By Ryan Ekvall | Wisconsin Reporter
MADISON – Deep-pocketed investors in risky start-up businesses want Wisconsin taxpayers to protect them from losses in case their investments go sour.
Democratic and Republican leadership, including Gov. Scott Walker, appear to be willing to grant them that protection.
Editorial boards from Wisconsin’s major newspapers have wholeheartedly endorsed this investment high-wire act with a taxpayer safety net.
But a plethora of data, and plenty of tough-luck stories from several states, including Wisconsin, suggests subsidizing venture capital is at best a gambit, at worst a risk with little reward.
Lackluster in Ohio?
Nearly a decade ago Ohio passed similar legislation now being kicked around in Wisconsin. Buckeye State taxpayers haven’t lost money on the deal yet, but the results have been anything but robust.
Ohio uses a “fund of funds” model and requires venture capital firms to establish an office in-state. The companies must invest at least 50 percent of funds in Ohio to participate. Wisconsin economic development directors and politicians are tossing around similar ideas.
The Columbus Dispatch reported last June:
“A third of the 24 funds that so far have been given a total of $84 million are not meeting the state requirement that they invest at least 50 percent of that money into Ohio companies. In fact, two funds do not intend to invest any Ohio money in Ohio.”
The $84 million invested in The Capital Fund has produced 766 new jobs since 2006, a total that some critics see as less than stellar.
That works out to $105,000 a job.
Venture funds receiving government support made no investment in Ohio startups in some cases, thanks to lax oversight, according to Zack Schiller, research director of Policy Matters Ohio, a progressive-leaning economic policy research organization.
“At the time I did my report, 14 of 25 venture funds had not met that requirement (to invest 50 percent of funds in Ohio),” Schiller said. He testified before an Ohio legislative committee about his examination of the program. Subsequently, legislators increased scrutiny of the program and those firms have started investing in the Buckeye state, he said.
Ohio’s Republican-controlled Legislature decided not to ante up additional funding for The Capital Fund last session. There are rumblings they may do so this year.
Other states haven’t been so lucky.
In 2006, state auditors found the Oklahoma Capital Investment Board, which operates a program similar to Ohio’s venture capital initiative, was in debt $31 million with additional unfunded commitments of $26 million.
In August 2011, a bi-partisan committee of lawmakers grilled the OCIB’s president Devon Sauzek for investing too much money in out-of-state firms, not creating enough jobs, and its lack of transparency, according to the Tulsa World.
“I think we’re finding out that there are too many dollars that are being invested in companies and corporations outside of the state borders,” said Rep. David Dank, R-Oklahoma City.
Tom Adelson, D-Tulsa, said the board spent 85 to 90 cents of every dollar out of state.
After tens of millions of lost taxpayer dollars, one state lawmaker told The Oklahoman newspaper it was “time for the state to get out of the venture capital business.”
Wisconsin taxpayers have been down this road before. In the late 1990s, a $50 million venture capital program with Certified Capital Companies, or CAPCOs, saw one firm — Wilshire Investors LLC – “take advantage of a loophole to walk away without investing $8 million, almost half of the taxpayer money it received from the state,” according to a Milwaukee Journal Sentinel report.
“The company didn’t report how it used the money — and didn’t have to — so it could have used the $8 million from taxpayers for salaries, operating expenses or whatever it wished,” the report disclosed.
At about $90,000 per job created, according to the Legislative Audit Bureau, Wisconsin’s previous foray into venture capital was not exactly a paragon of efficiency.
When a new CAPCO program was introduced last session, Sen. Glenn Grothman, R-West Bend, led the charge to kill the legislation, calling the operation a “scam” and the CAPCOs “bunco artists.”
Lawmakers across the country sing the same tune about the dearth of venture capital dollars. They say the way to grow jobs is to seed programs with taxpayer dollars. They warn their respective states are falling far behind in the venture capital chase.
Peter Klein, director of the McQuinn Center for Entrepreneurial Leadership at the University of Missouri, however, says it’s hard to rationalize state governments playing venture capitalist.
“There’s a huge private investment industry,” Klein said. “If there really are $20 bills on the sidewalk waiting to be picked up, why are private investors who have this money and profit incentives, why aren’t they getting at them?”
Klein said these investors scan the globe looking for potential profits. They often fail.
Last September, The Wall Street Journal reported three out of four venture capital-backed start-ups fail to return investors’ capital. That’s a far cry from the 25 percent to 30 percent failure rate the National Venture Capital Association publishes. Harvard Business School lecturer Shikhar Ghosh told the Journal the industry “bur(ies) their dead very quietly.”
In the political arena, voters hear about the successes more than the failures. You won’t see a lawmaker’s press release on a failed venture. No one put out a release lamenting the exodus to Chicago by the Sagence Group, a former Wisconsin-based VC-backed firm, taking its 245 jobs with it. The companies that do make it get their names in the media and politicians get to pat their own backs.
“This kind of a model just sounds sexier than, ‘We’re going to do a bond issue to pave more roads or build another elementary school.’ It sounds high tech, innovative,” Klein said.
Klein said it’s more important for government to “improve the general business climate” than micromanage markets. Government can better serve business growth by “having a legal and regulatory system that is fair and honest. A tax structure, a regulatory structure that does not make it difficult to make a business,” he said.
Venture capitalists such as T.J. Rogers, CEO of Cypress Semiconductor, have advised the federal government to keep out of the business.Rogers, who at the time had made nearly 100 venture capital investments, in 1993 testified before Congress. He said the best thing the government could do to spur innovation was reduce wasteful spending and cut taxes.
“Venture capitalists without subsidies are carefully balancing the costs of alternative investments,” Klein said. “There’s a lot of research on the-long term rate of returns on government subsidized venture capital. The evidence is pretty disappointing.”
Joshua Lerner, Harvard economist and author of “Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed – And What To Do About It,” has done much of the heavy lifting on that work.
In December 2009, he told the Freakonomics blog that government programs often act counterproductively.
“Decisions that seem plausible within the halls of a legislative body or a government bureaucracy can be wildly at odds with what entrepreneurs and their backers really need,” Lerner said.
Venture capital firms, like any business, know a good deal when they see it. Private- and public-sector entities team up to grab direct and indirect public-sector hand-outs are, the idea of regulatory capture, Lerner told Freakonomics.
“For instance, programs geared toward boosting nascent entrepreneurs may instead end up boosting cronies of the nation’s rulers or legislators,” Lerner told the publication. “The annals of government venturing programs abound with examples of efforts that have been hijacked in such a manner.”
Earlier this month, Wisconsin Reporter reported that the State of Wisconsin Investment Board told the Wisconsin Economic Development Corp that it wouldn’t “allocate” $200 million to back their venture capital program, even though SWIB itself invests in venture capital initiatives.
In his letter to SWIB, WEDC CEO Reed Hall noted some “first time fund managers” might have trouble attracting their own investing money on the private market, hence the need for the subsidy.
SWIB has invested more than $300 million in venture capital in Wisconsin over the past dozen years, including a $25 million allocation in 2012. SWIB has allocated $126 million in VC funds that haven’t been deployed yet.
The state also offers tens of millions of dollars in tax credits for early stage investments and attracts tens of millions more in private venture capital funding. SWIB says they will invest even more than the planned $25 – 50 million over the next five years if they see the right opportunities.
While state lawmakers and industry lobbyists bemoan a supposed lack of capital for venture capital in Wisconsin, studies show government subsidized programs often crowd out private investment.
“ … (W)e find that enterprises funded by (government-subsidized venture capital) tend to underperform on most outcome measures,” economists James Brander, Edward Egan and Thomas Hellmann find in a National Bureau of Economic Research study. “They are less likely to have successful exits and, in particular, are much less likely to have IPOs on major exchanges. Furthermore, they generate lower exit values when they do have a successful exit….Our results provide no evidence that (government-subsidized venture capital programs) increase employment or competition.”
Klein, of the McQuinn Center for Entrepreneurial Leadership, advises Wisconsin to focus on its business climate, and be weary of government-subsidized venture capital.
“It begs the question, why aren’t very hungry venture capitalists going to do it anyway?” he said.
Chris Edwards of the libertarian Cato Institute contends subsidies change the behavior of businesses.
“An economist recently quipped to me: ‘I don’t know whether the government is better at picking winners rather than losers, but I do know that losers are good at picking governments,’” Edwards said in congressional testimony.
Contact Ekvall at [email protected]