Above the Crowd

Just Say No to a VC Bailout: A Green Government Venture Fund Is a Flawed Idea

February 18, 2009:

[Note: Update to this post, posted 2/22/09]

A few weeks back, a friend mentioned an idea he had heard suggesting that the government consider entering the VC (venture capital) business as part of the overall stimulus plan.  Specifically, the argument was made for the government to provide excess venture capital funding to the green sector.  At first, I assumed this was just one individual’s idea, but the noise level has risen to the point where it is reasonable to assume there is a group pushing or lobbying for this outcome.  Last week, Thomas Friedman jumped on the bandwagon in a New York Times article titled Open Door Bailout.  Friedman noted: “I would have loved to have seen the stimulus package include a government-funded venture capital bank to help finance all the start-ups that are clearly not starting up today — in the clean-energy space they’re dying like flies — because of a lack of liquidity from traditional lending sources.”

Clearly, there is a group of individuals that believes the government should enter the venture business.  With all due respect to Mr. Friedman – and by the way I am a huge fan of The World Is Flat — this is a remarkably flawed idea.  Startups and VCs simply do NOT need bailout dollars.  Allow me to provide more detail:

1) No Lack of Venture Capital.  Simply put, there is no shortage of venture capital dollars.  In fact, if you talk to anyone in the business, or perhaps even the limited partners who provide capital to VCs, they all believe the industry has been substantially over-funded for the past fifteen years.  According to the NVCA, the venture capital industry has averaged approximately $30 billion in investments each of the past three years.  Even in Q4 of 2008, when everyone was supposedly hiding under a rock, venture capitalists invested $5.4 billion in 818 deals.  Most interestingly the NVCA notes, “The Clean Technology sector, which represented seven of the ten largest deals of the year, experienced significant growth in 2008 with $4.1 billion invested in 277 deals.  This investment level represents a 52 percent growth in dollars and a 16 percent growth in deal volume over 2007 when $2.7 billion was invested in 238 companies.”  The remarkable disconnect between Friedman’s cry of desperation (“dying like flies”) and the indisputable fact that is the hottest sector in venture capital is both confusing and curious.

2) VCs Don’t Deserve a Bailout.  It’s hard to imagine that venture capitalists or startup executives are eager to submit themselves to the scrutiny and the compensation restrictions that are now part and parcel of any stimulus package.  If American citizens were truly appalled with John Thain’s bathroom and the GM executive’s private plane, then they should find plenty to abhor in the well-compensated VC community.  One could only assume that any potential venture fund package would include similar restrictions on any venture capitalists whose investments are “buoyed” by this kind of stimulus.

3) Lender of Last Resort.  Warren Buffet is noted for saying, “There is a fool in every market, and if you don’t know who it is, it is probably you.”  The government will undoubtedly find its way into deals where every single player in the already over-funded VC community has said “no.”  This is not because these VCs are sitting on their hands as Friedman implies (once again VCs put out $5b in Q4 alone).  Any companies that are not getting funded are simply failing to meet the basic requirements of a rather open-minded green investment community.  Separately, it is quite unclear how the government would attract the talent needed to separate the good deals from the bad (remember quality VCs are handsomely paid).  The more likely scenario is that a government VC would invest behind the companies and investors with the best lobbyists and Washington networkers.

4) Excess Capital Hurts Markets.  One thing that has become particularly evident over the past fifteen years is that excess capital in any market has a consequential and negative impact.  First and foremost, excess capital keeps third-tier competitors in the market longer.  This has a subsequent negative effect on pricing and, as a result, makes it harder for the first-tier players to reach profitability and sustainability – a falling tide lowers all ships.  It is healthy and a requirement for the less competitive companies to fail in an emerging market.  Second, when an overfunded market comes crashing down, the result is a negative self-reinforcing spiral.  The press jumps on the broad-based failure and then capital really does dry up in the industry.  Skepticism weighs on the effectiveness of the market leaders and the whole industry – and therefore the general mandate – suffers.

5) Good Companies Do Not Lack for Capital.  This seems brain-dead simple, but great companies do not have a hard time raising capital, especially in an over-funded venture market.  If you have a great team, a compelling idea, and a demonstrable probability of success, then you simply will not go unfunded.  Just because a company may have an inspirational goal, does not mean that it deserves unfettered funding.  An anti-gravity machine would be a nice thing to have, but it doesn’t demand venture investment.

6) Do Not Reinvent the Wheel.  If you want to ensure that green technologies are successful, use the government dollars to employ subsidies rather than wasting them on third tier venture investments.  Japan and Germany are the clear world leaders when it comes to solar, and they both achieved this leadership status through customer subsidies.  What solar needs in the U.S. is not more dollars for companies producing a product which is then exported, but a fair, predictable, and profitable local market.  A viable customer subsidy would create a market that is suitable to attract any amount of private investment dollars into the companies that are seeking to serve it.  And this approach would not favor VC backed companies over large established, high-employment participants.  This form of market approach is proven and dependable (Japan and German).  Why would the U.S. try something different?

Great ideas have never suffered from a lack of capital availability.  Bringing extra government dollars to the investment side will only ensure that marginal and sub-par companies get more funding dollars, which historically has had a perverse and negative effect on the overall market.  Put aside whether the government wastes money or not – if you want to see these green technologies successful in the marketplace, it would be a disservice to support a government venture fund.  It simply will not work.

17 Comments

  1. Stu February 18, 2009

    I had the same feeling when I read Friedman – government-backed venture seemed like the wrong way to go. From trusty ole econ 1, there’s an curve for the productivity of capital, and it declines if there’s too much capital. I am a fan of rising gas tax, offset by payroll tax, because I think it’ll create a good floor to the green industry. It’s just far more politically difficult than putting more money into green VC, especially with the downturn.

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  4. Q dub February 18, 2009

    Friedman’s basic mistake is whether the constraint is on the capital side or on the opportunities side. Subsidies will also lower the bar like excess capital does, but it does so in a way that actually increase performance of the real operations.

    Reply
  5. Marc Dangeard February 19, 2009

    The other issue with this idea is that the VC model works great for VCs but does not really work for entrepreneurs, so creating another fund if it is going to use the same investment model as VCs will not help.
    VCs will tell you that out of 1000 business plans they receive, they look at 100, invest in 10, and then 1 makes it really big, 3 make it ok, and the rest of loosers or goners. While in the end the numbers work for them, it leaves out a lot of entrepreneurs with very viable businesses that are just not sexy enough for the VC to invest in. VCs will pick 1% (10 investments out of 1000), but it does not mean 99% of the businesses who started are bad. Actually if you look at the numbers from Inc magazine, out of their top 500 fastest growing companies, only 6% received VC funding. So 94% of the top fastest growing companies have been doing without the VCs.
    If the government is looking at helping entrepreneurs in any specific area, they should look at how these 94% did rather than look at how the VC do it…

    Reply
  6. Dick Moser February 19, 2009

    Good points, all. Friedman is further off base by attributing the death of claan tech companies (if in fact he’s factually accurate, which is questionable) to a lack of traditional lending liquidity. Okay, maybe a few of those companies are far enough along to have been able to acquire some venture debt and maybe a few of those sources are drying up or lines are being pulled. First of all, that isn’t traditional lending. And if there’s a problem with debt availability in tech companies, the Government vehicle to solve it is the SBA, not a venture fund.

    Reply
  7. Pingback: Why the Government Should Not Be A Green VC « Earth2Tech

  8. fred wilson February 22, 2009

    bill, for some reason i had not seen this post when you wrote it

    i wrote a similar post today and a commenter linked to this post

    you nailed it and i agree completely

    http://bit.ly/oEkyi

    Reply
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  11. NickDG February 23, 2009

    It’s naturally American to appeal to revolutionary innovation – it’s worked well in many situations in our history. But there are some situations where evolutionary re-invention is more appropriate. The VC model – fund startups/entrepreneurs and wait for the disruptive technologies – worked for the Internet/Web. But this is because another robust communications infrastructure (the public switched telephone network) existed that could support the population and serve as a base for the Internet.

    But our present energy and transportation challenges are fundamentally different. They require more evolutionary systems thinking than revolutionary innovation. It’s naive (and dangerous) to think we can just throw out systems that serve 300M people – no matter how inefficient and creaky they are – and hope that brilliant entrepreneurs develop magical new energy sources and means of transportation that a) work and b) immediately scale. Otherwise said, do we plan our energy future around biofuels that don’t yet exist, or get down to the dirty work of making each piece of the system we have as efficient as it can be?

    The John Doerrs of the world – no matter how attractive their stealth battery startups might sound – are the wrong people to dig us out of this mess. We need the Norm Augustines and Fred Smiths for this one.

    http://blog.vanno.com/index.php/2008/11/23/tesla-gm-and-a-national-cto/

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  13. пaпa April 12, 2009

    Ну и после такого, как говорится, хотелось бы услышать начальника транспортного цеха ;)

    Reply
  14. online travel guide May 31, 2009

    No company “NEEDS” a bailout. If a company is sound, investors will pay the market price. Its the world around the company that needs the bailout – autoworkers in Detroit, bank customers, and even eventually taxpayers.

    No big damage is done if a start-up fails – so there is no need for VC bailout.

    Reply
  15. Pingback: Government Debt for Startups? Not Such a Great Idea « abovethecrowd.com

  16. любoвь January 11, 2010

    Ого! Сенкс! Теперь на день есть работа! :)

    Reply
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