A Forgotten Past, Dying Present and (No) Future | Orla, Texas | Feb 2009

Tom Friedman raised a few feathers with his article Start Up the Risk-Takers and the ideas about redirecting part of the US financial stimulus package to venture capital investors to invest in startups.

The basic idea about creating jobs and economic activity through supporting startups and new businesses is a concept that many in the venture industry have voiced previously. But this article stirred up a little debate as Fred Wilson, Roger Ehrenberg, Alan Patrick, Don Dodge, Brad Feld, Tom Evslin and others (including many, many insightful commenters) entered the scene with a range of opinions.

I’ll summarize and throw in a couple points along the way…

In a perfect world, “more money for entrepreneurs” would mean more businesses would get created. But it doesn’t work that way.

The title of Friedman’s article might be the most insightful part: “Start Up the Risk-Takers”.

That does not mean “start up the venture capitalists”: entrepreneurs are the true risk-takers in the venture industry.

Helping entrepreneurs create businesses in order to jump start the USA’s economy is a good idea: but simply giving money to existing venture capitalists is not the way to execute it.

Hopefully we’ve learned what happens when we give money to companies: they spend it how they see fit, not how we want them to.

The history of the government directly investing in startups is spotty at best, with In-Q-Tel as one of the possible success stories. But it’s unlikely that the USA government bureaucracy would be the most effective organization to invest in startups, and not surprisingly, few commentators advocate that approach.

That said, I would be curious to hear more about the examples of government-supported entrepreneurship in other countries. Examples? Thoughts?

But even more telling, more money doesn’t necessarily mean more (or better) businesses even if venture capitalists are the ones placing the bets.

Why?

The fundamental math behind venture capital works against:

• Early-stage investing. Roger has written about the subject of early-stage investing before, and Matt explained it particularly well in Roger’s post about the debate.
• Service-based businesses. As Don explained, “Service based companies create lots of jobs, but don’t get VC funding.”

  Fred also pointed out a role for government programs (using the example of current programs like SBA and SBIC as examples) to fund businesses that don’t fit the traditional VC economic model.

Incentives guide behavior; and the current venture capital models simply don’t create the incentive structures to invest in the early stages of new ventures, especially service-based businesses.

If you’ve read some of my past posts, none of this should be a surprise.

If “more money” is the path, where should it be directed?

Where are the needs?

• Traditional seed-stage, $200K to $1 M. We’ve developed effective ways to test ideas, but we’ve created a funding gap between “testing ideas” and “building businesses”

  Given Marc Andresson’s plans to start a venture fund and his thoughts on the industry from a recent interview with Charlie Rose, Marc might agree.

• Government programs or new private funds to “incubate lives”, focusing on service-based and “lifestyle” businesses. These companies won’t create big-hit investment returns, but they can generate cash flow and create jobs. The SBA and its programs are a start, but without other structural changes they are not the ultimate answer.

Should we focus or direct money towards specific industries, technologies or geographical regions? I’m open to thoughts, but I still believe the market, not the government, should decide which deals to fund. The big win is to focus on strategies instead of tactics, the system instead of the specifics.

The current needs will not always be needs; instead of plugging the gaps, let’s address what created the gaps.

Everyone is focused on pumping more money into the venture ecosystem. But why don’t we think more about removing costs?

My comment on Fred’s post:

Thank you. Dumping more money into the same structures, the same incentive systems, the same uses, is not the answer.

Instead, how about streamlining the legal processes behind creating businesses? Or reducing other transaction costs to starting new ventures?

Why don’t we invest in the underlying venture ecosystem by removing transaction costs and streamlining the processes in starting, funding and growing business?

A number of commentators touched on the issue:

• Fred explicitly noted the opportunity in investing in education; others added in thoughts about funding basic and applied research and development.
• Dan pointed out the opportunity to use existing structures like the SBA to increase the funding of the SBIC and SBIR programs.
• Brad pointed out the Seed Capital Tax Credit, a way for the government to incent seed stage investments. Chris Schultz mentioned similar programs in Louisiana specifically aimed at igniting post-Katrina economic growth when I met him in December.

But it’s not enough.

How can we invest in streamlining the system?

• Create easier and quicker processes for researching, applying for and accessing government funding (SBA, SBIC, SBIR, research grants, etc.)
• Reduce transaction costs, including legal requirements, taxation policies, accounting rules and government regulation. How can we make it cheaper, quicker and easier for companies to start?

Let’s be clear: this is not about “propping up startups”. I’m not advocating creating more structures to help entrepreneurs, but instead removing the need for those support structures in the first place. Investing in creating better structures would mean less distractions, less costs and more productivity, right?

Entrepreneurs face the problem of navigating government bureaucracies all around the world: take Singapore as an example in the difficulty (and opportunity) in figuring out government funding programs.

At the end of the day, this is just the latest round of a debate over the future of the venture capital industry.

It’s all about money: who, what, when, where, why and how, and the traditional answers to those questions may not be the right ones for the current situation.

More money does not mean more businesses, better businesses or more jobs.

Blindly pumping more money into the existing system will exacerbate, not fix, the venture industry’s structural issues.

All industries go through cycles of creative destruction and resurrection: why would venture capital be any different?