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Don’t make it harder for startups to exit

Policymakers are making it easier for startups to exit by going public — but harder to exit via an acquisition. That’s not a good sign.

Leo Ringer

By Leo Ringer

Startup funding globally is going off the scale: more than $260bn was invested in 2020, despite the pandemic. This explosion of VC-backed startup activity is based on the ability of those investors to get their money back — ideally, a whole lot more of it. It’s also one of many motivations for founders to take the huge risk of starting a company. 

So the question of how that liquidity happens — in other words, how equity in a company turns back into real money for investors — is critical to the incentive to start, and invest in, a company.

Policymakers understand this, at least as far as going public is concerned: there are efforts underway globally to improve the path to exit via a listing. In the UK, listing rules are being reviewed to give companies an easier time when going public — a key source of investor liquidity. In the US, exchanges like NYSE are seeking permission to update their rules to widen the range of listing options, including the ability for those directly listing to raise primary capital at the same time.

In Europe companies founded pre-2010 accounted for more than a third of VC capital raised in 2020.”

Part of the motivation here is the well-documented observation that startups are choosing to stay private for longer. Many perceive the downsides of public ownership — whether in terms of governance or cost — to outweigh the benefits. They have found later-stage private investors — the likes of SoftBank’s huge fund or Balderton’s new secondaries fund — to be more convenient sources of both new capital and liquidity for early investors and founders. In a stark indication of this trend, in Europe companies founded pre-2010 accounted for more than a third of VC capital raised in 2020. 

Policymakers see the need to reinvigorate public markets by clearing the flight path from private to public. But at the same time they are putting new obstacles in the way of liquidity, where that liquidity involves acquisition rather than listing. 

Two policymaking themes are set to reshape what non-public liquidity looks like in the 2020s. Both create fresh barriers to successful exits.

Cracking down on tech deals

First, policymakers globally are tightening anti-trust (competition) regimes to ‘crack down’ on tech deals, a theme which the tech sector has been slow to notice and has struggled to understand. Critically, barriers to these deals are not just an issue for ‘big tech’ but for the companies who may exit to them. In these deals, an adverse competition policy perception of the buyer becomes a liquidity problem for the seller.

“Policymakers globally are tightening anti-trust (competition) regimes to ‘crack down’ on tech deals.”

This policy trend is growing, but is already here. Amazon’s investment in food delivery company Deliveroo was almost derailed by the CMA, the UK competition regulator which is applying intensive scrutiny to tech-related deals and seeking greater powers to do so via recent proposals. US web advertising platform Outbrain’s merger with Israeli advertising business Taboola was scuppered in part by the duration of concurrent competition reviews in the US, the UK and Israel. Viagogo’s acquisition of ticket platform StubHub may have to be unwound — at least in the UK — pending the conclusion of a CMA investigation. The list goes on.

Tech company investors, founders and advisers need to spend time understanding the rationale for tightening competition policy. It is as material to their fortunes as any other policymaking trend because it bites the very moment when liquidity is closest, and therefore most precarious. For their part, policymakers need to more closely consider the liquidity impacts of competition policy reforms.

When politicians step in

But a second threat to liquidity-by-acquisition could become more widespread and more acute: national investment screening regimes. They give politicians the power to cite a range of reasons — such as national security, media plurality or financial stability — as the basis for deciding whether deals can go ahead.

In the UK, legislation before parliament would equip elected politicians with extensive new powers to block acquisitions — of companies, IP, data, and more — on the grounds of ‘national security’, which are widely and loosely defined. Any acquirer (foreign or otherwise) of any company involving AI in its business model would have to get government permission before the sale can go ahead — which would include just about every startup.

Such regimes are popping up and strengthening globally, from the Committee on Foreign Investment in the United States (CFIUS) to enhanced Foreign Investment Control (FIC) rules in Germany. The risk is that, as politicians elide concepts like ‘national security’ with a looser concept of ‘national interest’, sales of startups to ‘foreign’ entities in particular become subject to political discretion on a routine basis.

In time the balance of liquidity may shift back towards listing and away from staying private for longer. It seems a natural outcome of policymaking which promotes the former and constrains the latter. SPACs are an interesting middle-ground here: they take a company public, but via an acquisition. They would avoid competition-based policy concerns given the acquirer is a cash shell, but could still fall foul of investment screening regimes.

Guinea pig scalps

In the short term, the impact will be borne by those deals which become the guinea pigs of the tightening competition and investment screening regimes. The justification for these new policy tools is that they are needed, whether to protect markets, the public, or some other political aim. There is no better way to demonstrate that need than with some scalps.

Policymakers need to hear constructive voices explaining that liquidity — whether by acquisition or listing — is a critical part of the lifeblood of any startup ecosystem.”

Policymakers need to hear constructive voices explaining that liquidity — whether by acquisition or listing — is a critical part of the lifeblood of any startup ecosystem. Successful exits release capital for investment back into the next generation of companies, for example as newly-wealthy entrepreneurs begin angel investing and even anchor new VC funds. They also demonstrate to limited partners — investors in VC funds — that venture as an asset class can return real value, which in turn will see more capital flow into the ecosystem.

It is important that the tech community asserts this ‘right to exit’ as a counterbalance to the ‘right to block’ that policymakers are claiming with growing confidence, and effect.

Leo RInger is partner at VC firm Form Ventures.

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Antoine Loudenot
Antoine Loudenot

Understood that it is a hurdle, but when competition authorities come in, we are usually hardly talking about startups, still. I guess the companies that have grown must also come out of their sandbox at a point, and meet the real world of antitrust, and other regulations.
I do agree however that it is about time for public listing to become as attractive as private (VC) ownership. That will come through education of VCs, issuers, and for sure exchanges.

Leo Ringer
Leo Ringer

You’re right, often by the time competition authorities come in they are large, hundred-million if not billion dollar companies. But Investors who backed them at seed stage, when they were worth perhaps a few million or less, are still tied in. All of that capital, and valuation gain, is still only on paper, not real. So falling foul of the competition regulators still has real impact on the liquidity back to those early investors.