A Stimulus Plan For Venture Capital? No Thanks.

Tom Friedman, who I admire in many ways, has an op-ed piece in today's NY Times where he suggests that the US government take the bailout money they are thinking of giving to the auto industry and instead give it to the top venture capital firms.

You want to spend $20 billion of taxpayer money creating jobs? Fine.
Call up the top 20 venture capital firms in America, which are short of
cash today because their partners — university endowments and pension
funds — are tapped out, and make them this offer: The U.S. Treasury
will give you each up to $1 billion to fund the best venture capital
ideas that have come your way. If they go bust, we all lose. If any of
them turns out to be the next Microsoft or Intel, taxpayers will give
you 20 percent of the investors’ upside and keep 80 percent for
themselves.

I understand the point Tom is making – that we ought to be investing in the future instead of the past. And for that, I applaud him.

But the venture capital business, thankfully, does not need any more capital. It's got too much money in it, not too little. Just ask the limited partners who have been overfunding the venture capital business for the past 15-20 years what they think. You don't even need to ask them. They are taking money out of the sector because the returns have been weak.

And the top 20 firms in the venture capital business are the least in need of a bailout of any group I've ever thought about. These firms, the Sequoias and Benchmarks and Accels and Kleiner Perkins etc etc can raise a fund anytime they want. Accel raised a ton of money last fall in the midst of the worst global financial meltdown in my lifetime.

The venture capital business is an asset class where the top 10-20 percent of the firms make 80%+ of the returns. That's how its always been and that's how it will likely always be. It's because the best entrepreneurs want to work with firms with reputations for making money, making connections, recruting top talent, and getting the right exit at the right time. And those are the top 10-20 percent of the firms.

So Tom's idea, while it looks good on paper, is a dream. The top venture firms don't want, don't need, and are never going to take government money. The same is true of the top entrepreneurs.

The worst firms, on the other hand, will gladly accept government money. And that is what is going to happen with all of these government efforts to pour more money into the "innovation sector". That money will go to bad investors and weak entrepreneurs and management teams for the most part. It's a problem of adverse selection.

If you take a look at all of the economically targeted investment programs that have been built and managed over the past twenty years in the venture capital industry, you'll see this plain and clearly.

There are some good ideas out there. My friend Brad Feld told me about a new legislative effort in Colorado to give angel investors a 50% tax credit for making investments in early stage companies. That makes better sense to me. Let the market work but lubricate it a bit with tax credits, particularly for the angel sector which has been the most hurt in this downturn.

But please leave the venture business alone. It's working pretty well as it is and it certainly doesn't need more money or some kind of stimulus plan.