Feb 18, 2020

FTC examining tech exits could change the landscape in Silicon Valley

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Businesses born to be acquisition targets may be less explicit about that.

Last week, the Federal Trade Commission said it would examine hundreds of past tech deals to see if they were hurting the competitive landscape. Big tech companies buy a lot of startups, either to acquire technology or to get their hands on hot engineering talent — a system that benefits venture capitalists.

In fact, mergers and acquisitions is by far the most common way for VCs to make back their money and then some. If the FTC puts a damper on deals, it could be a problem. I spoke with Paul Kedrosky, an investor with SK Ventures, and he said folks are stressing. The following is an edited transcript of our conversation.

Paul Kedrosky: I sent a note to a colleague of mine as soon as I saw the headline, [and] it was literally [in] all caps, OH MY GOD. It’s a bad thing. I always joke that the venture industry — and it’s not really a joke, I guess it’s probably true — the venture industry would not exist, were it not for friends selling to friends in the [Silicon] Valley. Specifically, meaning that former entrepreneurs who’ve joined venture firms, knowing people who still work at Google, Facebook, Microsoft and elsewhere [are] saying, “Hey, I’ve got this company we’ve invested in, can you help a fellow out here? I need to get it off my books. Can you buy this company? Can you have a closer look at it?” Those kinds of acquisitions are the dirty secrets of venture. That’s not to say that they’re bad deals or there’s something nefarious going on, it’s just those small acquisitions, as you alluded to, are a big part of what drives the venture industry — when you get away from a really few high profile successes.

Molly Wood: Were you surprised to see that action by the FTC?

Kedrosky: No, not at all. This has been rumbled at for some time. No, I wasn’t surprised. As a matter of fact, I actually thought we’d see something sooner, so no, I’m not surprised, I’m just saddened.

Wood: Even if it’s not the kind of “bro deal” version of your story, certainly companies can be grown and shaped as part of the pitch to say, “This is an acquisition target for Google. That’s why you should give me money.” 

Kedrosky: Oh, 100%.

Wood: How is this going to change business plans?

Kedrosky: It does. That happens all the time. We see this as the term of art is “tuck-in” acquisition. We see this as a tuck-in acquisition for Google to fill out this part of its product line. There’s nothing wrong with saying that, [but] if that becomes more difficult to do, then all the hurdles go up because now I need you to be a larger company that’s more independently viable, that isn’t relying on M&A for an exit. That changes the dynamic across the board, in terms of how much money I think you’re going to need to be viable, how long it’s going to take. It really does tilt and change the landscape, which is not necessarily a very good thing.

Wood: Is it going to change anything for you, and how you invest, just as a quick follow up?

Kedrosky: No, because we only have about 10% of our … we’ve got about a 50 company portfolio and only four or five of those companies are in the Bay Area. They’re the ones who are the most reliant on selling out to these incestuous transactions, so we’re not as reliant on as many of the more [Silicon] Valley-centric funds. It’s not a bigger problem for us, but it’s a panic-in-the-streets problem for more [Silicon] Valley-centric venture investors than us.

Wood: So [being] geographically diverse is one lesson.

Kedrosky: It’s got its pluses and minuses because obviously, most of the best transactions tend to happen in the Bay Area, in terms of getting exits. On the other hand, being reliant on this bro deal phenomenon is really problematic right now.

Related links: More insight from Molly Wood

Axios and the Wall Street Journal reported from a workshop held last week at Stanford, featuring Silicon Valley investors and representatives from the Department of Justice, where most of these same themes played out. Some VCs said government regulation could end up killing innovation if it has a chilling effect on funding smaller startups. Others said that it’s a problem if there’s a promising company out there that you want to invest in but you know it’ll just be snapped up immediately by a big tech company and never get a chance to reach its full potential, which would mean even bigger returns than a sub $100 million acquisition. 

In fact, there are entire categories of business that some investors call “kill zones,” because if you try to build a company in that sector, a big company will buy and very likely kill you. To be fair, according to the Financial Times, this strategy has been happening in tech since the ’80s.

The team

Molly Wood Host
Jody Becker Interim Senior Producer
Stephanie Hughes Producer

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