These are my notes from a presentation by Prof Josh Lerner of Harvard made at the 2nd annual venture capital forum in Kingston, Jamaica.
- everyone is struggling with debt so public finance is tough
- there is a sense that something different needs to be done to create opportunities for growing populations
The essential formula tends to focus on more inputs
- productivity growth is likely to be only long-term avenue to growth
- at least 85% growth can only be explained by innovation
Entrepreneurship is a key part of the answer
- small firms contribute a disproportionate share of major innovations
- large portion of jobs created by companies less than 3 years old
- venture capital is 3-4 times more powerful than corporate R&D
Desperate need around world for “green shoots”
- governments around the world trying to have more dynamic economies
Since the Great Recession young businesses have not been creating as many new jobs as in the past
- venture capital returns down since 2000
- harder access to capital
- harder to exit
- VC IRRs down from 51.92% for vintage years 94-98 down to 1.95% for 99-
Role of Government
- increasing returns to scale (much easier to do 100th deal than the first)
- knowledge and expectations of entrepreneurs
- familiarity of intermediaries (lawyers, etc.)
- sharing of info among peers
- comfort level of institutional investors
An ecosystem that exists makes it easier to grow. Getting started is hard. Governments can play a catalytic role.
U.S. History shows:
- critical role of SBIC program
- many early VC firms started as SBIC awardees then opted out
- building critical infrastructure such as new law firms
Similar insights from Israel and Singapore
- often, relatively little familiarity with worlds of entrepreneurship and venture capital
- many well-intentioned efforts are poorly executed
Sweden was great example with Post Office deciding to build a car. 4,000 units if lucky, mostly bought by the post office
- govt introduced tax credits
- differentiated in terms of capital sources, investment managers and practices
- tried to be same size as USA VC industry
- surge in fundraising by inexperienced funds (10x increase)
- intensified overheating in market
- established funds mainly exited to the US
"Bad deals done at too high a valuation"
What Govt CAN do
3 key principles
1) make sure the table is set
2) Catalyze outside funding
3) Long-run perspective
Before you start handing out money…
1) Table setting
- ensure that high potential entrepreneurship is attractive
- tax regime (capital gains vs income effective tax rate)
- easing formal and informal sanctions in failed ventures (Singapore’s Phoenix Award)
- easing barriers to technology transfer
- entrepreneurship education for students and professionals alike
Legal and financial environment
- legal enforcement, minority shareholder protection, intellectual property
Large robust stock market locally or nearby
- supply side effect limited when LPs tax-exempt
- affects decision to startup and ability to hire and fire employees
- countries with high employment protection have less VC
- countries that replace protection with insurance have more VC
- US States that have loose enforcement of non-competes have more startups and attract more star innovators
- positive impact of immigrant entrepreneurs
Singapore realized that Asians didn’t want to leave corporate jobs and try startups because of being afraid to fail. Culture SW it as losing face so they created a failure award
2) Catalyzing private funding
- govt funds often fail to listen to market’s dictates
- temptation to jump into popular areas
- universal temptation to “share the wealth” (spreading funds out)
- better to provide matching funds instead, a cap on government returns usually included (Israel Yozma, NZ Venture Investment Fund)
- facilitating private funding most appropriate way to ensure success
- loans and quasi-loans
- loss guarantees
Importance of pension funds
- long-term source of capital: typically across decades
- some corporate and public pensions hAve emerged as savvy investors
- US opening the door to pension funds made a huge difference
- venture capital is fundamentally a global industry
- international investments transfer not just capital but knowledge
- success of Israeli, Singaporean, etc. market seems driven by role of international groups
Some countries afraid to lose best and brightest to other countries but actually beneficial. Israeli companies listing in US take front office to US and move. But VCs go back to well in Israel to invest in more firms. Successful entrepreneurs go back to fund projects.
3) The need for long-run perspective
- building an effective ecosystem takes many years (longer than typical election cycle)
- many efforts abandoned prematurely
- need to be seen as part of legacy building
What makes a country attractive to VC investors
- must distinguish between early stage and growth stage
- in common is a situation where you have lots of economic dynamism
- a sense that it is relatively easy to begin and succeed in new businesses (hiring labor, etc.)
- a legal system where you feel that contracts are enforceable
For early stage
- a lot has to do with sources of ideas
- big companies doing creative innovation, universities doing interesting research
Corruption hampers VC because you need to believe that if you build you will be able to benefit from it rather than see people ready to reach into your pocket
What happened in the USA happened a long time ago and was more specific. Better to look at more recent ones such as Israel, China and New Zealand.
It’s not going to happen overnight. There was an element of trying again when they mess up and learning from the mistakes.
They recognized to borrow expertise from other countries, recognizing that they could not do it on their own.
China is starting late so they get to bypass stuff that is part of the traditional systems. Instead of tons of bank branches they have ATMs with video. You input your national ID card and the video camera compares the picture to your image and then you do things like buy insurance or take out a loan and so forth.
Silicon Valley is not a meritocracy despite what we think. It is much easier to raise money once you’ve had a success.
Companies get funded because of the trust element that exists when a company is referred to a VC vs receiving a business plan via the website.
Everything does not need to be absolutely perfect economically before money is handed out but do not put reform aside. Move in parallel and promote reforms.
There is a learning curve that exists - entrepreneurs on their second venture do better than those on their first, VCs second funds do better than their first, etc.
Jamaica’s geographic location stands out as one opportunity to leverage
More governments are learning from India and trying to catalyze leveraging the diaspora. Singapore and New Zealand have setup offices in Silicon Valley to find their nationals there, social events and so forth, and also open doors for their companies.
It takes time for people to build comfort and familiarity to be able to take more risk. Latin America and many other areas have grown much slower than the US but it is getting there.
Low hanging fruit:
- education and giving students the tools to consider entrepreneurship
- diaspora involvement
- thinking carefully about talking to existing entrepreneurs to find out about existing barriers
Some problems can be solved quickly and others with take 10-15 years
3 key points
1) entrepreneurship is a key driver of innovation and growth
2) it’s hard to do from a public policy approach
3) if it’s done right, it can make a material difference