Weakening antitrust empirically reduces venture capital investment which is key to the success of startups which foster innovation.

Venture capital (VC) and startups backed by VCs are important contributors to the economy. According to Gornall and Strebulaev (2021), around half of the U.S. public firms founded within the past fifty years were financed by a VC fund in their early stage, accounting for 41% of the total market capitalization. Moreover, the macroeconomic impact of VC investments is much greater than that indicated by market valuations since the profound contribution of innovations generated by VC-backed startups is not fully reflected in the valuations (Opp, 2019). However, these startups are vulnerable to the anticompetitive conduct of incumbents (e.g., killer acquisition (Cunningham, Ederer, and Ma, 2021), predatory or exclusionary acts, etc.). To promote competition in the product market and foster innovation, antitrust laws intend to protect startups from being abused and deterred by the monopoly power of incumbents. Recently, these protections are becoming more intense. In December 2022, the U.S. Federal Trade Commission (FTC) sued Microsoft’s acquisition of Activision for harming the competition in gaming consoles and subscription services. Shortly thereafter, in January 2023, DOJ antitrust division filed its second antitrust lawsuit against Google in just over two years, seeking to break up Google’s online advertising business. These major antitrust cases brought against tech giants have caused debates among VCs on whether more intense antitrust enforcement could hurt the startups they are meant to protect 1 . Some VCs express the concern that intense antitrust enforcement will deter the incumbents from acquiring the startups and thus stifle an important pathway for VC exit. Other VCs suggest that adequate enforcement on anticompetitive practices can level the playing field. Therefore, it’s worth investigating how antitrust enforcement affects VCs’ investment decisions and VC-backed startups.

Antitrust laws in the U.S. play a crucial role in promoting competition and innovation by prohibiting anticompetitive mergers and business practices. Specifically, the antitrust laws regulate the three main aspects: cartels and anticompetitive agreements (Sherman Act, Section 1), anticompetitive business practices (e.g., exclusionary acts, predatory acts, etc.) used by dominant firms (Sherman Act, Section 2), and mergers that may significantly reduce competition (Clayton Act). While the antitrust laws undoubtedly restrain the market power of incumbents, their effects on new entrants and the VCs investing in these startups are mixed. On the one hand, antitrust enforcement protects the new entrants from being abused by the anticompetitive practices of incumbents (Sherman Act, Section 2) and thus increases startups’ chance of survival. In this case, antitrust enforcement motivates the VCs to invest more in startups. On the other hand, intense antitrust enforcement may refrain VCs from investing in new entrants and thus harm the development of startups for the following three reasons. First, increasing antitrust enforcement on mergers (Clayton Act) deters the incumbents from acquiring new entrants, reducing the chance of a successful VC exit. Second, under intense enforcement (Sherman Act, Section 1), firms are less likely to form cartels that collude to raise product prices, leading to more vigorous competition, lower prices, and fewer profits for both incumbents and new entrants. Startups’ poor performance in the product market makes VCs reluctant to continue investing in these companies. Third, strict enforcement on monopolization (Sherman Act, Section 2) makes the startups less likely to take advantage of their market power even after surviving the competition and gaining significant market share, leading to fewer investments by VCs.

To identify the causal effect of the antitrust enforcement on VC investments and VC-backed startups, I exploit the DOJ Antitrust Division field office closures in 2013 as an exogenous shock to the antitrust enforcement intensity in the local market. DOJ Antitrust Division closed 4 of its 7 field offices in 2013 in response to the call for a more efficient federal government by the Obama administration. The field offices mainly conduct investigations and litigation on anticompetitive business practices. They also handle merger cases depending on their available resources. The office closures significantly reduce the antitrust enforcement in the local market near the closed offices (Ha, Ma, and Zaldokas, 2024). Given this regulation change, I employ difference-in-differences method. The treated units are startups that become farther away from antitrust field offices after office closures in 2013 and thus whose local market is less policed by the antitrust division.

To understand how VCs adjust investments to accommodate the reduction of antitrust enforcement in the local market of startups, I first examine the effect of antitrust office closures on the amount of VC investments in a startup. It turns out that the reduction in antitrust enforcement causes the amount of VC investments in startups in affected areas to decrease significantly. Specifically, the reduction in antitrust enforcement causes a 683.169 thousand dollar (17%) decrease in the total amount invested in a startup within a year. I further explore whether the reduction in VC investment amount is driven by a smaller number of VC investors or less amount of investment by each investor. The result shows that both fewer investors per round of VC financing and less average amount of VC investment across investors contribute to the total investment reduction.

Since the ultimate goal of VC investors is to gain financial returns when they exit the startups, I next investigate the effect of antitrust enforcement on VC exits. A successful VC exit is defined as the startup being acquired or the startup going public (Sørensen, 2007; Bottazzi, Da Rin, and Hellmann, 2016; Gu, Huang, Mao, and Tian, 2022). I find that the lowered antitrust enforcement causes the likelihood of a successful VC exit to decline by 2.1 percentage points. I further decompose the VC exits into two categories and find that the smaller chance of success is mainly driven by less likelihood of exit by going public.

Given that startups lose investments from their major funding source, VCs, I further explore the subsequent effect on the startups’ innovation. On the one hand, startups are motivated to innovate and differentiate their products from incumbents to avoid being abused by the incumbents’ monopoly power. On the other hand, the startups receive less financial support from VCs, which may hinder them from investing more in risky R&D projects. I measure the innovation output with the number of patents generated by startups and find that startups’ innovation output is negatively affected by a reduction in antitrust enforce-ment. Specifically, the reduction in antitrust enforcement causes the number of patents applied by a startup within a year to reduce significantly by 12.5% - 17.2%. The negative effect is especially pronounced from the 4th year after the event and onwards. This result indicates a long-term negative effect on firms in areas less policed by the antitrust division.

In addition to the effect on startups already invested by VCs before the antitrust field office closures, I also examine the extensive margin, i.e., the effect on the number of new startups invested by VCs. I employ difference-in-differences method at the state level with the antitrust field office closures as an exogenous shock to the enforcement intensity within a state. The treated units are states overseen by the offices closed in 2013. Compared with the states overseen by the remaining three field offices, the number of new VC-backed startups in the treated states decreases by 11.8% more. This result implies that VCs not only decrease their investments in affected startups already in their portfolios but also avoid investing in new startups in the states less protected by the antitrust division.

I further explore the potential mechanisms driving the negative effect of the reduction in antitrust enforcement. First, I show that the negative effect is more prominent for startups in more concentrated industries. In more concentrated industries, anticompetitive practices of incumbents take place more often since these incumbents with large market shares have a deeper pocket of cash to predate the startups and more power to exclude the startups from the business. This result suggests that negative effects on VC-backed startups are driven by the potential anticompetitive practices of monopolists in more concentrated industries.

Second, I find that innovative startups are less affected by the reduction in antitrust enforcement. This result indicates that VC investors are confident that innovative startups can differentiate their products from the incumbents’ and thus are more likely to survive and thrive. In other words, the innovation ability of startups can mitigate the negative effect caused by less protection from the antitrust division.

In summary, this study finds that the reduction in antitrust enforcement refrains VC investors from investing in startups in less protected areas and subsequently harms the innovation performance of these startups. This is because startups in areas less policed by the antitrust division are likely to be abused by the market power of local incumbents. These results suggest that antitrust enforcement plays an important role in nurturing the development of new entrants to promote competition and innovation. This study highlights the importance of strengthening regional antitrust enforcement to motivate VC investments in startups, promote competition, and foster innovation.