Venture Capital Doesn't Need Government Help

New proposals by the VC industry for low taxes and less oversight may impede innovation, not promote it

By Vivek Wadhwa

The venture capital industry's chief lobbying group is arguing that VCs should get government help for their troubled industry. But new research suggests seasoned entrepreneurs don't need venture money to be successful and that venture backing may even impede innovation.

Let's start with the lobbyists' report. On Apr. 29 the National Venture Capital Assn. (NVCA) released a "four-pillar" plan to resuscitate the moribund market for initial public offerings, including less regulation of public companies and new routes to market for private ones. On June 17 the NVCA called for the Obama Administration to exempt the venture capital industry from proposed new regulations.

After reading the press releases, one could be forgiven for coming away with the impression that a failure to help VCs would significantly harm chances of a U.S economic recovery. The group's April statement and its accompanying slides argue that U.S. job growth won't revive unless more companies can launch initial public offerings. "The revitalization of the venture-backed IPO market is critical to U.S. economic recovery and to the ongoing viability of America's competitiveness," the NVCA said.

It would be unwise to give venture capital firms what amounts to a government bailout. There's significant evidence that venture capitalists, with a few exceptions, don't add much value to the economy. Any sort of help that involves taxpayers' funds would be a waste of money.

A Steady Underperformer

First off, the venture capital market actually needs to shrink—not grow. Venture capital as an asset class has underperformed the Russell 2000 index by about 10% in the past decade, according to a June 10 report by the Ewing Marion Kauffman Foundation, a philanthropic group that promotes entrepreneurship.

The NVCA cites statistics that say venture-backed companies, including superstars such as Microsoft (MSFT), Apple (AAPL), Google (GOOG), and Starbucks (SBUX), accounted for 10 million jobs and $2.1 trillion in revenue between 1970 and 2005.

But the Kaufmann report's author, Paul Kedrosky, points out that many other factors were at work. Those companies could have raised capital from other sources if they needed to, he said. The venture capital industry doesn't deserve any more credit for these companies than does Pacific Gas & Electric, the Bay Area's power provider, according to Kedrosky.

Second, venture capital has become a less attractive investment for many pension funds and endowments, which often put a small percentage of their money into risky venture capital funds in hope of high returns. But Kedrosky's research shows a sharp deterioration in venture capital returns during the past five years, and he predicts steeper drops ahead. As a result, many institutional investors have become less sanguine about VC funds. Kauffman Foundation Chief Investment Officer Harold Bradley argued in a May 8 blog that most institutional investors and pension funds would be better off putting money earmarked for venture into an index or exchange-traded fund.

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