share of firms that already have substantial market power. Occasionally, big firms buy little firms not to integrate their new technology into existing products or develop new product lines, but instead to kill them off so they don't turn into genuine competitors down the track. And even when the acquisition is a genuine R&D strategy, it often merges two similar companies into one monolith. Think: Facebook buying Instagram and Whatsapp – acquisitions that have added billions of users to Facebook's already enormous global social media presence.
This can be troubling for those responsible for keeping markets fair – in particular, competition regulators.
In Australia, the Australian Competition and Consumer Commission has been concerned about this for some time. Recently, it recommended that the Federal Government make it harder for tech acquisitions to go ahead in Australia. The ACCC would like to see tech companies singled out by requiring them to give it prior notice of proposed acquisitions (giving notice is optional). It would also like the governing legislation to be amended so the ACCC is required to consider whether the company being acquired was a "potential" competitor of the acquirer's.
While neither of these recommendations would be catastrophic, the direction is wrong.
These acquisitions aren't hostile takeovers – each sale is approved (and often actively solicited) by founders and investors in the acquired businesses. When start-ups are acquired, the capital that pours into the pockets of founders, employees, and investors is often redeployed into new ventures. These new companies are all the more successful thanks to all that extra available capital and the experience of the previous company's success and ultimate sale. As a result, almost uniquely in tech, acquisitions have strong positive effects on the competitive landscape.
Among others, the founders of successful tech companies ... have reinvested hundreds of millions of dollars into the emerging domestic tech sector.
The clearest practical example of this was when PayPal was acquired in 2002 by eBay for $US1.5 billion. That acquisition put hundreds of millions of dollars in the pockets of founders and early employees such as Elon Musk, Reid Hoffman, Peter Thiel, Chad Hurley and Jawed Karim. They used that money to go on to create some of the world's leading tech companies: Tesla, SpaceX, LinkedIn, Palantir, and YouTube – companies that injected huge competitive forces into established industries across the planet.
We've also seen this in Australia. Among others, the founders of successful tech companies Seek and Atlassian have gone on to start investment firms (Square Peg, Grok Ventures, and Skip Capital) and have reinvested hundreds of millions of dollars into the emerging domestic tech sector.
If we make tech acquisitions harder in Australia, we make it harder for founders and investors to realise a return. That will hurt local tech across the board, making it less likely we will produce a PayPal of our own, let alone the companies it, in turn, spawned.
The ACCC's view is based on an understandable concern that US firms with substantial market power are using acquisitions to increase and extend that power. But the solution it favours – tightening acquisition laws – is out of date and won't work in the world of modern tech. It's an awkward approach that seeks to apply a local solution to a global problem, at the cost of domestic firms.
Australia's best shot at combating the market power of global digital platforms is to develop a thriving tech industry and back our best entrepreneurs to build well-funded global companies. That's the only way we will produce genuine "potential competitors" of the big digital platforms. An essential part of that is developing a thriving acquisition environment that encourages investment and rewards success.
If, down the line, an Australian digital platform has an uncomfortable share of the global market, we should turn our minds to whether we need to further restrict its ability to buy its "potential competitors". In the meantime, let's do everything we can to encourage the growth of some home-grown global champions.
ALEX McCAULEY
This article was originally published on 16 September 2019 in the Australian Financial Review.