It’s May Day, and in the pages of The New York Times appears a paean to the halcyon days of the 1930s, urging a return to the “trust-busting” of that era. The new targets of interventionist ire are not “Robber Barons,” but the “Tech Titans” like Facebook, Google (and its parent, Alphabet), and Apple. As in the past, however, the real solution to dominant companies has been insurgent innovative companies. Facebook displaced MySpace, Apple appears to have displaced Microsoft, and Google knocked off Yahoo after being founded by two immigrants maxing out their credit cards.
Yet there may be something different today—young, innovative companies are often bought up by the big players rather than going on to be big firms in their own right—Waymo, Oculus Rift, and WhatsApp have all cashed in their rewards by sale rather than by IPO. Those smaller companies that have gone public, moreover, have struggled, like Snap and Blue Apron, which are trading at well below their initial price listings. Even successful companies like Uber, Airbnb, and Spotify have delayed IPOs. Mergers and acquisitions are at an all-time high worldwide, finally eclipsing the M&A frenzy of the dot.com boom.
Moreover, there are fewer starts-up now than in previous years, with—for the first time—business closings outnumbering new business openings, according to the U.S. Census Bureau. This suggests that businesses are finding it harder to get off the ground. If entrepreneurs cannot start businesses, the next Google may not get founded. Other figures back this up. In 2010, startups accounted for only 8% of companies in the U.S., compared to 13% in the 1980s at a similar stage in recovery from recession.
There is therefore significant concern among regulators that the Tech Titans are snuffing out competition by buying up anyone who might pose a threat. As The Economist reported recently, a “conclave” of antitrust experts was told “there is a ‘kill zone’ around Alphabet and Facebook, which startups cannot survive.” It predicted “the antitrust regulators (the DoJ and the competition arm of the FTC) will make it nearly impossible for the big five companies to acquire smaller ones” in response.
This would be a very serious mistake. The likely consequence is fewer tech start-ups, not more.
The reason is that changes in start-up formation and growth are simply the predictable result of overly stringent financial regulation.
Figures show that start-up capital is very hard to find—58% of start-up respondents to a Federal Reserve survey in 2015 say they were unable to meet their funding needs. A New York Fed report in 2016 showed that 67% of small firms received none or only some of the funding they applied for. Banks have decreased lending to start-ups by 15% since 2008. The biggest banks have decreased funding the most, lending only $45 billion to small businesses in 2015—down from $73 billion in 2006.
These restrictions in funding availability are almost certainly due to financial regulations imposed after the financial crisis. Banks are shying away from risk, and funding a start-up is certainly a risk. While venture capitalists (VCs) have filled some of the funding gap, their lending patterns exhibit geographical and sectoral biases—low-tech entrepreneurs in Wichita have less opportunity than their counterparts in Silicon Valley. Very few venture capital firms invest in firms in “flyover country”—only 10-15% of VC funding goes to firms in this region. Some VC firms have a “twenty-minute rule,” stating that if a startup needing capital is more than a 20-minute drive from the offices of the VC firm, it will not receive funding. About half of the companies in the U.S. funded by venture capital are located in the same three cities with the highest number of venture capital firms: San Francisco, Boston, and New York.
Venture capital also has sectoral biases. The high technology/software sector has become the favored sector for venture capital funding over the past few years, with two to three times more tech startups getting VC funding now than just a few years ago. Biotech has also grown, representing 54% of VC-backed IPOs over the past three years. Low tech entrepreneurs, particularly in the middle of the country, are therefore unlikely to find VC funding.
For those businesses that do make it through to moderate success, the traditional route to the next stage has also been made more difficult. Ever since the passage of the Sarbanes-Oxley law in 2002, Initial Public Offerings (IPOs) have become extremely onerous undertakings. This has meant that selling equity to public investors in an open market has become extremely difficult. Instead, equity is restricted to founders and private investors. In turn, this restricts investment opportunities for the public. Selling out to Tech Titans therefore becomes an important part of the profit motive and the exit strategy for the founders and early investors. Cutting off that exit strategy will likely reduce the number of ventures that are started.
Financial technology (“FinTech”) has shown some capacity to solve these problems, but regulators have not been open to it. The financial technology of equity crowdfunding has not been embraced by the Securities and Exchange Commission, despite the passage of the JOBS Act in 2012. Moreover, the promised revolution of peer-to-peer business lending never really materialized, as regulators set their sights on these lenders and forced them to act like more traditional lenders, undermining the business model.
The result is that financial regulation aimed at stopping “too big to fail” actually created a problem of “too small to succeed.” Larger firms may have become entrenched because regulation makes it too difficult to lend to startups and skews the incentives when it comes to a successful startup growing or selling out to a larger firm. Dominant corporations that have become so since 2008 may therefore be a product of regulation as much as their own entrepreneurial success. More regulation to break them up will simply exacerbate the dysfunction.
Moreover, the geographic and sectoral biases of venture capitalists have been exposed by the regulation-induced retreat of regional banks from small business lending. This results in less economic opportunity available in the American heartland, compounding other well-documented factors such as the decline in manufacturing employment and lack of infrastructure.
Finally, the lack of businesses going public results in a shortage of investment opportunities, reinforcing the strength of dominant companies on the stock market. While it would be a mistake to call this a vicious cycle, the feedback effect is important.
A Deregulation Agenda: If the current antitrust problem is indeed an artifact of regulatory policy, it makes no sense to try to solve the problem by applying more regulation to large firms. Instead, the solution should be deregulatory—removing the regulation-induced barriers to startups and business growth. At the heart of the problem is the banking regulations introduced in two waves (Sarbanes-Oxley and Dodd-Frank) since the turn of the millennium.
Two forms of regulation need to be examined and targeted for reform:
- Regulations that impose costs on banks that would otherwise lend to small businesses. These may be direct regulations that discourage risk-taking or indirect regulations that encourage a bank to hire a compliance officer rather than a loan officer.
- Regulations that restrict the opportunity for a firm to go public. These may be regulations that increase the cost burden of going public, such as requiring expensive audits, or regulations that disincentivize entrepreneurs from taking the personal risk of becoming the head of a public company.
This May Day, we should be looking not to the 1930s for a solution to perceived problems of corporate dominance, but to the future—to a world where financiers and entrepreneurs can work together to create the innovations that will create wealth and make our lives better.