Antitrust Enforcement of Startup Acquisitions

In a classic scene in movies and television shows, two friends invent a technology company in their garage. A mega-firm offers to buy their fledging startup, making them newly wealthy.

This happy ending for the friends, however, has harmful implications for the economy, according to two antitrust experts.

Kevin A. Bryan and Erik Hovenkamp argue in a 2020 article that antitrust law—which prohibits companies from taking actions that limit competition—has been largely silent about large technology firms’ acquisitions of small startups. Bryan and Hovenkamp claim that the U.S. Supreme Court’s adoption of an “error-cost” framework, which aims to prevent enforcement actions against innocent companies, has unfortunately resulted in too little enforcement of antitrust rules in connection with startup acquisitions.

Proponents of the error-cost framework prefer little antitrust enforcement because they want to avoid false negatives, or situations in which a court mislabels a business’s practice as anticompetitive when, in reality, it is either neutral or procompetitive. Since anticompetitive firms tend to charge higher prices than procompetitive firms, advocates of the error-cost framework argue that new firms will want to enter the market and attract customers by charging lower prices. Consequently, courts should avoid stifling business activity because the market will become competitive again without intervention.

Despite the risk of false negatives, Bryan and Hovenkamp urge antitrust enforcement of startup acquisitions because these deals harm competition. Sometimes a technology firm acquires a startup because the startup could have become the acquirer’s competition if it developed further. Such acquisitions harm competition by reducing the number of competitors.

At other times, the large incumbent firm purchases a startup to prevent its rivals from obtaining promising new technology. In these situations, consumers get lower-quality products because rivals are not able to improve their products with that new technology.

Bryan and Hovenkamp acknowledge that the government will face challenges when bringing actions against technology firms for startup acquisitions. Merger enforcement involves examining the market shares of the acquiring and acquired firms. Courts typically determine whether the acquisition of one firm with a large market share by another such firm would result in higher prices for consumers.

Startups, however, lack large market shares because they are new companies, making it more difficult to measure how their acquisition would harm future competition. As a result, traditional empirical methods that courts use to measure anticompetitive effects become ineffective.

To help the government overcome these challenges, Bryan and Hovenkamp suggest three criteria to guide antitrust enforcement of startup acquisitions.

First, antitrust officials should consider the buyer’s market share. As a firm gains more market share, that firm has greater incentive to exclude its rivals. After acquiring a startup, a dominant firm is unlikely to license the acquired technology to its rivals. Bryan and Hovenkamp recommend limiting enforcement of startup acquisitions to deals in which the buyer has a large market share.

Second, courts can determine how much an acquisition will affect competition by considering the “commercial significance” of the startup’s technology. Sometimes, courts will easily recognize that the startup’s technology adds value to the market. When the value of the startup’s technology is unclear, a court should use the price of the acquisition or the market value of the startup as a proxy for the value of the startup’s technology.

Finally, courts should examine whether a buyer previously acquired other technology startups. Courts may be able to determine that a firm has a “broader exclusionary strategy in which persistent acquisitions are used to restrain rivals’ access to new technologies,” Bryan and Hovenkamp note. They explain that a pattern of startup acquisitions may support an antitrust claim “under Section 2 of the Sherman Act,” which makes monopolization attempts a felony.

Bryan and Hovenkamp recommend that, after the government succeeds in showing that a startup acquisition violated antitrust law, courts award a retrospective remedy, such as requiring a buyer to license newly acquired technology to its rivals. This remedy would address the concern of false negatives by allowing the acquisition to proceed while preventing competitive harm.

The current lack of antitrust enforcement of startup acquisitions does not avoid errors. Rather, nonenforcement demonstrates that courts are failing to distinguish startup acquisitions from conventional mergers, Bryan and Hovenkamp argue. They recommend that courts acknowledge the potential competitive harms of startup acquisitions and “develop standards that strike a reasonable balance between administrability and the risk of judicial error.”