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In light of our current situation and lessons learned across the Atlantic, what is Scotland to do? The final piece of our Venture Capital and Public Policy series from Michael Clouser. We hope you feel a bit more enlightened and sufficiently armed for any government policy discussions during Entrepreneurship Week (and beyond!). If you have any further thoughts, questions, or points of view, by all means chime in by adding your comments below.

INCREASING THE SUPPLY OF VENTURE CAPITAL THROUGH POLICY

Learning from the US example, the government can enact policies to increase the supply of risk capital in the Country (used interchangeably to mean either devolved Scotland or the UK – while their powers are different, the issues are basically the same).

Tax Policy is OK, but Not Enough:

Tax policy can help. Already this has happened in the angel market, with tax benefits for these investors who are part of venture capital trusts. However, tax policy is but one option. It hasn’t yet been able to drive large flows of capital into the technology risk investment sector as of yet. Even at the angel level, most are not playing in the high growth technology firm game.

Other policies could drive money into the venture capital industry and should be pursued. For example, all public institutions with investment portfolios [most of them are in equities (stocks) and debt (bonds)] could be required to allocate a % of their portfolios to domestic venture capital managed by third parties. This % allocation might be around 2% at the beginning, rising to 10% over time. Something similar to the ERISA legislation could be enacted, but with the specific requirement of a minimal investment in venture capital.

What about the government just simply investing in venture capital itself? In the United Kingdom, the government now owns a large portion of a lot of big banks. I believe that the ownership share of the taxpayers is around 70% of the Bank of Scotland now. With that much exposure to financial institutions, which might fail anyway, why wouldn’t the government legislate policies to increase the supply of risk capital, especially venture capital, both early and later stage?  Let’s ask the taxpayer: which would you rather invest your tax pounds in?  a) Venture capital firms based in your Country that invest in exciting, early stage technology companies that could change the world, and create really cool new jobs or   b) Big banks that create and sell shaky derivative things, buy and create bad mortgages, don’t lend money to the small business, don’t invest in the small business, and buy groups of banks (that you never heard of) in other countries?

By pursuing such policies and growing the venture capital supply base, the Country will effectively undertake a contrarian strategy that could reap great benefits in the long run. Its science and technology base will grow and be exploited. With the venture capital industry predicted to downsize 50% over the next 5 years in the US, the UK will grow its risk capital base here upwards of 500% over the same period, and harvest good venture capital talent from around the globe in the process. Dawn of a new day, perhaps.

WHAT ARE THE HISTORICAL RETURNS IN INVESTMENT IN VENTURE CAPITAL?

I’ll be addressing this in greater detail in a future paper, but suffice to say for now that all classes of venture capital have historically beaten the public equity markets in the US context over the long haul. And let’s not forget what happened over the last year, when most public institutions lost 20 – 30% of their portfolio values because of the public equity markets. Supposedly these were “safe” investments.

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Did you miss something?

Part 1: The Rise of Venture Capital in the US: An Unintended Consequence

Part 2: Why aren’t there more start-ups and technology companies of size in Scotland?