Having been involved in half a dozen startups, I enjoy celebrating successful entrepreneurs. I admire their vision, their willingness to take calculated risks, and the perseverance required to lead a company from zero to wildly successful. I also believe there could and would be significantly more successful startups if not for a factor frequently ignored or accepted as a fact of life.
“It was not the existence of monopoly that
caused the federal government to intervene
in the economy, but the lack of it.”
—Gabriel Kolko
While founders focus on strategy, funding, and market differentiation, their biggest competitor can be the corporate capture of government regulators that oversee their market space. Hundreds of government agencies originally created to protect the public are heavily influenced (or even controlled) by moneyed interests who protect themselves by reducing competition.
“…the agencies themselves were mostly established by large business interests to stop the growth of competition in their industries. If this is true, it becomes difficult even to imagine what these agencies would do if not impose rules and enforcement on behalf of the dominant market players.”
—“The Racket of Regulatory Capture” by Jeffrey A. Tucker, Epoch Times, May 5, 2023
A small sampling of agencies illustrates how their mission gets repurposed to favor large businesses:
Agency | Corporate Capture Impact |
Agriculture Dept. | Regulates in ways that favor large corporations over small farming operations. |
CDC | Acts as marketing agency for vaccine makers and Big Pharma in general. Almost all CDC scientific reviewers are current or former employees of a large pharmaceutical company. |
DoD | Large defense contractors have a significant influence on defense policy and spending through the considerable lobbying power they apply. |
FCC | It's dominated by big media interests that use the power of government to exclude, punish, and censor alternative media. |
Federal Reserve | It functions as the government arm of the private banking industry which has become subservient to it. |
FTC | Large industrial interests manipulate it to keep competition at bay. |
SEC | Employees rotate into and out of Wall Street firms. |
Treasury Dept. | It’s recognized as being led by the interests of large bond dealers. |
Corporate Capture Practices
“As a rule, regulation is acquired by the industry and
is designed and operated primarily for its benefit.”
—George Stigler, 1982 Nobel economics laureate and
developer of the Economic Theory of Regulation
Large players stifle competition by manipulating the original purpose of regulatory agencies:
Market barriers
Industry incumbents employ lobbyists and lawyers to shape regulations and policies to their advantage by working closely with federal agencies. Under their influence, federal agencies impose onerous licensing requirements, certification processes, and compliance standards that disproportionately burden small businesses. Lacking the same level of influence and resources, startups find it very time-consuming and expensive to comply with these regulations, thus creating an uneven playing field that favors established companies.
Intellectual property protection
Intellectual property (IP) laws are intended to encourage innovation by protecting the rights of creators, including startups. Corporate capture results in laws that greatly favor large corporations, making it difficult for startups to navigate the IP landscape. For example, patent laws shaped by pharmaceutical companies prevent the entry of generic competitors by extending patent terms. This stifles innovation and limits the ability of young companies to develop affordable alternatives.
Procurement and contracting practices
Federal agencies continually engage in procurement and contracting processes to acquire goods and services from external vendors. Skewing these processes in favor of established corporations means startups face an uphill battle to win contracts or secure government funding. Biased selection criteria, excessive paperwork, and requirements for prior experience and large-scale operations are some of the ways startups are blocked from participating.
Revolving door phenomenon
The corporate capture barrier is heavily reinforced by the revolving door between federal agencies and the private sector. Agency officials who have previously worked for or have close ties to powerful corporations prioritize their interests over the needs of startups. Policies and decisions favoring incumbents stifle competition and hinder innovation.
Negative Effects on Returns
Successful startups have three exit options: execute an IPO, partner with a PE firm, or get acquired by a larger company. Corporate capture influences outcomes toward acquisition by increasing the difficulty of acquiring sufficient scale to meet competition from large players or to interest a PE firm. Small companies can be driven prematurely to being acquired by incumbents in their market space, thus negatively impacting returns to small company investors in several ways:
Dilution of ownership
A large acquirer usually purchases a controlling stake in the smaller company. Ownership for existing small company investors gets diluted, impacting their potential returns if the company performs well in the future.
Acquisition price
Large companies acquire small companies at a negotiated price that may not reflect the full potential value of the smaller company, so the returns to small company investors are frequently limited compared to what they reasonably anticipated.
Integration challenges
After an acquisition, integrating the operations, cultures, and strategies of the small company within the larger acquirer can hinder the small company's ability to fully realize its growth potential or achieve anticipated synergies. As a result, if the expected benefits of the acquisition do not materialize, the returns to small company investors may be constrained.
Loss of autonomy
Small companies have more flexibility and agility in decision-making compared to large companies. When a small company is acquired and it becomes part of the larger company's structure and decision-making processes, its loss of autonomy often limits its ability to pursue planned growth strategies or to make independent business decisions, which can negatively impact the potential returns for small company investors.
Call to Action
Most business plans I’ve reviewed don’t consider how the prevailing level of regulatory capture by large incumbents creates barriers. This potential growth-limiting effect should be part of every evaluation of market risk. Omitting it leads to overly optimistic growth projections. At the very least, startup founders should assess regulatory obstacles in place that could limit growth.
Corporate capture affects almost every business in some way, and it's not a partisan issue. The broad issue is how can we unlock the massive unrealized creativity and growth that’s held back by the present level of corporate capture?
To connect, visit me on LinkedIn here.