Publicly Funding Entrepreneurship

Literally thousands of government programs worldwide have tried to boost innovative new ventures in recent decades. While some–such as those in Israel and Singapore–have dramatically encouraged entrepreneurial and venture activity, many more have been abject failures. The same critical mistakes have been made again and again, most recently in efforts to boost entrepreneurial innovation in clean tech.

One major problem is that funds end up getting distributed in ways that have less to do with the needs of high-­potential ventures or society generally than with the whims of the powerful and well-connected. From the empty BioValley site in Malaysia to the many U.S. Small Business Innovation Research grants won by DC-area firms that produce few real innovations, the pattern is depressingly familiar. Successful programs, by contrast, have well-defined investment processes and limit the danger of political influence by establishing independent administrative bodies.

Faced with a clean-tech funding bonanza in the stimulus bill, entrepreneurs have responded the old-­fashioned way: by hiring lobbyists. The big winner of the Department of Energy’s battery funding orgy, A123 Systems (see the TR50), spent about a million dollars on Washington representatives from 2007 through early 2009. A partner at New Enterprise Associates suggested last March that at least half of its 25 clean-tech firms had hired lobbyists.

The only sure way to prevent political and other pressures from distorting public efforts to boost innovation is to look carefully at which firms private investors think are viable. By focusing on supporting firms that have raised matching funds, public officials can boost innovative entrepreneurs far more successfully.

Yet many recent efforts on behalf of clean-tech firms have shown a willful disregard for market signals. Consider Massachusetts’s support for panel maker Evergreen Solar. As its stock price has tumbled from almost $19 in late 2007 to under $1.50 today, the state has continued to fund the firm, in apparent violation of its own spending limits. The crucial consideration in these decisions seems to be not the potential for innovation but, rather, the PR nightmare that could result if the company failed.

High-potential ventures do not exist in a vacuum. And the Japanese government’s unsuccessful efforts to boost entrepreneurs over the past 15 years are evidence enough that without a suitable environment, failure is certain. The United States should focus on ensuring that the overall economic environment is attractive to entrepreneurs (for example, through low marginal tax rates on long-term capital gains), that subsidized firms and venture funds are able to raise matching funds from private investors, and that government programs to promote innovation are implemented in a thoughtful and transparent manner.

Josh Lerner is a professor of investment banking at Harvard Business School. His latest book is Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed–and What to Do About It.