Thomas Friedman of the New York Times today (2/29/2009) wrote “Startup the Risk Takers” where he suggests the US government should stimulate the economy by funding startups, not by bailing out GM and Chrysler.
“You want to spend $20 billion of taxpayer money creating jobs? Fine. Call up the top 20 venture capital firms in America, which are short of cash today because their partners — university endowments and pension funds — are tapped out, and make them this offer: The US Treasury will give you each up to $1 billion to fund the best venture capital ideas that have come your way. If they go bust, we all lose. If any of them turns out to be the next Microsoft or Intel, taxpayers will give you 20 percent of the investors’ upside and keep 80 percent for themselves.”
“GM has become a giant wealth- destruction machine — possibly the biggest in history — and it is time that it and Chrysler were put into bankruptcy so they can truly start over under new management with new labor agreements and new visions. When it comes to helping companies, precious public money should focus on start-ups, not bailouts.”
Friedman’s main point is this; invest in the future (startups), not the past (bailouts). Startups are the best opportunity to create new jobs in high growth industries, and do it fast. According to the SBA small businesses created 70% of all new jobs in 2007, and account for about 50% of all employment in the US economy. Small business is defined as 1-500 employees.
Fred Wilson of Union Square Ventures says “No Thanks”. Fred writes “The venture capital business, thankfully, does not need any more capital. It's got too much money in it, not too little. Just ask the limited partners who have been overfunding the venture capital business for the past 15-20 years what they think. You don't even need to ask them. They are taking money out of the sector because the returns have been weak.”
Government wants to create jobs, VCs want to create wealth – Do VC backed companies create jobs? Yes, but their primary objective is to create wealth. VCs invest about $25 billion a year in over 3,500 companies. These companies grow fast and create jobs. But, VCs primarily fund technology companies with fewer employees and explosive growth potential. Most VCs only fund 2% – 5% of the companies they see, leaving 95% unfunded. These might be the companies that create lots more jobs.
Service based companies create lots of jobs, but don’t get VC funding.- What about all the viable companies that don’t meet the 10X return potential that most VCs demand? Would a VC have funded Wal-Mart, McDonalds, Subway, or ServePro when they were small startups? No way. Service based companies don’t fit the VC model. But, a successful service company might have 5,000 employees, compared to a successful technology company with 500 employees. The government should focus its stimulus money on programs that create jobs. New approaches are needed, but some existing programs are listed below.
Create 50,000 startups for $1B - How about funding for startup incubators similar to Ycombinator and TechStars. These startup mentorship programs are very successful in creating startups and driving innovation but they only cover 30 to 50 companies a year, investing about $20K in each one. Why not start 50,000 companies a year? It would only cost $1B, and could incubate the next Facebook, Google, or Microsoft…and millions of jobs. How many jobs will $1B invested in General Motors create? Government funding for VCs is probably not a good idea, but maybe a small amount of funding for startup incubators would create the jobs that VC backed companies won’t. $1B invested in 50,000 startups would conservatively create 250,000 jobs immediately. If just 2% of those startups became wildly successful they would create 3 million to 5 million jobs.
What can government do? Government should create incentives for investment. It is probably best not to make the investments directly. There are already some good programs and incentives in place that have been forgotten or underfunded for too long. Pouring money into these programs is certain to stimulate investment, inspire innovation, and create jobs. Here are a few examples of programs that stimulate investment from the private sector.
SBIC – Small Business Investment Company A program managed by the SBA, SBICs are privately owned and managed investment funds, that use their own capital plus funds borrowed with an SBA guarantee to make equity and debt investments in qualifying small businesses. The U.S. Small Business Administration does not invest directly into small business through the SBIC Program. This program encourages private investment in startups and small businesses.
SBIR – Small Business Innovation Research Another SBA managed program, the SBIR encourages small business to explore their technological potential and provides the incentive to profit from its commercialization. SBIR targets the entrepreneurial sector because that is where most innovation and innovators thrive. By reserving a specific percentage of federal R&D funds for small business, SBIR protects the small business and enables it to compete on the same level as larger businesses. SBIR funds the critical startup and development stages and it encourages the commercialization of the technology, product, or service, which, in turn, stimulates the U.S. economy.
R&D Tax Credits – There a 20% R&D tax credit for “incremental” R&D spending, over and above what you spent the previous year. There are lots of restrictions on expenses that qualify. Unfortunately startups are limited to a 3% credit because they don’t have lots of prior years spending base. This program could be significantly enhanced by loosening the restrictions, which would in turn stimulate research investment.
Seed Capital Tax Credit – Maine has a 40% Seed Capital Tax Credit for startups, that can go as high as 60% for startups based in high unemployment areas. This is a good example of targeted support for private investment to create startups, jobs, and innovation. More states should adopt Seed Capital investment tax credits.
There are probably lots of other little known programs that support investment in startups. We need to publicize them and invest more in them. Please leave a comment and a link to your favorite program.