There has been much discussion over whether the government's bailout money was well spent. Of particular interest to the venture capital community is the idea that—rather than spending billions of dollars on such banks as Citigroup (C) and Bank of America (BAC) and on automakers, including General Motors (GM)—Uncle Sam should invest in Silicon Valley-style innovation. The argument goes that the government could give a chunk of cash to venture capital firms to invest in the most promising startups. If those companies make it big, everyone wins.
It's a seductive idea on the face of it. And yes, funding entrepreneurship and innovation is a great way to create jobs. That said, injecting billions of dollars more into early-stage investments is not the way to go, in our humble opinion.
The companies that really need help are those that began life as venture-backed startups from 2003 to 2006 and now desperately need additional capital to grow. In ordinary times, the best and brightest of these companies would have little problem securing loans or raising capital from private or public markets. But as we all know, these are not ordinary times. Credit is scarcer than a credit default swap trader with a conscience.
Growth Capital for Midstage Companies
Without access to further capital, many innovative and promising companies will fall by the wayside. This is especially true in the area of clean technology, where companies need to invest heavily up front in R&D and manufacturing, and it can take 10 years or more to see a return on investment. There are many companies ready to build new plants and create hundreds of jobs if only they could secure additional funding. These are "shovel-ready" jobs worthy of stimulus dollars. And this is the technology that Americans are counting on to lead us to energy independence in the future.
We don't need the government to invest in startups. We do need it to provide a financial bridge to make sure that successful midstage companies have access to growth capital until the capital markets revive. This is the kind of project where it makes sense for the venture capital community to partner with the government.
The venture capital funds that originally nurtured these companies are best placed to figure out which most deserve additional funding. We propose that the government make available a bridge fund in the form of loan guarantees to a group of venture capital firms that meet certain criteria in terms of track record and size. The individual venture firms would determine which of their existing portfolio companies receive a guarantee—and how much. By offering loan guarantees rather than actual funds, there is no up-front cash outlay for the government.
Not a Venture Capital Bailout
In return, the government would benefit from any future success of those companies, just as investors in venture capital funds do. We propose that the government be given preference over existing investors when it comes to the fund's future returns. We also recommend that the individual companies taking advantage of the program offer the government warrants equal to 10% of the original loan amount—or, to put this another way, offer it the opportunity to buy a future additional equity stake at an agreed price. This ensures that a win for any of those companies also translates into a win for the government, whose loan guarantee will have made their success possible. In the process a significant number of high-tech and green-collar jobs would also be preserved and created and promising companies would be given the chance to realize their full potential.
I know what you're thinking: Isn't this just a way for VCs to bail out companies in their ailing portfolios with taxpayer money? Absolutely not. The benefit to venture capital firms in this proposal is in building viable, valuable companies. Prolonging the agony of failing companies benefits no one. The goal is to reward and support the good behavior of companies that have succeeded thus far, only to be thwarted in their attempt to grow by a moribund capital marketplace. A bridge fund would help these companies through the next few years of financial uncertainty and economic drought, enabling them to get their innovation and technology into the global marketplace.
There are many in the venture community opposed to any form of government involvement, perhaps fearing that it might lead to greater oversight. We disagree. Now is the perfect time for government and venture capital to partner and build a bridge to the future for some of our most promising midstage companies.
Jim Hornthal joined CMEA Capital as a venture partner in 2006, focusing on digital media and the Internet.