12 Oct 09 Eddie's Blog Global

Venture Capital

It has become apparent in the last while that in addition to the difficulty of getting money from banks there is another source of illiquidity.  It has equally devastating effects on progress towards growth in our society.  Venture capitalists have stopped investing in companies.  There are several instances that I am aware of where entrepreneurs who have splendid ideas and a considerable amount of early entrepreneurial work done are currently starved of cash and can’t get any through normal venture capital channels.

The entrepreneur can be the workhorse and engine for recovery in society but like all workhorses needs feeding.

The engine for growth in any and every society is the small and medium sized business and they are being choked to death globally right now.

I believe the issue to be so serious that I think the Government has to take action because if the entrepreneur is denied the capability of working then the future creation of small and medium sized businesses gets choked off at the outset.

Unlike banks, venture capitalists answer only to investors.  They do not suffer from capital adequacy ratios.  They are much less constrained than the average bank.  Yet right now they are not open for business.    It almost does not matter how good the idea is, venture capitalists or hedge funds are reluctant to invest right now.

Part of the reason that these venture funds don’t engage in their normal activity is that they have the option not to do so.  An option is created by the Government’s huge capital needs.

They won’t earn much but the capital is protected.

So as with many other areas of life, Governments have immense power to lead in these difficult times.

As a stratagem, Governments ought to use a carrot and stick to get venture investment going.    An instrument that suggests itself is taxation.  If the Government were to tax venture funds but to forego that tax if the venture funds were to engage in normal levels of activity you would see a completely different outlook and attitude from these funds.

So what percentage could the proposed tax be set at?

It would have to be high enough to sting them into action but not so high as to be demonstrably too penal.  20% is a figure that suggests itself.

I have seen instances recently where venture funds are even refusing to invest in companies that they themselves have a major share holding in.  On the surface of it you would think that this is very odd behaviour, odd that is if you weren’t aware of the mind of the day trader.

It is in the interest of these venture funds to push their companies in which they have investments into deep retrenchment mode.  They thereby throttle growth, put the future of the company at risk and set themselves up to pick up a much larger share than what they currently own.  A very old fashioned but still equally potent mechanism is at work and that is of course old fashioned greed.

The world of business is forever caught up in a dilemma type debate, efficiency and effectiveness vie one with the other in the mind of every business man. When a business is in start-up mode the really relevant attribute of the entrepreneur or the manager is effectiveness.  In other words how do I get the thing done at all?  Once it has been done and the feasibility and practicality demonstrated, well then the world and its wife will copy that business.  Competition will guarantee efficiency.  From the viewpoint of the entrepreneur, particularly the very innovative entrepreneur, the key is to get the thing working in the first instance.  Demonstrate the idea to create something where nothing existed before.  This is the glorious work of the entrepreneur.

Unfortunately in the world as it exists what gets taught in our business schools is largely efficiency as distinct from effectiveness.

Right now what the western world needs more than at any other time in its history is a series of ways to get out of the awful dilemma in which we find ourselves.  My father never tired of explaining how by far the worst phenomenon in the world was deflation.  He had experienced it during the great depression.  He had studied economics and was well aware of the awful implications of the hopelessness that attends deflation.  We are in that spiral now.  It isn’t just Ireland that has seen 6.5% deflation in the last year.  There still remains a genius in the population.  Entrepreneurs will still have a go and despite everything will try and create wealth.

But money is needed to create wealth, we are all aware of the great expression that money is round and created to go around.

We see Governments making valid efforts, largely I believe successful, at dealing with the banking crisis.  It is hard to argue that that isn’t the most important thing with which to be dealt.  Indeed one does not seek to argue that Governments ought to change direction.  They do need to recognise this other dimension to the problem.  The entrepreneur if backed can perform great wonders.  They however operate at the most insecure part of the business cycle.     They are the guys who lay their neck on the line if they are backed.  Collectively they can transform society by revving up the SME engine.  Right now they need to be backed.