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JOSH LERNER HARVARD BUSINESS SCHOOL The Promise of Venture Capital
Why is venture capital important? Venture capital is still very young: First fund in 1946. Venture capital is still very small: In largest market, U.S.: Only about 4000 professionals. Average of 1,500 companies funded for first time annually, 2000- 2008. Relative to 1 million businesses started annually. Considerably less elsewhere.
But importance far beyond its size The backdrop: Young high-tech and restructuring firms pose many challenges: Uncertainty. Information gaps. The nature of the firm’s assets. Market conditions.
“I realize, gentlemen, that thirty million dollars is a lot of money to spend. However, it’s not real money and, of course, it’s not our money either.”
General Doriot’s insight Difficult for traditional financiers to fund these firms: – Banks. – Public markets. A new organization could address with three key mechanisms: – Sorting: picking the right entrepreneurs. – Controlling: limiting “agency” problems, through a mixture of incentives and monitoring. – Certifying: developing a tradition of quality and fair dealings.
The evolution of venture capital Venture capital has developed many tools to address challenges: Intensive scrutiny of business plans. Restrictions in preferred stock agreements. Staged financing. Board service and monitoring. Informal advice. Not surprising that dominant funding source.
Venture capital has had a profound impact Between 1972 to 2007, ~2500 venture-backed firms went public in U.S.: 13% of all public firms at end of 2008. 8% of market capitalization ($2.0 trillion). 6% of total employees. Particularly true in high-technology industries.
Supporting evidence Hellmann and Puri : Look at 170 Silicon Valley firms. Venture capital-backed firms seem more innovative on several measures. Unfortunately, hard to control for causality: Does VC spur innovation or does innovation spur VC?
Supporting evidence (2) Kortum and Lerner  look at industry level: VC appears to have a strong positive effect: Even after controlling for corporate and government R&D spending. Use 1979 ERISA shift to address causality issues. In 1983-95 period, while VC <3% of corporate R&D, accounted for 10-12% of innovations. Mollica and Zingales  also demonstrate strong relationship with different appproach: State pension fund holdings.
Why a government role? Increasing returns to scale Much easier to do 100 th deal than the first: Knowledge and expectations of entrepreneurs. Familiarity of intermediaries. Sharing of information among peers. Comfort level of institutional investors. Economists term these “externalities.” In these cases, government can frequently play a catalytic role.
Also historical precedents In the U.S.: Critical role of SBIC program. Established in 1958. Many early VC firms started as SBIC awardees, then opted out. Building critical “infrastructure”: Lawyers, data providers, etc. Similar insights from Israel, Singapore, etc. Suggests that some of funding should be directed to growing industries!
Particularly in light of boom in emerging market private equity fundraising ($Bs)
But history also suggests need for care But many pitfalls from earlier efforts. Three key points from report: More than money is needed: entrepreneurship is not in a vacuum. The virtues of market guidance. Getting details right important as well. Need for patience!
Josh Lerner Rock Center for Entrepreneurship Harvard Business School Boston, MA 02163 USA 617-495-6065 email@example.com www.people.hbs.edu/jlerner
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