Startable – Healy Jones’ & Prasad Thammineni’s Blog

There has been a lot of talk recently about the amount of value venture capital brings to the US economy. As usual, this includes a lot of griping by entrepreneurs who were unable to raise venture funding and who thus rip on venture capitalists. Occasionally, there is an academic report that attempts to shine a little light on the subject. Many times these professors do not really understand VC, having never helped start a company nor invested money in startups. But on those rare times when a person who really understand finance and startups publishes a robust study it is really worth paying attention.

That is why a recent TechCrunch article, “What Have VCs Really Done for Innovation,” posted by Vivek Wadhwa, has got me thinking. Vivek is a professor (at Harvard, and I think Duke) who has also helped grow software companies and worked for CSFB. Not only his is his background the right one to study entrepreneurship and venture funding, but his post was thoughtful and much more measured than the typical VC-bashing.

Vivek is responding to the NVCA’s recent PR campaign. In this campaign, the NVCA highlights venture capital’s contributions to the US economy and how a lot of innovation in the US has been done at/by venture funded companies. Here are some of Vivek’s key points, as picked by me:

1. The NVCA claims that 81% of tech jobs and 21% of GDP is produced by venture-backed companies; Vivek responds by asking: “would those jobs never have been created if the VCs had never appeared on the scene? How can the NVCA prove causality?”
2. He highlights some research he is about to publish on how, after interviewing over 500 successful entrepreneurs, only 10% raised VC in their first venture and only 25% raised VC for their second. In other words, not that high of a percentage of successful companies bother/need to raise venture funding.
3. “The fact is that VC’s follow innovation, they don’t lead. They go where they smell blood.”
4. VC investments don’t really out-perform other investment asset classes (he specifically discusses research vs. the Russell 2000 index).
5. “What’s behind the NVCA’s voodoo economics? Even though they vehemently deny it, VCs are looking for bailout money and tax-breaks.”

These are some pretty negative opinions – from someone who has a right to be making them. I agree with some of his points, but not all. At the risk of sounding too much like a VC industry defender (remember I used to be one!) here are my responses/takes on his points:

5. Starting from the last point, I think Vivek is half right. The venture industry is fighting a real battle to avoid having their carry taxed as capital gains. However, other than a change in government policy towards cleantech I don’t think VCs are looking for bailout $. What I really think VCs are looking for from the government is to try to avoid being lumped in with “evil” private equity and hedge funds and thus become regulated as “risks to the US economy.” See my post on how private equity regulation might impact venture capital firms. In fact, this point is really a core reason why the NVCA has started making so much noise recently. Regulation could have a negative impact on venture investments, at least for smaller firms that can’t afford the time and effort to comply/prove to the government that their investments aren’t about to cause a global financial meltdown.

4. He’s probably right.

3. Again, he has a real point. But I disagree that all VC funds ignore innovation. First of all, what defines innovation? Would Google have been innovation? It’s not like they were the first search engine. In fact, the search space was already a sexy place to invest when they got funded. But, as a user of their search, analytics and ad words products I’m pretty happy this non-innovative company received money from their venture capitalists. Secondly, what makes venture capital so important for the US economy is not just the creation of innovation, but the commercialization of innovation. Universities are great at fostering innovation, but it is usually companies that take that innovation and create jobs and technologies that can be used. But, I do agree that there is a lot of me-too investing in the venture capital world. Too many of the same ideas do get funded – sometimes I actually wonder if this actually hurts innovation by creating too much undifferentiated competition in nascent markets. But that is probably something for another post.

2. I also agree with this. The ratio sounds about right. I’m willing to bet that many of those unfunded companies would have been less successful if they had raised venture capital. Venture funding is not right for most companies, even “successful” ones. Entrepreneurs too often think that their business needs venture funding to be successful – but as I like to say “don’t raise venture capital.” But I don’t think this is an indictment of the venture industry; it is more a generic point that most companies do not require VC to get where they are going.

1. I can’t really speak to the validity of the NVCA’s numbers in terms of what % of the US economy is based on venture funded businesses. However, I can say that venture funding does help companies get bigger faster. I know I just made fun of it, but would Facebook be as large as it is without venture funding?

Vivek has some very good points, and he presents them with data – which makes them even more powerful. I understand his negative reaction to the NVCA’s PR campaign – it is a little over the top. However, I think venture capital is important to this country’s technology leadership. While I don’t think the US needs MORE venture funding, I do think that a healthy early-stage financing environment is necessary to foster continued innovation here. I hope that as we come out of this downturn and seek to change the financial landscape that early-stage investors are not caught in a regulatory net designed to keep hedge funds from doing silly things with highly-leveraged derivatives or other exotic instruments.