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Daily Archives: November 10, 2009
Congress seems intent on punishing the financial industry, but it is important to remember that VC firms don’t ask for bailouts. Gordon Crovitz in the WSJ:
Just when the economy needs risk-taking the most, risk-takers are under the most threat. The Treasury now wants venture-capital firms declared as systemic risks and put under tight restrictions as part of the broader re-regulation of financial firms. Venture capitalists argue that since they don’t use debt and their firms are comparatively small, they shouldn’t come under rules designed for highly leveraged, too-big-to-fail banks.
No venture capital firm has asked to be bailed out, and none are too big to fail. As hard as it is for regulators to understand, the nature of venture capital is such that it should not even aspire to be a low-risk enterprise.
How this debate turns out matters, because some 20% of U.S. gross national product is created by companies that were formed through venture backing. They include Intel, Apple and Google. How policy makers treat venture capital is a measure of the amount of innovation and enterprise that happens in an economy, with more regulation leading to less innovation.
This is a tough time for venture capital, with investments by firms falling more than 50% in the second quarter. The 700 or so venture-capital firms in the U.S. are mostly small partnerships, with a modest voice in Washington. They say the industry as we know it can’t survive if firms are regulated as investment advisers, which would mean complying with rules for disclosure, compliance, record keeping and privacy designed for huge firms.
This is a good time to recall that the venture-capital industry was born as a reaction to New Deal regulations that stifled capital and prolonged the Depression. The country’s first venture-capital firm (other than family-run funds) was American Research and Development, planned in the 1930s and launched after World War II in Boston.
Its leader was longtime Harvard Business School professor Georges Doriot, who is the subject of a fascinating recent biography, “Creative Capital,” by Spencer Ante. Mr. Ante, a BusinessWeek editor, tells me that as he researched the topic “one of the most surprising things I learned was how concerned financiers and industrialists had become about the riskless economy in direct response to the New Deal. Even in the 1930s, people understood that small business was the lifeblood of the economy.”
American Research and Development backed early-stage companies deemed too risky by banks and investment trusts at the time. The firm was an early investor in Digital Equipment Corp., the Boston-area company that revolutionized computing.
Despite financial success, the history of the firm is a reminder that our regulatory system, by its nature focused on avoiding risk, has a hard time dealing with investment firms whose mission is to take risks. Doriot was a well-known name in commerce and academia from the 1940s through the 1970s. He was the first French graduate of Harvard Business School, a founder of the INSEAD business school and a leading adviser to the U.S. military.
But even as a pillar of Boston’s commercial and academic worlds, Doriot had many run-ins with federal regulators. Over the years, regulators dictated compensation for the American Research and Development staff, tried to force disclosure of the performance of its early-stage companies, and second-guessed how it tracked the valuations of its investments.
The Securities and Exchange Commission hounded the company so often that Doriot once wrote a three-page memo saying, “ARD has more knowledge of what is right and wrong than the average person at the SEC.” He was prudent enough not to send it. He did mail another memo to the SEC enforcement office in Boston, in 1965: “I rather resent, after 20 years of experience, to have two men come here, spend two days, and tell us that we do not know what we are doing.”
Uncertainty about which regulations applied to early-stage investing slowed the growth of venture capital. It wasn’t until deregulation in the late 1970s that the industry took off. The capital gains tax rate was cut to 28% from nearly 50% in 1978, and for the first time pension funds and other fiduciaries could include venture capital as part of an overall portfolio. During this vital period venture firms began to nourish what are today’s high-tech leaders, from information technology and the Internet to genetic research and health care.
The proposal now to tighten how venture firms operate suggests that we are in a stage of the regulatory cycle closer to the New Deal than to the entrepreneurial era that followed. Adding regulatory burdens would do nothing to help the investors in venture funds who are willing to take the big risks, knowing that about half of venture-backed companies fail. It would only increase the costs of doing business and make risk-takers more risk-averse.
A study co-authored by Dan Breznitz, assistant professor at Georgia Tech, indicates that Atlanta leads the nation in infrastructure required for start-ups, but that those start-ups often leave once they achieve a certain critical mass. Among the reasons cited for this phenomenon included raising capital from outside the southeast. VCs provide critical connections to their portfolio companies – suppliers, customers, management talent, potential acquirors – and if those VCs are on the coasts it increases the odds that successful growth will end up moving the company to the coasts.
The Atlanta Business Chronicle reports that the Atlanta startup community is taking steps to build more ‘social bonds’ that would lead to more local financing:
Growing a serial entrepreneur community will help embed technology companies in Atlanta, said John Yates, tech-industry rainmaker and partner at Morris, Manning & Martin LLP.
“It’ll be the serial entrepreneurs who will be the angel investors in those early businesses, will be on the board of directors and will help bring venture funds to town,” Yates said. “They’re going to be the glue that’s going to keep those tech companies right here in town.”
…the study’s findings regarding a lack of social bonds is not new. And in the past year, the community has rallied to do something about it. Community boosters, for instance, have organized discussions between emerging technology companies and Fortune 500 firms to identify problems in search of a solution.
“The purpose is to give the big companies a chance to communicate to the smaller companies, ‘This is what we’re interested in,’ ” Blake said. “The goal is to create a demand-pull rather than a supply-push to the innovation process.”
Other local initiatives include StartupChicks, which fosters entrepreneurship among women, and Startup Riot, a pitch-fest that connects entrepreneurs with investors. Ignition Alley, a new co-working space in Atlanta, hopes to get entrepreneurs out of their bedroom offices and into a shared working space, where they can network and bounce ideas off each other.
The Breznitz study’s findings helped shape the reinvention of the Advanced Technology Development Center (ATDC). In its new avatar, the tech business incubator at Georgia Tech has moved from a “private club,” which helped incubate about 15 companies annually, to a more inclusive organization that works with more than 200 firms, said Fleming, who is also ATDC’s interim director.
“One of the things that we are trying to do with the ATDC reboot,” he said, “is to bring in more entrepreneurs [and] build more linkages between them.”