Thoughts on the Early Stage Innovation Fund

Robb Mandelbaum wrote an article for the NYT this morning discussing the proposed Early Stage Innovation Fund program. Essentially, this program would lend matching funds to venture capital firms who raise between $20 million and $50 million on their own and then require that at least half of that fund’s investments be made in companies that do not yet have positive cash flow from operations. The program seeks to utilize $1 billion over 5 years to help 4-10 VC funds in any given year.

Because young, high-growth companies hire, assisting these companies in raising funds should help lower the unemployment rate. Additionally, the requirement to fund companies in their earliest stages should help companies caught  needing funding in order to grow but needing to grow in order to get funding. Additionally, the program hopes to be able to encourage venture investment outside of California, Massachusetts, and New York as these three states currently receive nearly 75% of all venture capital investment in the United States.

This program certainly means well and an additional $1 billion for entrepreneurs is not something to be disregarded. However, I see a couple of problems with this program in that it doesn’t address persistent barriers to entry, nor does it do anything for small businesses that are not considered “exponential growth candidates.”

First lets focus on the issue of barriers to entry:

This program will give money to investors who have a track record of success and who are able to raise funds on their own. That means that the people managing this money and making decisions about investments are the same people that already manage venture capital money and make decisions about investments. While the early stage investment requirement may help to  mold behavior slightly, there are much bigger problems with the VC industry, that have been discussed at length, than the unwillingness to invest in very early stage companies and that are also true of the angel investment space (historically more willing to invest in younger, less proven companies).

The major problem is a lack of access. We’ve already mentioned that a massive proportion of VC money goes into just 3 states. Are those the only states where innovation is occurring and good business models are being developed? Of course not. While there is some truth to the argument that because these three states are the startup hubs the most promising entrepreneurs move there, there is also a much bigger reason for this pattern: investors invest in those they know. If you know anyone in the industry or even do a cursory scanning of the blogosphere, you will quickly learn that VCs and angels are notoriously difficult to get a meeting with unless you already know them or at the very least know their friends and can get an introduction.

VCs and angels are a pretty homogeneous bunch: disproportionately White, male, rich, and living in one of the 3 hub states. So, naturally, those able to get meetings with them are going to be those within the same social circle. What does this mean for entrepreneurs who happen to be female, minority, not from MIT or Standford, or living outside of CA, MA, or NY? It means that the already steep uphill battle to get funding is even steeper. Again, there is an endless amount of discussion about the absence of minorities (primarily Blacks and Hispanics) and women in the VC world – both as funders and founders – and studies have shown that investors tend to invest in founders “like them” along these key demographic lines.

For the purposes of this post I don’t intend to open a debate about whether or not there are systemic issues that create unique barriers for minorities and women in the high-growth, venture-funded entrepreneurship space. I take that as a given. My point in mentioning this here is that the Early Stage Innovation Fund will put more money in the hands of these same investors, so it in no way addresses these issues of access.

Secondly, the program focuses exclusively on companies that would be candidates for venture capital investment thereby ignoring the vast majority of small businesses:

While it is true that these high growth companies that are appropriate candidates for venture capital investment are the ones that create major job growth, these companies do not make up the majority of new businesses created each year in this country. As the SBA’s purpose is to advocate for ALL small businesses, a program that funds only 4-10 investment funds per year, which will in turn fund perhaps dozens of businesses, certainly doesn’t have the reach that one may expect when he/she first hears the $1 billion price tag. This is not a “problem” per se, as of course not every program is going to help every entrepreneur, but it’s definitely something to keep in mind when assessing the program.

The SBA hopes to start taking applications from investors in April but the comment period is open until February 7, 2012. If you’d like to give feedback, please click here and then on the “Submit a Comment” button.

Also, make sure to leave your thoughts and responses below! I want to hear what you think the pros and cons of this proposed program are and whether you think it will help entrepreneurs and/or unemployment.


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