What's Wrong With Washington Playing Venture Capitalist?

Two simple rules for governments helping entrepreneurs: (1) Don't help the most promising startups, and (2) Don't help the most hopeless startups. Where does that leave Washington?

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In 1990, the state of Iowa, hoping to boost entrepreneurship in the state, set up the Heartland Seed Capital fund, a government funded venture capital program. It seeded the fund with $15 million from the state's Public Employees Retirement Fund. After issuing a request for proposals, it selected the investment firm McCarthy Weersing to run it. Over the next three years, the fund made only one investment of $1 million - perhaps partially explained by the fact that the firm had no investors based in Iowa - while collecting a fat three percent in management fees. When the state decided it had made a mistake, the investors sold back their one equity investment to the company to recoup for themselves management fees that the state refused to pay, and promptly sued the state of Iowa.

When Mitt Romney and other politicians claim that the government makes for a lousy venture capitalist, stories like the Heartland Seed Capital fund and Solyndra figure prominently in their anecdotal evidence. Are these skeptics right?

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Maybe not. I recently finished reporting a series for BostInno about the Massachusetts state government's efforts that confirms that government venture activity can succeed in boosting innovation. Such programs existed during Romney's tenure as governor of the state and one such fund was even created by his administration. And while it would be a mistake to equate state and federal programs, understanding the role that government venture capital can play in principle casts doubt on Romney's attacks.

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Why do governments consider getting into venture capital in the first place? The importance of new, innovative high-growth startup companies to the economy -- the jobs they create, the growth they promote, the new technologies they bring to market -- is well documented. So it is a legitimate goal of any government to encourage startup activity. Venture capital funds raise money from pension funds, universities, and other large institutional investors and then make investments into early stage companies in exchange for partial ownership, and are a key driver of startup growth.

Sadly, the Iowa debacle is indicative of the broader record of government venture efforts.

"Unfortunately, these experiences are more the rule than the exception," writes Harvard Business School professor Josh Lerner in his 2009 book Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed - and What to Do About It. In Lerner's telling, the record of government venture investment is dismal. From New York City to Malaysia, such efforts have been plagued by poor program design and implementation. But as Lerner notes, these failures are not inevitable. In fact, there is reason to believe that, when done properly, venture investments by government can help address critical market gaps and boost a city, state, or region's innovation ecosystem.

The fundamental challenge for a government venture program is that to succeed, it must toe the line between investing in viable companies and filling a market gap. It shouldn't duplicated private sector efforts by chasing after the most promising deals. But it also shouldn't waste taxpayer dollars by dumping money into nonviable companies. Where is the happy medium?

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Walter Frick is a Staff Writer at BostInno covering technology and venture capital. He has also written for The Atlantic, Nieman Journalism Lab, and The Energy Collective, among other publications.

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