Written evidence submitted by Josh Lerner
Much of my research focuses on the structure and
role of venture capital and private equity organizations. (This
research is collected in three books, The Venture Capital Cycle,
The Money of Invention, and the recent Boulevard of
Broken Dreams.) I also examine policies towards innovation,
and how they impact firm strategies. (The research is discussed
in the book Innovation and Its Discontents and The Comingled
Code.) I founded, raised funding for, and organize two groups
at the National Bureau of Economic Research: Entrepreneurship
and Innovation Policy and the Economy, and serve as co-director
of the overall Productivity Program.
In the 1993-94 academic year, I introduced an elective
course for second-year MBAs on private equity finance. In recent
years, "Venture Capital and Private Equity" has consistently
been one of the largest elective courses at Harvard Business School.
(The course materials are collected in Venture Capital and
Private Equity: A Casebook, now in its fourth edition, and
the forthcoming textbook Private Equity, Venture Capital, and
the Financing of Entrepreneurship.) As part of that process,
I have written three case studies on CDC and Actis over the past
decade. I also teach a doctoral course on entrepreneurship and
in the Owners-Presidents-Managers Program, and organize annual
executive courses on private equity in Boston and Beijing. I am
leading an international team of scholars in a multi-year study
of the economic impact of private capital in collaboration with
the World Economic Forum and the Brookings Institution, and am
the winner of the 2010 Global Entrepreneurship Research Award.
Entrepreneurs have attracted increasing attention
and from policymakers. These business creators and the investors
who fund them play a dramatic role in creating new industries
and revitalizing economies. Many nations have launched efforts
to encourage this activity. Such attention is only likely to intensify
as nations seek to overcome the deleterious effects of the credit
crunch and its recessionary aftereffects. This approach has characterized
CDC's approach over the past decade as well.
This can be distinguished from other efforts to boost
entrepreneurship at a more modest level. In recent decades, there
has been an explosion in the number of efforts to provide financing
and other forms of assistance to the poorest of the world's poor,
in order to facilitate their entry into entrepreneurship or the
success of the small ventures they already have. Typically, these
are "subsistence" businesses, offering services such
as snack preparation or clothing repair. Such businesses typically
allow the owner and his or her family to get by, but little else.
The public policy literature—and indeed academic studies
of new ventures—has not always made this distinction between
the types of businesses that are being studied. But as Antoinette
Schoar of MIT and I have highlighted in our recent volume for
the National Bureau of Economic Research, International Differences
in Entrepreneurship, a substantial literature suggests that
high potential ventures are where the bulk of the job creation
and economic growth come from promising entrepreneurial firms
rather than subsistence businesses.
It might be obvious to the reader why governments
would want to promote entrepreneurship, but why also the frequent
emphasis (which CDC shares) on venture and growth equity funds
as well? The answer lies in the challenges facing many start-up
firms, which often require substantial capital. A firm's founder
may not have sufficient funds to finance projects alone, and therefore
must seek outside financing. Entrepreneurial firms that are characterized
by significant intangible assets, expect years of negative earnings,
and have uncertain prospects, are unlikely to receive bank loans
or other debt financing. Venture capital and growth equity—independently
managed, dedicated pools of capital that focus on equity or equity-linked
investments in privately held, high-growth companies—can
help alleviate these problems.
Typically, venture capitalists do not primarily invest
their own capital, but rather raise the bulk of their funds from
institutions and individuals. Large institutional investors, such
as pension funds and university endowments, want investments in
their portfolio that have the potential to generate high yields,
such as venture capital, and typically do not mind placing a substantial
amount of capital in investments that cannot be liquidated for
extended periods. Typically, these groups have neither the staff
nor the expertise to make such investments themselves. Thus, they
invest in partnerships sponsored by venture capital and growth
equity funds, which in turn provide the funds to young firms.
While venture funds finance new ventures, buyout firms are an
important provider of governance and professional management to
companies, especially in emerging markets.
While the public sector is important in stimulating
these activities, I will note that far more often than not, public
programs have been failures. Many of these failures could have
been avoided, however, if leaders had taken some relatively simple
steps in designing and implementing their efforts. Among the key
principles associated with success have been the following:
- Let the market provide direction.
Two successful efforts have been the Israeli Yozma program and
the New Zealand Seed Investment Fund. While these programs differed
in their details—the former was geared toward attracting
foreign venture investors; the latter encouraged locally based,
early-stage funds—they shared a central element: each used
matching funds to determine where public subsidies should go.
In using the market for guidance, policymakers should keep certain
points in mind:
- These initiatives should not finance substandard
firms that cannot raise private capital. Emulating successful
initiatives in the past, programs should require a substantial
amount of funds be raised from nonpublic sources.
- These funds should be structured in ways that
mirror groups that are entirely based on private capital, in order
to maximize the chances of raising outside financing.
- Resist the temptation to overengineer. In
many instances, government requirements that limit the flexibility
of entrepreneurs and venture investors have been detrimental.
It is tempting to add restrictions on several dimensions: for
instance, the locations in which the firms can operate, the type
of securities venture investors can use, and the evolution of
the firms (e.g., restrictions on acquisitions or secondary sales
of stock). Government programs should eschew such efforts to micromanage
the entrepreneurial process. While it is natural to expect that
firms and groups receiving subsidies will retain a local presence
or continue to target the local region for investments, these
requirements should be as minimal as possible.
- Recognize the long lead times associated with
public venture initiatives. One of the
common failings of public entrepreneurship and venture capital
initiatives has been impatience. Building an entrepreneurial sector
is a long-running endeavor, not an overnight accomplishment. Programs
that have initial promise should be given time to prove their
merits. Far too often, promising initiatives have been abandoned
on the basis of partial (and often, not the most critical) indicators:
for instance, low interim rates of return of initial participants.
Impatience—or creating rules that force program participants
to focus on short-run returns—is a recipe for failure.
- Institutionalize careful evaluations of initiatives.
All too often, in the rush to boost entrepreneurship, policymakers
make no provision for the evaluation of programs. The future of
initiatives should be determined by their success or failure in
meeting their goals, rather than other considerations (such as
the vehemence with which supporters argue for their continuation).
Careful program evaluations will help ensure better decisions.
These evaluations should consider not just the individual funds
and companies participating in the programs, but also the broader
context.
By and large, based on my knowledge, CDC has done
a reasonably good job of adhering to these principles. While there
are questions about the specifics of the program which can be
raised (e.g., whether the apparently high staffing level of CDC
is justified, given its mandate to invest in independent venture
capital and growth equity funds), in general its design seems
to adhere to best principles as seen across the world in the promotion
of high-potential entrepreneurship.
|
