HBS Working Knowledge
December 7, 2009 8:00 AM

Government’s Positive Role in Kick-Starting Entrepreneurship

Q&A with: Josh Lerner
Published: December 7, 2009
Author: Sean Silverthorne

Silicon Valley is the poster child for capitalism, the synergistic geography where smart private money supports cool ideas, creates jobs, boosts national productivity, and provides a handsome return for investors.

Less well understood about the area’s development was the role played by the U.S. government in making it a success. "Particularly during the early years, the government played a critical role in shaping Silicon Valley," especially spending and funding from the U.S. Department of Defense, writes HBS professor Josh Lerner in his new book, Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed—and What to Do about It.

Government has played similar catalytic roles in creating hubs of innovation is places such as Tel Aviv and Singapore. Such success stories often get lost against the common perception that government just bungles things when it wades into the private sector.

Lerner’s book studies where public efforts to spur entrepreneurial activity have gone right and wrong—there are many more of the latter, the author acknowledges—and offers policy prescriptions to guide government actions in the future.

Sean Silverthorne: Why is this book right for the times?

Josh Lerner: There are two sets of events that make this book particularly timely.

First, there is a keen awareness on the part of many governments of the need for "green shoots," high-potential firms that will lead to growth after the recession.

The financial crisis opened the door to massive public interventions in the world’s economies, in which the government served as venture capitalist. But these efforts focused on the most troubled and poorly managed firms in the economy, some of which may be beyond salvation. Since many nations believe that these extraordinary times call for massive public funds to be used for economic interventions, shouldn’t these efforts be at least partially designed to promote new enterprises?

Second, in many nations the venture industry is on life support, fighting for survival. The industry has struggled to realize good returns from investments since the year 2000. Many traditional investors are questioning whether they should continue to provide capital to these funds. But given the important role that venture capital has had in spurring innovation, it is natural to wonder whether there is a public role in ensuring the industry’s survival. Indeed, governments from London to New Delhi have announced venture initiatives in the past few months.

Q: Why is there a need for government encouragement of entrepreneurship and VC? Should bureaucrats just get out of the way?

A: Entrepreneurship is a business in which there are increasing returns. To put the point another way, it is far easier to found a start-up if there are 10 other entrepreneurs nearby. In many respects, founders and venture capitalists benefit from their peers.

For instance, if entrepreneurs are already active in the market, then investors, employees, intermediaries such as law firms and data providers, and the wider capital markets are likely to be knowledgeable about the venturing process and the strategies, financing, support, and exit mechanisms that are required. In the activities associated with entrepreneurship and venture capital, the actions of any one group are likely to have positive spillovers—or, in the language of economics, "externalities"—for their peers. It is in these types of settings that the government can often play a very positive role as a catalyst.

This observation is supported by numerous examples of government intervention that has triggered the growth of a venture capital sector. For instance, the Small Business Investment Company [SBIC] program in the United States led to the formation of the infrastructure for much of the modern venture capital industry. Many of the early venture capital funds and leading intermediaries in the industry—such as law firms and data providers—began as organizations oriented to the SBIC funds, and then gradually shifted their focus to independent venture capitalists. Similarly, public programs played an important role in triggering the explosive growth of virtually every other major venture market around the globe.

Yet for every successful public intervention spurring entrepreneurial activity there are many failed efforts, wasting untold billions in taxpayer dollars.

Q: Specifically, what can government add to the potting soil that encourages entrepreneurial growth? Tax breaks? Research? Access? Protection?

A: Policies that governments employ to encourage venture capital and entrepreneurial activity take two broad forms: those that ensure that the economic environment is conducive to entrepreneurial activity and venture capital investments, and those that directly invest in companies and funds.

First, it is necessary to ensure that entrepreneurship itself is an attractive option. Often, in their eagerness to get to the "fun stuff" of handing out money, public leaders neglect the importance of setting the table, or creating a favorable environment. Such efforts to create the right climate for entrepreneurship are likely to have several dimensions. Ensuring that creative ideas can move easily from universities and government laboratories is critically important. However, many entrepreneurs come from corporate positions, not from academia. Studies have documented that, for these individuals, the attractiveness of entrepreneurial activity is very sensitive to tax policy. Also important is ensuring that the law allows firms to enter into the needed contracts—for instance, with a potential financier or a source of technology—and that these contracts can be enforced.

A second important—though very challenging—role for government is to intervene directly in the entrepreneurial process. But these programs must be executed carefully to be effective. Among the key avenues to success are

  • Being sure to let the market provide direction when offering subsidies to stimulate entrepreneurial and venture activity.
  • Understanding the need for, and active encouragement of, strong interconnections with entrepreneurs and investors overseas, rather than solely focusing on domestic activity.
  • Recognizing that the temptation for individuals and organizations to take steps that benefit themselves, rather than the broader social good, is universal and minimizing that danger.

Q: When governments do attempt to spur venture capital and entrepreneurial growth, where are they most likely to get it wrong?

A: Two well-documented problems can derail government programs to boost new venture activity.

First, they can simply get it wrong: allocating funds and support in an inept or, even worse, counterproductive manner. Decisions that seem plausible within the halls of a legislative body or a government bureaucracy can be wildly at odds with what entrepreneurs and their backers really need.

Economists have also focused on a second problem, delineated in the theory of regulatory capture. These writings suggest that private- and public-sector entities will organize to capture direct and indirect subsidies that the public sector hands out. For instance, programs geared toward boosting nascent entrepreneurs may instead end up boosting cronies of the nation’s rulers or legislators. The annals of government venturing programs abound with examples of efforts that have been hijacked in such a manner.

Q: You devote a chapter to sovereign wealth funds, which I know are a research interest of yours. Are these a promising source of public support for entrepreneurial efforts?

A: In the book I consider a special, but highly visible, manifestation of the government as entrepreneur: the sovereign wealth fund. A sovereign fund can be defined as a state-owned fund that invests in various financial assets. These institutions have been experiencing remarkable growth, and an even greater increase in scrutiny from business and political leaders worldwide.

Sovereign funds can spur entrepreneurial activity due to their abundant capital resources and long-term outlook. To be sure, this is not easy: Many of the challenges facing sovereign wealth funds are similar to those encountered in the other public venture capital and entrepreneurial promotion schemes that I’ve summarized above. But these organizations must struggle as well with added issues, which make the effective leadership of sovereign funds especially challenging.

First, these organizations face political scrutiny, particularly in Europe and the United States. One might assume that sovereign funds, which have been part of the economic landscape for more than half a century, are too familiar to cause worry. But the rapid growth of these funds in recent years and their role in a few high-profile transactions have called attention to them and inflamed public anxieties.

Careful scrutiny suggests that many of the criticisms of sovereign funds have been misleading, but even these problematic perceptions can make performing their roles difficult.

The second major challenge relates to the need to generate good returns on investments. Groups, particularly the larger ones, must struggle with the cruel mathematics of size. Strategies that may be attractive for a small capital pool become much more difficult to implement with more capital under management. This problem is most acute when investing in entrepreneurial projects and private equity, on which many sovereign funds have increasingly focused.

Q: Let’s put you on the spot. How is the Obama administration doing in boosting entrepreneurship?

A: The administration appears to have a keen understanding of the importance of research and innovation. To the extent that it follows through on the promise to create a more favorable environment for entrepreneurship—by using steps such as increased public funding for basic research, eased restrictions on immigration by high-skilled scientists and engineers, and a streamlined patent system—it is likely to translate into a better environment for high-potential entrepreneurs.

In other respects, the track record is not so good. As we’ve discussed, one of the most common fates of programs to stimulate high-technology ventures is capture. Funds end up getting distributed in ways that have little to do with the needs of high-potential ventures or society more generally, but rather by the whims of the powerful and well-connected. From the empty BioValley complex in Malaysia to the repeated U.S. Small Business Innovation Research grants to Beltway "mills" that produce few real innovations, this pattern is depressingly familiar.

Successful programs, by way of contrast, have clear, well-defined investment processes. They limit the danger of political influence by establishing independent bodies to oversee the programs. In many cases, they have further reduced capture problems by passing the funds onto intermediaries such as venture capital funds that make the real investment decisions. By keeping individual awards relatively modest, they limit efforts to misdirect these funds.

Unfortunately, the funding of clean tech innovation under the stimulus program has been characterized by a lack of clarity and consistency. In this uncertain environment, it is not surprising that entrepreneurs have responded in the old-fashioned Washington way: by hiring lobbyists. The big winner of the Department of Energy’s battery funding orgy, A123 Systems (with $249 million in awards), spent about $1 million on Washington representatives between 2007 and early 2009. A partner at leading venture capitalist New Enterprise Associates suggests that at least half of the 25 clean tech firms in its portfolio have hired lobbyists. This does not seem like the ideal way to boost entrepreneurial innovation.

Q: Is there more research to be done in this area?

A: Sadly, the academic literature in this area is comparatively sparse. Economists have turned only recently to the question of how to boost entrepreneurship. In contrast to other government interventions designed to boost economic growth, such as privatization, programs to promote entrepreneurship have received little scrutiny by economists. Not only are the theoretical foundations much less well developed, but empirical studies are much fewer in number and generally less sophisticated. While related issues—such as the impact of research and development subsidies—have attracted more attention, definitive answers are scarce even among these better-researched topics.

Thus there is a substantial opportunity for further research into these questions that work over the next few years will hopefully begin to address. At the same time, these problems are complex and unlikely to yield easy answers. Policymakers face the challenge of having to consider many different options. It is often unclear how proposed changes will interact with each other. Furthermore, there is no clear "instruction manual" that explains which changes will have the desired effects, and academic research is unlikely to quickly develop one.

Q: What are you working on now?

A: I am working on a variety of related questions. First, venture capital’s "big brother"—private equity or buyout funds—are attracting increasing scrutiny as regulators seek to prevent another potential economic meltdown. We are trying to understand the extent to which private equity contributes to the economic volatility, or "systemic risk," in the economy.

Another project is looking at the very smallest of investors in young firms: angels or individual investors. These investors are frequently hailed as a crucial component of the innovation system, but the choices behind and consequences of angel investments are poorly understood.

About the author

Sean Silverthorne is editor-in-chief of HBS Working Knowledge.

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Fast Company
December 28, 2009 9:55 AM

FastCompany.com‘s Top Slideshows of 2009

What visual features connected with our audience this year? From cool packages and creative people to digital characters and business books, these are the most viewed galleries of 2009.

The 12 Best and Worst Digital Characters

The Most Creative People in Business: Top 25

12 of the World’s Coolest Packaging Designs

Off the Deep End: A Look at the Decline of Dubai

Seven Shows That Found a Second Life on Hulu

The Best Business Books of 2009

The Biggest Stories of Our Time, Visualized

8 Must-have Gadgets for Your Business Trip

Gadget Flops of the Decade: 10 Devices That Didn’t Survive the Aughties

10 Green Startups to Watch

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Fast Company
December 29, 2009 10:44 AM
by Nathaniel Perez

No, I Don’t Want to Be Friends With My Butter: Brand Relationships for the Social Media Era

friends with butter

While brands still try hard to "crack the Social Media code," most seem to understand consumers no longer find the prospect of being friends with a brand more engaging than the single click it took to fan the brand page on Facebook. After all, what’s so novel about the thought of a friendship with my butter? Precisely, nothing.

The impact of social media at the heart of new media is shaking up how brands think of experience design and what consumers expect from brand experiences.

Let’s talk digital sociology. I’ll quote three impactful points of view from Michael Wesch, Assistant Professor of Cultural Anthropology at Kansas State University. In his series called "The machine is (Changing) Us: YouTube and the politics of Authenticity," he describes the following (which I’ve roughly transcribed):

"Media defines us while we define media." "We’ve shifted from media to mediated relationships." "Connections were the constraint, we now have connections without constraint."

How can these statements help us understand how to be better at building brand through social media and digital experiences in general? Here’s a set of guiding principles to help you get beyond tactical earned media generation and enable you to create richer and more successful "social movements" around brands.

You can shape the outcome, but can’t prescribe it. Leave predictable outcomes behind. Successful social experiences all have one thing in common: They relinquish control. Bring your consumers closer to action and let them take over. When insights are scarce, leverage the good old reward method to get them to play, then watch them play. If your brand has risk and readiness constraints, consumer control is not a pipe dream. Make it a priority. From Communication to Connectivity. Your brand should no longer think of itself as an authority (even if it is one), but rather a facilitator or enabler. Its role is no longer to broadcast, but to connect. Understanding brand connectivity requires more than just digital listening and influence identification. Moving beyond single degree measures is crucial. Examining passions and motives within dynamic behavioral contexts is essential. Digital discovery (or anthropology) can help uncover motive “in action”. Social media is an unbound source of insights, allowing limitless exploration of digital personas and their behavior. Your brand can engage and build connectivity through behavioral contexts it can associate with. Create mediated experiences. Focus on understanding the potential impact of various media interactions against consumer motives and apply that understanding to your experience strategy. Leverage YouTube as more than an outlet for brand video and search traffic. Instead, study how video sharing can promote the quality of the engagement and motives you seek to trigger. As you plan your experience, don’t limit yourself… Define the media while giving it the opportunity to define you. Create experiences that are engaging but unconfined. Experiences that impose less constraint (or more connection) lead to a greater ability to mine insights from engagement. Branded widgets and social network applications can surely help amplify brand messaging but are really little more than evolved direct media. UGC campaigns with very prescriptive requests cannot allow you to measure much more than response rates. Listen to your experiences. Leverage digital listening to clearly understand how the media has shaped you. Extend your discovery efforts against your conversation to understand patterns of behavior, motives of engagement, audiences and other measures of how your brand is or can be more connective. Measure impact beyond response and conversion by putting your data to work across all sources to truly understand consumer behavior against key business metrics, both offline and online. Keep Shaping & Being Shaped. Whether looking to sustain successful initiatives or creating new ones, brands need to understand how to play in a fully dynamic context. Focus too much on the media itself and your efforts won’t scale. Instead, focus on measuring and extending your “connectivity” step by step, creating a well balanced insights & experience machine.

While butter brands of the world now have their work cut out for them, I’m hoping they’ll leverage Facebook, YouTube, Twitter, or their own media as mere interaction vehicles while devoting their attention to understanding the essence of consumer engagement within the media. Only then can they design experiences that shape conversation, to then understand how those conversations have shaped their brand.

marketing shift

Nathaniel PerezNathaniel is head of Community Intelligence at Sapient Interactive. Part of a world class group of digital strategists, he works on groundbreaking social marketing approaches, platforms and offerings. Community Intelligence is all about creating marketing experiences that are focused on influence, harnessing its power across channels to trigger measurable digital engagement, action and communication. He’s also a co-chair of the ARF Social Media Council. Follow him on Twitter: @mahumbaba.

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Fast Company
December 29, 2009 1:21 PM
by Stephanie Schomer

Did John Mackey’s Media March Cost Him the Whole Foods Chairmanship?

MackeyWF

Since Whole Foods CEO John Mackey wrote his now-infamous op-ed in the Wall Street Journal about health care this summer, he’s been a target. It’s unclear whether his own conscious consumers or media heat–first cranked up in mid November for the December issue of Fast Company and in the last few days in The New Yorker and Reason–led him to announce via his blog on Christmas Eve that he was relinquishing his role as Chairman of the Whole Foods board. But something clearly got to him.

"I have held the Chairman title since Whole Foods Market’s [sic] beginning in 1978, but the reality is that today it is merely a title with no authority or responsibilities," Mackey wrote under the misleadingly benign headline "Latest 8k Filing." "Despite this shift in responsibilities, Whole Foods, along with many other companies with combined CEO/Chairman roles, has been targeted by corporate governance activists for several years now seeking a separation of these roles," Mackey went on to say, adding, "The members of the Board and E-Team tried to talk me out of giving up the title; however, I don’t believe it is in the best interest of our company or our stakeholders to devote any more time or resources to fight this misperception over a title any longer."

In December, Fast Company looked into the quasi-hippie’s efforts to reshape capitalism, and came up questioning whether his ideals match his actions. Mackey just landed on the January cover of Reason and also snagged a feature in The New Yorker.

In Fast Company’s piece, Danielle Sacks examines how Whole Foods’ success and growth is leading to the compromise of the very values it was built on—produce is typically flown in from other continents, rather than purchased locally, and Ceres ranked the company’s environmental record among the lowest of corporations. And even while Mackey himself said, to the Journal, that his company sells "a bunch of junk," he stands by his product.

"If I get run over by a truck later today, I will have already in my life made a difference in helping many people," he says. "Customers are better off because millions of people are eating in a way they never would have had we never existed." That may very well be true, but as he continues to explain his ideals to Fast Company—the four pillars that support the "higher purpose" of conscious capitalism are the good, the true, the beautiful, and the heroic, and he commends Berkshire Hathaway for pursuing "the beautiful"—it’s easy to lose sight of his actual goals.

The Q and A in libertarian Reason was, unsurprisingly, the most kind to Mackey, giving him the chance to explain how "conscious capitalism" will fix the world’s problems. "The best way to think about business is in terms of a complex system with stakeholders who are interdependent: customers, employees, suppliers, investors in the larger community," he tells Reason. "Capitalism is creating value for all of these people, creating value for customers, creating value for employees by providing jobs, creating values for our society through taxes, creating value for investors. It’s creating prosperity. It’s wonderful, and yet how poorly we do articulating that."

Regarding Mackey’s evolution as a public figure, he tells the New Yorker that he had to "grow up," and not "embarrass the company," saying, specifically, "I can’t have affairs with women. One of the things that happened was you have more money and you have more opportunities for such things. And those are sort of off-limits. You can’t do that. Think of Mark Sanford, in South Carolina."

Sorting through Mackey’s ideals, actions, and thoughts is a hefty task, but one thing’s for sure: The man’s got some entertaining things to say. We just wonder whether his board was as entertained as we were.

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As netbooks optimize for lighter OSs, For the SMB market, can netbooks be the next generation for office computing with cloud as the backend infrastructure?

TechCrunch
December 27, 2009 4:38 PM
by Michael Arrington

Can Jolicloud Win In A Chrome OS Netbook World?

Only the truly adventurous are running Chrome OS on their computers today. But it’s the elephant in the room whenever Jolicloud, an ambitious netbook operating startup, is discussed.

We first covered the startup in late 2008, when netbooks were mostly running Windows XP or Linux. In June, when the first invites to Jolicloud went out, it looked like a winner.

But less than a month later Google announced Chrome OS, their own operating system tailored to netbooks.

Jolicloud soldiered on, raising a high profile $4.2 million venture round and finally, earlier this month, releasing a public beta of the product at Le Web in Paris.

I caught up with CEO Tariq Krim and Director Partnerships Brenda O’Connell backstage at Le Web and asked them how Jolicloud would compete with Chrome OS.

Krim doesn’t have a full answer, but he says that part of the answer is Jolicloud’s focus on partner services like Dropbox. Google will rely mostly or entirely on Google services to run Chrome OS, although you’ll be able to access website services.

Jolicloud netbooks will be able to run local high definition video, which is hard to do over the browser today. And with services like dropbox users can store files locally on their netbooks and sync them to the cloud. Chrome OS users won’t be able to store files locally on their machine, other than via offline browser access.

It’s not clear Krim believes that’s much of an advantage, though. He says in the interview that hardware is becoming unimportant and that people will start to spend that money on cloud services instead.

Jolicloud is negotiating partnerships with hardware manufacturers to ship their OS directly with devices. Eventually consumer decisions will say whether there’s a place for Jolicloud in a suddenly crowded netbook OS market. Krim, who has fought Google successfully before with Netvibes (which competes with iGoogle), seems reasonably optimistic.

The video is below:

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Company & Product Profiles jolicloud

TechCrunch
December 23, 2009 5:08 PM
by Jason Kincaid

23AndMe Completes $27.8 Million Series B Round

Personal genomics startup 23andMe has recently raised another $14.2 million to close out its $27.8 million Series B round, according to regulatory filings with the SEC. The filing indicates that the new funding is an amendment to the company’s previously reported raise of $11 million in May, which was followed by an additional $2.6 million in June. We’ve reached out to 23andMe to confirm the funding amount, and to also determine if there are any new investors. Update: 23andMe have confirmed that they’ve raised funding, but have not yet confirmed the amount.

The last few months have been rocky for the company. In September, co-founder Linda Avey left 23andMe to start a foundation dedicated to studying Alzheimer’s disease. In late October, the company laid off a substantial chunk of its workforce, but declined to comment on how many people were affected.

23andMe is one of the first personal genomics companies, allowing customers to have portions of their DNA analyzed for around $400 (there are a few different products available). After completing a test, customers can log into the site to get reports on their genetic makeup, including a listing of some diseases they may be at risk for.

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23andMe