Thomas Friendman thinks like Finland. Both should think again
Thomas Friedman, a New York Times reporter and an author, writes how US should invest in and bet on potential the future successes instead of bailing out the dying Detroit car manufacturers. You don’t need to be rocket scientist to come to this conclusion, even though nationalistic feelings can make even the brightest of us make ill judgements when local jobs are on stake.
Regardless, that was not the issue that made many in the technology industry rise to the barrikades. The devil was in how Mr. Friedman proposed to do the investing in to the future success stories. He went on to suggest that the US government should give the bailout money directly to the top venture capital firms instead of to the dying auto industry whose own short sightedness have got them in trouble.
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 U.S. 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.
A prominent New York venture capitalist and a blogger, Fred Wilson of Union Square Partners, responded strongly this this suggestion and explained how the well meaning intention what seems the sensible and smart thing to do in the times of economic hardship and illiquid markets, does not actually work at all. He explains how top 20 firms in the venture capital business are actually the least in need of extra money:
The venture capital business is an asset class where the top 10-20 percent of the firms make 80%+ of the returns. That’s how its always been and that’s how it will likely always be. It’s because the best entrepreneurs want to work with firms with reputations for making money, making connections, recruting top talent, and getting the right exit at the right time. And those are the top 10-20 percent of the firms.
So Tom’s idea, while it looks good on paper, is a dream. The top venture firms don’t want, don’t need, and are never going to take government money. The same is true of the top entrepreneurs.
The worst firms, on the other hand, will gladly accept government money. And that is what is going to happen with all of these government efforts to pour more money into the “innovation sector”. That money will go to bad investors and weak entrepreneurs and management teams for the most part. It’s a problem of adverse selection.
Does part of this sound as familiar to you as it does to me. If you live in Finland as I do, it just might. Here the situation is different, but still so similar. The government helps out by giving money to programs and institutions, which many times are created just for the purposes of directly investing in new ventures, creating a new catchy acronym or a traning program, or giving out cash based on what sector you operate in. This is done to create thriving entrepreneurial ecosystem, which is great. Really is. But the way you do it makes all the difference. In the most extreme cases these semi-governmental institutions or programs evolve to milk the government’s own programs, and subsequently the startups learn to milk these semi-governmental institutions. This could create more companies, but it is unlike that it will create the healthy competitive entrepreneurial ecosystems that are filled with strong growth companies (and where bad ones die off, thus potentially enaling the human- and capital resources to be reinvested in new, potentailly more successful, ventures) ready to take on the silicon valleys of the world.
To be clear, I am not saying every program is ill deviced or that industrial cluster building is a bad idea from government’s part. Nor am I saying the government should not correct the market in situations where it does not performs in the best benefit of the society’s long term prosperity, like in the case of very early stage startups run by students just out of college. Here government is on a right track. There are many outstanding examples for example by Tekes, which has been crucial for many Finnish success stories to materialise. What I am saying is that devicing a blue print for a working entrepreneurial ecosystem is a trickly business and the eventual incentive systems should be very carefully build. I don’t know the right answer on how to do this, but I have a few ideas where to start. 1) Just as when building a company, one needs to start with the right people, the best people that can be found. These should ideally have experience from government and from private sector to know how to work with both sides. 2) Go iteratively and measure where possible. 3) De-emphasize planning and support doing 4) and communicate successes to make it desirible for others to follow the example. Not the way goverment normally operates? Perhaps, but there’s first time for everything.
