Government bodies have played an active role in financing new firms, particularly in
high-tech industries, for many decades. But in recent years, interest in such efforts has
surged, particularly in many European and Asian nations. While these efforts have
proliferated, a consensus as to how to structure these ‘public venture capital’
programmes remains elusive.
Writing i n the latest issue of the Economic Journal, Professor Josh Lerner of Harvard
Business School describes key lessons for governments seeking to design effective
public venture capital programmes. In particular, he highlights a common fault of these
efforts: the presumption that technological criteria can be divorced from business
considerations when evaluating firms. Instead, government officials must seek to
understand the business environment in which young, high-tech firms operate.
Lerner has four lessons for policy-makers:
· Learning from the venture capital industry: first, there is a strong need for public
officials to invest in building relationships with and an understanding of the private
organisations that play a similar role, especially the venture capital industry.
Financing small entrepreneurial firms is exceedingly challenging. The venture
capital industry employs a variety of important mechanisms to address these
challenges, which empirical evidence suggests are quite effective. Because of the
magnitude and success of venture capital financing, it is important that
administrators view their actions in the context of this financial institution.
· Technology focus and follow-on capital: a corollary to this first point is that public
venture capital investments should be made with an eye to the narrow technological
focus and uneven levels of independent investments. Venture investments tend to
be very focused into a few areas of technology that are perceived to have great
potential. Increases in venture fund-raising - which are driven by factors such as
shifts in capital gains tax rates - appear more likely to lead to more intense price
competition for transactions within an existing set of technologies than to greater
diversity in the types of companies funded. Administrators may wish to respond to
these industries conditions by: (a) focusing on technologies that are not currently
popular among venture investors; and (b) providing follow-on capital to firms already
funded by venture capitalists during periods when venture inflows are falling.
· The need for flexibility: third, government officials must appreciate the need for
flexibility that is central to the venture capital investment process. Venture capitalists
make investments in young firms in settings with tremendous technological, product
market and management uncertainties. Rather than undertaking the (often
impossible) task of addressing all the uncertainties in advance, they remain actively
involved after the investment, using their contractually specified control rights to
guide the firm. These changes - which often involve shifts in product market strategy
and the management team - are an integral part of the investment process.
· Evaluating high-performers and underachievers: fourth, just as the venture capital
community carefully analyses the track record of entrepreneurs they are considering
funding, government officials should examine the track record of the firms receiving
public venture awards. As it is now, public venture capital programmes are often
characterised by a considerable number of underachieving firms. In particular,
certain company characteristics - attributes that may not be adequately considered
in the selection process of these programmes - appear to be highly correlated with a
company’s ability to achieve its research and commercialisation goals. These
include the experience of the management team, the presence of a clear product
market strategy, and a strong desire to seek private financing. By devising new
methods to search for such factors, government officials would be better able to
distinguish between high-performing and underachieving firms.
ENDS
Notes for Editors: ‘When Bureaucrats Meet Entrepreneurs: The Design of Effective
‘Public Venture Capital’ Programmes’ by Josh Lerner (Harvard Business School and
National Bureau of Economic Research) is published in the February 2002 issue of the
Economic Journal. Lerner is Jacob H. Schiff Professor of Investment Banking, Harvard
Business School, Morgan Hall, Room 395, Boston, Massachusetts 02163.
For Further Information: contact Josh Lerner on +1-617-495-6065 (fax: +1-617-496-
7357; email: jlerner@hbs.edu); or RES Media Consultant Romesh Vaitilingam on 0117-
983-9770 or 07768-661095 (email: romesh@compuserve.com).