StartupCafe

This weekend, as we mentally prepare ourselves for Entrepreneurship Week (16-22 Nov), we bring to you a 3-part series on driving startup activity in Scotland. With an understanding of the Silicon Valley’s roots below the surface, Michael Clouser offers insight on what it will take in Scotland to better support high-growth companies.

The case will be delivered in 3 sections:

Today: The Rise of Venture Capital in the US: An Unintended Consequence

Saturday: Why There aren’t More Startups and Technology Companies of Size in Scotland

Sunday: Increasing the Supply of Venture Capital Through Policy

We guarantee that by Monday, we’ll have you prepared for any discussion or debate on government policy, startups, and driving Scotland forward with its existing assets. Thanks to Mike for sharing his work with us.

VENTURE CAPITAL AND PUBLIC POLICY: HOW TO DRIVE START-UP ACTIVITY, INVESTMENT, AND ECONOMIC GROWTH

Americans often deny that government intervention is a good thing in the entrepreneurship and venture capital game. Most of them believe that the growth of the venture capital industry and the high growth technology start-up phenomenon was the result of some sort of pure capitalistic forces that were devoid of any sort of government intervention. That is simply not the case.

THE RISE OF VENTURE CAPITAL IN THE US: AN UNINTENDED CONSEQUENCE

The growth of the venture capital industry in the United States was really a side effect of a policy intended to protect pensioners. The Employment Retirement Security Act (ERISA), which was enacted in 1974, resulted in driving a large amount of capital into the venture capital industry.  Essentially the reason was that pension funds managers were pressured to use sound portfolio allocation models that resulted in a portion of their investment portfolios being allocated to “alternatives” including venture capital. Also, these managers were forced to invest in 3^rd party expert managers, or bear personal liability for backward-looking poor investment decisions. Thus the supply of institutional capital that became rapidly available to the venture capital industry was an unintended consequence of the Act.  One can trace the growth of the venture capital industry right back to 1974, and before that, its birth around the time that the Small Business Investment Act of 1958. This programme was really responsible for launching the venture capital industry in the United States.

SUPPLY IS A GOOD THING – AND SO IS COMPETITION

Supply creates demand. The increased supply of risk (venture) capital in the Silicon Valley had a positive effect. New firms were formed and existing firms grew larger. The competition between venture capital firms caused them to aggressively seek out investments and offer as much help to these early stage start-ups as they could so that they could grow and form competitive advantages. This, in turn, caused more angels to enter the market in the early stages, for they were confident that the later stage venture capital funds could assist the firms in which they invested, and increased the odds of exit down the road. This increased supply of capital, in turn, lured entrepreneurs from not only the halls of the universities in Northern California such as Stanford and Berkeley, but also from the world at large. Entrepreneurs flocked to the Valley “like flies on sugar”.  Entrepreneurs needed angels and venture capitalists, and angels and venture capitalists needed entrepreneurs. It was a match made in heaven. And the snowball effect took hold. Fast forward 35 years and the Silicon Valley is now home to 50% of the planet’s venture capital supply.