Your house is on fire, and you’re smoking in bed!
—Billy Tauzin, U.S. Representative, Louisiana Third District, 1985–2005
Like most asset classes, timing is everything. Sometimes, this is preordained by way of making the right decisions, and sometimes it’s just pure luck. Either way, I’ll take it. Coming out of the 2007–2008 recession and entering into the ensuing investment climate, which featured near 0 percent interest rates, higher taxes, and more regulation, our raison d’être at GCA is to control the destiny of our investments. In order to be sure we are able to pay the higher taxes imposed upon our invested capital, we strive to make outsized returns on invested capital. That is easier said than done.
As a result, we launched the latest in our vintage series of venture capital funds in late 2012. The GCA Catalyst Fund is in fact an inflection point fund, hence the name “catalyst,” which we reset or rebooted to achieve the near impossible. Catalyst seeks to back serially successful repeat entrepreneurs who can demonstrate business plans with milestone roadmaps that are capable of achieving a critical mass of operating, financing, and strategic value such that they are positioned to consider a possible liquidity event within 18 months. Yes, you heard right, I said within 18 months. Moreover, we are looking for minimum cash-on-cash returns of more than 10×!
This VC investment strategy obviously doesn’t work for every business plan—in fact not even for most; however, it works for those who meet our prevailing economic climate-adapted investment criteria. Most important is our ability to identify companies where we invest not just financial capital, but, equally important, our intellectual capital. This includes our time, sector skill set, wisdom forged from experience, and the company-relevant relationship Rolodex to go with it. If aligned properly, this combination will materially enhance our portfolio company entrepreneur’s prospects of success. I truly believe that, irrespective of the challenges faced in prevailing investment climates, it is possible to succeed, provided the VC investor and their portfolio companies adapt in an appropriate manner.
Our present economic situation is unparalleled in American history. Real GDP growth rates for each decade from 1790 to 2012 reveals the sluggishness of our present economic environment. The 1.8 percent average rise this century pales in comparison to the 3.8 percent growth rate since 1790. Only the 1930s growth rate was worse! The current and forward-looking economic and investment climate depends, more than any other time in our history, on the policy makers and their accurate interpretation of the facts and their understanding of the underlying drivers.
It is not my intention to indict public policy or put forward a political conclusion. My interest is solely in presenting the facts and putting forward the economic and investment ramifications. The specific recommendations made are an attempt to find true north and suggest remedies to correct some of the problems which threaten to discourage opportunities for our economy’s two most important drivers—SMEs and VCs.
As Harvard professors Josh Lerner, Ann Leamon, and Felda Hardymon point out, policy makers are acutely interested in the venture capital industry and monitor it closely. They have a compelling interest to regulate the industry, to protect the general economy from the “problematic practices” of large buyout funds and hostile takeovers; but at the same time, they must encourage the industry to invest more in young firms that are developing promising technologies with enormous social impact and helping to create jobs.1
We are, unfortunately, in the proverbial Red Zone. The U.S. economy is like a patient suffering from congestive heart failure and running out of options and time. It does not have the latitude of extra time or spare capacity, like previous post–World War II recession periods, where our baselines gave us additional flexibility. As such, we are operating in an investment environment akin to a live powder keg that could ignite with the slightest provocation and set off a chain of events that no one wants to see: credit defaults, bankruptcies, credit downgrades, higher levels of real unemployment, civil unrest, and the accompanying unraveling of the internationally-intertwined bond markets.
The near-to-intermediate-term negative impact of doing nothing is, in my opinion, magnified by both our untested monetary policy and lack of fiscal policy leadership. This, coupled with the unprecedented and extraordinarily high levels of government and household debt and historically low levels of household savings, has distorted or created the illusion of record corporate profits and earnings multiples. This is another economic bubble that is quickly reaching the point of being ready to burst like a tsunami across the financial landscape.
We can no longer allow policy makers to just kick the can down the road and avoid dealing with the fundamental causes of the coming economic implosion. That would be extremely reckless and irresponsible. Addressing this Red Zone will require some heavy lifting and major multi-tasking decisions regarding a host of related investment climate ecosystem issues. One of two things needs to happen very soon. The first is proactive and will require political leadership that is truly bipartisan and courageous enough to abandon ideology and enact tested and proven fiscal policies that would, at this late stage, prove painful and unpopular in the short-to-intermediate run. Given the modus operandi of the cast of characters currently running the show in Washington, DC, both Democrat and Republican, that course of action seems improbable.
The second, more reactionary solution is probably going to be the inevitable default scenario. The bond markets will finally draw the line in the sand, as they have in Europe, and the retraction will not be pretty. Unless we have some adult leadership step forward and take decisive action, it is highly improbable that our economy can continue to struggle forward for more than another 12 to 18 months before imploding.
The Detroit bankruptcy is emblematic of the type of catalyst that could set off a chain reaction. It could be the revelation of yet another banking scandal that is brought to light; insiders will tell you that there are many lurking just below the surface. Whatever event serves as the trigger, we are staring at a meltdown that will not only dwarf the Great Depression of the 1930s, but will likely lead to the balkanization of the Republic and widespread civil unrest as the expectations and demands of the entitlement class finally outstrip the willingness of the producers to participate any further in the government’s political Ponzi scheme.
That is, granted, the worst-case scenario. In times of crisis, Americans have historically come together and rallied around leaders offering reasoned and rational solutions. To that end, allow me to offer a compass direction for an SME/VC-friendly policy platform of solutions for consideration while we still have time in which to act. I do not believe that we have to accept being in the Red Zone with its anemic 1 percent GDP growth and low job creation. If we can recognize the structural headwinds beating against us, we can set our sails to change course.
In a column entitled “What Should We Do about National Debt, and When?” published Tuesday, August 17, 2010, by the McClatchy Newspapers Washington, DC, online daily, Kevin G. Hall and Robert A. Rankin clearly defined the government’s annual deficit as the gap between tax revenues and the government’s spending in a year. The government covers the gap by borrowing, which raises the national debt.
The Heritage Foundation, which tracks U.S. debt (www.heritage.org) shows that the federal debt currently held by the public totals almost $16.4 trillion. The 50 states’ debt obligations add another $4.17 trillion (not even counting municipalities), and including the long-term unfunded Social Security and Medicare obligations adds another $48 trillion. And even this does not include other federal obligations in the form of Medicaid or veterans’ benefits, for example. A November 2012 column in the Wall Street Journal revealed that the sum total exceeds a staggering total of $86.8 trillion, or 550 percent of GDP!3
The Hall and Rankin column goes on to cite the findings of two prominent economists, Kenneth Rogoff of Harvard University and Carmen Reinhart of the University of Maryland, whose 2009 book, This Time Is Different, analyzed 800 years of national financial crises. Their book concludes that when any nation’s ratio of government debt to gross domestic product exceeds 90 percent, negative economic consequences commence. These damage GDP growth, which by historical comparison take close to 20 years to fully digest. Today’s U.S. debt-to-GDP level is 101.57 percent.4 Rogoff and Reinhart believe that the United States must reduce its debt or suffer economic stagnation. The adjustment must be controlled and done slowly, they concluded, or it could derail whatever fragile recovery we are currently seeing.5
By way of comparison, this debt alarm bell has now been met by countries that represent 75 percent of global GDP. A grimmer reality is that the financial markets do not seem to fully reflect this reality of stunted growth. In my opinion, this represents a psychology typical of irrational market behavior at play.
The federal government needs to enact a balanced budget amendment to the national Constitution similar to ones included in the constitutions of 48 of our 50 states.6 In order to do this, we should set a 10-year target to balance revenue and spending at the historical peacetime average of 18.5 percent of GDP. Several areas need to be addressed in order to reach this goal.
The first of these is the 600-pound gorilla in the room that nobody wants to talk about, government entitlements. We must first require means testing. Title I, Section 1 of the Social Security Act of 1935 specifically states: “For the purpose of enabling each State to furnish financial assistance, as far as practicable under the conditions in such State, to aged needy individuals. . . .” Social Security was never intended to be a monthly stipend that individuals received simply because they reached a certain age. It was a safety net for “needy” people. If people have retired on a full pension and savings plan that allows them to live above the poverty line, they should not automatically be receiving a monthly Social Security check. Yes, we all have paid into the system; but it was meant to be an insurance policy against reaching an age where you could no longer work and had no other means of income. We can have the debate about how far above the poverty line the cutoff needs to be, but we must all agree that people whose lifestyle places them comfortably in the middle class and above don’t need an extra monthly check from us, the taxpayers.
Secondly, we need to raise and, perhaps, even abolish the mandatory retirement age. Again, we have a program, the Age Discrimination in Employment Act of 1967 (ADEA), which is supposed to protect individuals who are 40 years of age or older from employment discrimination based on age. The problem is that it is not being prosecuted. Too many employers are replacing senior employees with less expensive, more technically savvy younger employees as a cost-cutting measure. In far too many cases, these senior employees are sidelined right before their pensions or other retirement obligations are vested. Any employer who voluntarily removes a senior employee should be required to show just cause for the action, even in right to work states, due to the fact that the financial ramifications of the action are often borne by the taxpayers.
We have brought together very smart people to form commissions, like the Simpson-Bowles Committee, to make recommendations on ways to reduce the government’s deficit, and then we allow our political representatives to ignore the recommendations. The plan is a balanced, comprehensive approach that addresses all parts of the budget. In addition to the $2.7 trillion in deficit reduction already enacted, not including sequestration, the new Simpson-Bowles plan would produce a total of $5.2 trillion in deficit reduction, enough to bring the debt down to about 69 percent of GDP by 2023, putting it on a clear downward path as a share of the economy.
There are five key components to the plan. The first of these is to tighten and strengthen discretionary caps to demand additional efficiency from Washington in place of abrupt across-the-board cuts. The recommendation is for this to be done in two steps: first, by restoring 70 percent of the sequestration cuts in 2013 and, second, by limiting the defense and nondefense spending growth to the rate of inflation through 2025. The dirty little secret about budget cuts in Washington, DC, especially with the sequestration, is that the “cuts” were not in any actual budgets. They were in the percentage of the automatic increase in the budget. In other words, if a department was budgeted to spend $8 million this year and their budget for next year was scheduled to increase to $10 million, it would be a 25 percent increase in the real world. If they were only authorized to spend $9.5 million, it would be an increase of 18 percent in the real world. Only in Washington, DC, is this considered a draconian 7 percent budget cut. As Charles Grodin so brilliantly summed up the federal budget to Kevin Kline in the 1993 movie Dave,
The second recommendation is to reform federal health spending. This would include means testing for financially better-off beneficiaries, reducing fraud and abuse at all levels of the healthcare system; modernizing cost-sharing rules with new cost protections; gradually increasing the Medicare age with a buy-in at age 65; and re-orienting incentives for doctors, hospitals, lawyers, and beneficiaries to improve the delivery of health care and truly bend the cost curve. These reforms would remove the insurance company from between the doctor and the patient, change the way hospitals are allowed to depreciate equipment costs, and introduce meaningful tort reform that would significantly reduce the number of frivolous medical malpractice suits that are filed every year.
The third recommendation of the committee was to identify additional spending cuts to reduce various government subsidies in areas like farming, education, and commerce. Various cuts were identified by modernizing the military and civilian health and retirement systems, improving the financial state of the Pension Benefit Guaranty Corporation (PBGC), modernizing the management and operations of the postal service, and eliminating all congressional earmarks.
Fourth, enact comprehensive tax reform that uses a “zero plan” model as a starting point to dramatically reduce the size and number of tax expenditures in the code, sharply reduce rates, improve overall simplicity, and move toward a territorial system to promote growth and generate revenue. Tax reform should be written by the committees but enforced with an across-the-board tax expenditure limitation.
Finally, the Simpson-Bowles Committee suggested that the federal government implement government-wide reforms to reduce waste, fraud, and abuse. The federal government needs to modernize their means and methods for more accurately measuring inflation. This data should be reflected within the budget and tax code to provide much-needed protections for low-income individuals and the oldest beneficiaries.
The plan also calls for reforms on a separate track to the Social Security and transportation trust funds to make them sustainably solvent as well as to restrain the growth of federal health care costs. It seeks to reduce long-term deficits in a way that promotes economic growth and protects the most vulnerable.7
Someone has to break the unwritten bureaucratic rule in Washington, DC, which says that once a federal program is created, it can never be shut down. All federal government programs need to have a sunset provision retroactively attached to them requiring the program to come up for review by an independent, nonpartisan citizen review board every 10 years or so. If the program can no longer be shown to be effectively addressing the issue for which it was created or is no longer financially viable, it should be terminated. This includes even the quasi-government programs like Freddie Mac and Fannie Mae. And there should be strict prohibitions against lobbyists having any contact whatsoever with members of the review board.
We also need real student loan reform. We need to get colleges and universities out of the business of education and back to the mission of education: 37 million young Americans owe $1 trillion in government-sponsored loans, a 300 percent increase in just the past eight years. Many of them have degrees that they will never use in the workplace. Offsetting federal grants to the institutions against tuition hikes would help to make a college education more affordable for a greater number of students and force the institutions to reexamine their priorities. Allowing the 50 states to serve as laboratories for what type of degrees and programs are offered would also bring some accountability back into the system. These are all well intended programs, but the focus should be on those who need them and are phased out by income for those who do not need them.
I would like to see a market-based auction process to privatize all nonessential government assets and services. In tandem, the 50 states can again serve as valuable test laboratories. New Jersey Governor Chris Christie issued an executive order in March 2010 creating the New Jersey Privatization Task Force, a short-lived advisory body established to identify a comprehensive set of privatization tools and strategies the state could apply to save at least $50 million in fiscal year 2010–2011. The New Jersey Privatization Task Force asserted, “States that have had the most success in privatization and have created a permanent, centralized entity to manage both privatization and related policies aimed at increasing government efficiency.” A case in point is the 1980 Staggers Act, which deregulated the U.S. freight railways and led to a surge in private infrastructure investment—$511 billion in total, or 17 percent of annual revenues over the ensuing periods, leading to all seven of the largest freight railways reaching profitability in recent years.8 This government-private sector privatization partnership is so important, that it is the subject matter for my proposed second and final book, Privatization: Monetizing U.S. Debt to Empower America.
It has been more than 50 years since Congress updated patent law, and its update is critical to American innovation and jobs. Reforms are needed at the U.S. Patent Office (USPTO) if the United States is going to remain a global player in technological innovations. The U.S. Patent Office should be privatized as it is currently a major drag on GDP. Veteran high-tech CEO Henry Nothhaft addressed this issue in his book, Great Again: Revitalizing America’s Entrepreneurial Leadership, in which he pointed out that it now takes an average of 3.7 years to obtain a patent, from submission of a patent application to award. Some applications can take as long as seven years. The problem is that over the last two decades, Congress has siphoned off over $1 billion in patent application fees to cover budget shortfalls in other areas. In that last 10 years, applications awaiting approval have soared to more than 1.2 million, leaving the understaffed office swamped. Congress would do much toward jump-starting the economy and the VC industry in particular if they would restore the office’s funding and make it a market-based, private sector–government partnership, with incentives for performance in processing applications and issuing patents in a timely manner.9
Issues of intellectual property ownership, period of ownership, and international enforceability also need to be addressed. The laws need to be changed to prevent large multinational companies from patent squatting. Every year, thousands of independent inventors are discouraged from bringing their products to market because of the threat of litigation for patent infringement by the legal departments of the large companies in the field. This is using the law as a cudgel to intimidate and discourage competition and innovation. This stifles innovation and only benefits the attorneys. This practice must be stopped.
Free trade agreements reduce trade barriers whenever possible and give everyone access to global markets. This helps to foster economic freedom, increase prosperity, and encourage equality for everyone around the world. As such, the government should complete free trade agreements with all World Trade Organization–approved countries. These agreements must include well-defined damages and sanctions for violators. Of ever greater importance is a clear process and punitive fines and trade restrictions for sensitive commercial and national security–related cyber security offenses.
Along with expanding free trade, we need to update and reform our immigration. This is a human rights issue that has been shamelessly hijacked by professional politicos who want to use it as a way to expand their power base. We have the technology to secure the borders and should spend the money for a technology-based infrastructure upgrade. We also need to reform the citizenship process for legal aliens and find a reasonable way to welcome those who are here illegally but who are working. Congress should create a realistic step-by-step approach rather than a single comprehensive proposal, such as a temporary work force program. More than 40 percent of S&P 500 firms were founded by immigrants or their children. This country was built by the wave of immigrants who came to America seeking freedom and opportunity. Last year, we only let in a paltry 225,000 immigrants who possessed some sort of special skills. This is only about 0.1 percent of the labor force. John F. Kennedy tried to impart to us the vision that we are a nation of immigrants, and, to the extent that we can create a climate where we can make immigrants rich, we can all prosper.
The other side of the immigration coin is expatriation. Just as immigration is creating problems in the workforce, expatriation is siphoning off jobs for that workforce as companies move their operations offshore. There are several factors influencing these companies, but first and foremost is the growing burden of the government bureaucracy as evidenced by the thousands of man-hours spent every year simply trying to comply with volumes of regulations by filling out reams of paperwork and countless forms. Many of these regulations have been applied broadly across entire industries, whether or not they had specific application to the company. Some regulations, especially those regarding the environment, are reactionary, have no regard for their economic and social impact, and have no basis in real science. We should allow free-market development of all energy resources—oil, gas, coal, wind, solar, nuclear, and even biomass—while maintaining adherence to environmental standards based upon substantive scientific research and data.
A second factor is the onerous and often incomprehensible tax code of the United States. It is deliberately obtuse to allow the federal government to do central planning and control the economy. There are many who espouse a flat tax across the board on all income, ranging from a low of 10 percent with no loopholes or exceptions all the way up to 19 percent with deductions for mortgages, education, medical, and savings. This would be fine, except that the politicians could still find ways to creep up the tax rate and generate more revenue for the government’s coffers. Others endorse scrapping the entire tax-on-income scheme and replace it with a consumption tax. Proponents of the “Fair Tax” point out that when you couple income tax with FICA deductions, their proposal of a 23 percent sales tax is absolutely revenue neutral. Their plan would only tax the purchase of new items, would exempt taxes on necessities such as food and medical expenses, and would have a monthly “prebate” for lower income earners that would help them cover the costs of their basic needs. The Fair Tax plan is the only one that would recover taxes from the underground economy of cash-only businesses, tourist expenditures, and earnings from illicit activities. It would also eliminate the grossly unfair double taxation of estate and inheritance taxes, allowing families to build successful enterprises and pass them on to their progeny. Any changes in the tax rate under this plan would be immediately noticed by the tax payers.
An elimination of tax on income would allow small business owners to take the necessary risks to grow and expand their businesses, creating more jobs, and freeing up the flow of revenue in the economy. Another spur to the economy would be the implementation of a small, flat repatriation tax, which would allow U.S. multinational corporations and individuals who have offshore earnings to bring that money back to the domestic economy without feeling that they were being robbed.
Thirdly, it is about time for us to honestly and objectively evaluate the monetary policy of this government. The monetary policy of the United States of America is managed by the private banking cartel known by the gross misnomer of the Federal Reserve System. There is nothing “federal” about it.
The Fed’s original monetary policy objectives at the time of its charter were maximum employment, stable prices, moderate long-term interest rates, and now setting targeted GDP growth rates. For the last 100 years under the Fed’s management, the purchasing power of the dollar has fallen by more than 90 percent. The Bureau of Labor Statistics vigorously denies allegations that it has to cook the numbers every month to make the public think that the unemployment rate is in single digits. They allegedly do this by no longer counting the people who have gotten discouraged and either quit looking for work or have used up all of their unemployment benefits. Government apologists say there is nothing wrong with that methodology. According to John Williams, the Dartmouth-educated economist who posts all of the government’s data on the website Shadowstats.com, there is another side to the story. When the total percentage of the available labor force currently not working is added together, the real unemployment rate is 23.3 percent. That is more than three times higher than the official 7.4 percent rate published at the time of this writing.10
Given the recent revelations of institutional disingenuousness in other agencies and departments, it not a stretch to believe that the American people are being misinformed and cozened by the very people who are supposed to be looking out for our best interests. The multinational banks create credit bubbles, and the Fed, itself a member of an international private banking cartel, arranges for them to get bailed out by our tax dollars when the bubbles burst. Only a truly independent arbiter of monetary policy can manage the elusive balance between interest rates and money supply in order to control economic growth, inflation, and unemployment (an objective that is highly debatable in my opinion). That independence has been thoroughly compromised with the revolving doors between the Federal Reserve, Wall Street, and the U.S. Treasury that have developed over the last few administrations. We are hopeful that adherence to the new Basel III accords will go a long way toward achieving the kind of economic certainty that allows for reasonably accurate financial projections and business planning. Abandoning the failed Fed experiment and returning to a resource-backed currency would further strengthen the nation’s monetary policy and support renewed economic growth.
In the aggregate, this 10-year public policy initiative would address government debasement and its unintended consequences—social debasement. As illustrated by the Cantillon Effect, the 99 percent blame the 1 percent, the 1 percent blame the 47 percent, the private sector blames the public sector, the public sector returns the sentiment, the young blame the old, everyone blames the rich, yet few, if any, question the ideas and policies put forward by the government.
I believe that merely articulating these policies as the U.S. government’s 10-year, market-driven mantra would have an exponential impact on the trajectory of improved investor confidence, spending, and hiring practices, which in turn would create drive for renewed vigor in the U.S. economy. The 10 years are important in order to dollar-average our way into implementation and minimize short- to intermediate-term collateral damage. But make no mistake; there will be collateral damage in all cases. That said, this series of bitter pills is the medicine that the patient needs and now!
Economist Tim Kane authored a study in July 2010 for the Kauffman Foundation, which examined for the first time job creation by newly formed firms, as opposed to small firms, using a new data series from the Commerce Department called Business Dynamics Statistics, which had annual counts of job creation and loss recorded by cohorts of firms by their age from 1977 to the present. The Bureau of Labor Statistics (BLS) issued an almost identical study in August 2010, which used Labor Department data (from 1994 to the present). Both studies affirmed the known fact to all but the “99 percenters” that start-ups create essentially all net new jobs. Existing employers, it turns out, tend to be net job losers, averaging net losses of 1 million workers per year. Entrepreneurial firms create a net 3 million jobs per year on average.
The state of entrepreneurship in the U.S. is, sadly, weaker than ever. There are fewer new firms being formed today than two years ago when the recession ended. As the Bureau of Labor Statistics (BLS) describes: “New establishments are not being formed at the same levels seen before the economic downturn began, and the number is much lower than it was during the 2001 recession.”11
On July 30, 2013, the Bureau of Labor Statistics issued a press release covering the business employment dynamics for the fourth quarter of 2012. The opening paragraph was blunt.
From September 2012 to December 2012 gross job gains from opening and expanding private sector establishments were 7.1 million, an increase of 238,000 jobs from the previous quarter, the U.S. Bureau of Labor Statistics reported today. Over this period, gross job losses from closing and contracting private sector establishments were 6.4 million, a decrease of 231,000 jobs from the previous quarter.
www.bls.gov/news.release/pdf/cewbd.pdf
One might expect entrepreneurship to be rising in the United States, especially with lower fixed costs for modern service-based start-ups, as well as other advantages, such as higher levels of human capital, higher incomes, and the rising availability of funding through bank and venture capital.
Based on Kane’s initial research into the importance of start-ups for job creation, cited by the 2011 Economic Report of the President, this paper extends that data series by an additional two years. The following figures show how important start-ups are for net job creation. Since 1977, newly born companies usually create a net 3 million jobs per year, but the most recently released data report this number as falling to 2.34 million in the year 2010. The Commerce Department did not release annual 2011 or 2012 data until after the 2012 election, but quarterly figures for start-up job creation have continued to weaken. Adding the quarterly figures in 2010 yields a total of 2.932 million jobs, but in 2011 that sum total dropped to 2.928 million. Kane estimated annual 2011 figures using that as the proxy. CNN released an updated report in October 2012, which showed that the net gain since the current administration took office in January 2009 was only 125,000 jobs.
The next step is to convert that start-up data into a per capita metric. The national population grew from 246 million people to 311 million, according to the U.S. Census. After converting, it is clear that entrepreneurs are having a harder time starting a company today than at any time since the government began collecting data.
The rate of job creation at start-up companies was steady in the 1980s and 1990s at 11 start-up jobs per 1,000 people (i.e., among every 1,000 Americans, 11 were newly hired at a company started that year). But the start-up jobs rate has collapsed in recent years. In fact, the rate of start-up jobs during 2010 and 2011, years that were technically in full recovery, is the lowest on record. The second figure shows how the rate declined during the recession years 2008–2009, but also shows that it continued to decline afterwards. The average rate for entrepreneurial job creation under the previous three presidents was 11.3, 11.2, and 10.8 respectively, but under the current administration it has been cut by one-third to 7.8.
Economic theory suggests that the modern economy offers a better environment for even more entrepreneurship. First, there is a wider technology frontier to explore. Second, a wealthier society enables more individuals to explore diverse opportunities rather than merely work to survive. Third, the shift to services requires less start-up capital than manufacturing or agriculture. In other words, the downward trend in the rate of entrepreneurship should, in theory, have rebounded by now. According to the economist Sander Wenneker, there is an empirically based U-shaped relationship between self-employment and economic development.
There is anecdotal evidence that the U.S. policy environment, or lack thereof, has become inadvertently hostile to entrepreneurial employment. At the federal level, high taxes and higher uncertainty about taxes are undoubtedly inhibiting entrepreneurship, but to what degree is unknown. The dominant factor may be new regulations on labor. The passage of the Affordable Care Act is creating a sweeping alteration of the regulatory environment that directly changes how employers engage their workforces, and it will be some time until those changes are understood by employers or scholars. Separately, there has been a federal crackdown since 2009 by the IRS on U.S. employers who hire U.S. workers as independent contractors rather than employees, raising the question of mandatory benefits. This has direct bearing on the VC process as new firms typically use part-time and contract staffing rather than full-time employees during the start-up stage.
According to Labor Department data, the typical American today only takes home 70 percent of their compensation as pay, while the rest is absorbed by taxes and the spiraling cost of benefits (e.g., health insurance). The dilemma for U.S. policy is that an American entrepreneur has zero tax or regulatory burden when hiring a consultant or contractor who resides abroad. But that same employer is subject to paperwork, taxation, and possible IRS harassment if employing U.S.-based contractors. Finally, there has been a steady barrier erected to entrepreneurs at the local policy level. Brink Lindsey points out in his e-book, Human Capitalism, that the rise of occupational licensing is destroying start-up opportunities for poor and middle-class Americans.
The quantitative impact of the shifting policies on start-ups and job creation is in need of further study. There is a widespread sense that globalization of the economy exposes companies to new challenges by leveling the playing field for trade. There is no doubt a level playing field among economic institutions as well, where service-based employment can move quickly from one jurisdiction to another. By cracking down on employing Americans part-time, and mandating higher benefits, new American policies may be pushing jobs overseas. This is an issue policymakers must consider carefully when designing rules and regulations for the twenty-first century economy.
As the voice of the U.S. venture capital community, the National Venture Capital Association (NVCA) advocates for public policies that encourage innovation, spur job creation, and reward long-term investment in start-up companies. By working with the venture capital community to foster a growth environment for emerging businesses, the federal government can help ensure that America maintains its global economic leadership and competitive advantage into the twenty-first century and beyond. Notwithstanding your author’s shared public policy panacea, following is a summary of the public policies advocated by the NVCA.
People who take the risk to invest their capital to start a company, which in turn creates jobs and stimulates positive economic activity, should not have to endure an extortionate shakedown by the government when their venture is successful. NVCA has long advocated for a tax structure that fosters capital formation and rewards long-term, measured risk taking. NVCA believes that the returns earned by venture capitalists and entrepreneurs for building successful companies over the long term should continue to be taxed at the capital gains rate. They continue support for a capital gains tax rate that is globally competitive and preserves a meaningful differential from the ordinary income rate.
As lawmakers consider broad-scale tax reform to create a simpler, fairer tax code, NVCA urges both Congress and the Administration to build a system that supports entrepreneurs and their investors. NVCA will support proposals that meet the criteria above and that take into account the economic value created by the venture capital asset class and the importance of encouraging investment in long-term job creation.
Studies show that significant job creation occurs when a venture-backed company goes public. In the last decade, however, the market for venture-backed initial public offerings (IPOs) has suffered. From Sarbanes Oxley (SOX) to the Global Settlement to Reg FD, regulations intended for larger multi-national corporations have raised burdensome obstacles and compliance costs for start-ups trying to enter the public markets. The recently enacted JOBS Act addressed many of these challenges, and the NVCA will work with the appropriate regulatory agencies as the new law is implemented. The NVCA will continue to support regulatory and tax policies that seek to encourage small, emerging growth companies to go public on U.S. exchanges. Such policies promise to bolster the economic recovery, spur job growth, and maintain our global competitiveness.
Maintaining America’s global innovation advantage requires continued federal funding for basic research and development. Discoveries in federal labs and universities remain the germination points for breakthrough ideas that can be commercialized by entrepreneurs and venture investors. The promising new companies that result will drive job creation and economic growth. This unique public-private partnership has delivered countless innovations to the American public and a decisive competitive advantage to the U.S. economy for decades. Therefore, NVCA supports policies that fund basic research across high technology industries, including life sciences, energy, and physical sciences. Programs such as the Small Business Innovative Research (SBIR) program fill the innovation pipeline and must receive robust federal support if America wants to continue to bringing breakthrough technologies to market.
The United States must continue to attract and retain the world’s best and brightest minds if it wants to maintain its global economic leadership. For this reason, NVCA supports policies that allow foreign-born entrepreneurs to come to America to build their companies and create jobs in the United States. Proposals such as the Start-Up Visa Act will allow enterprising professionals to come here to develop their ideas and then remain here to build their companies, as opposed to innovating and creating economic value overseas. Further, the NVCA supports a streamlining of the pathway to Green Cards for foreign-born graduate students who wish to remain in the United States upon completion of their studies.
The U.S. market for biopharmaceuticals and medical devices is one of the most heavily regulated industry sectors in the world. There are many good reasons for this, but we must balance regulation with innovation, a principle that has driven high-quality care for American consumers and competitive advantage for American companies for decades. By putting innovation at the forefront of health care reform efforts and regulatory policy making, we can provide incentives to America’s most promising young companies to discover new ways to improve the quality of health care, expand access, and reduce the costs. The NVCA supports policies that streamline the regulatory approval process at the Food and Drug Administration (FDA), particularly for novel technologies, as well as the reimbursement process at the Center for Medicare and Medicaid (CMS). Process improvements at these agencies are critical to encourage investors to take the risk and pursue new medical innovations that will save and improve patients’ lives and create U.S. job growth.
Innovations in clean technology will revolutionize how we produce and consume energy, reduce carbon emissions from fossil fuels, and strengthen national security. Clean-tech development can also spur U.S. job creation and economic growth for decades to come. Due to the exceptional risks and capital requirements associated with developing clean technologies, U.S. energy policy plays an outsized role in the success or failure of venture-backed clean-tech companies. NVCA supports policies that encourage clean-tech innovation and provide incentives for investing in promising young companies in this sector. Such policies include continued federal funding for early-stage basic research at government labs, support of the Advanced Research Projects Agency-Energy (ARPA-E) program, and the establishment of a Clean Energy Deployment Administration, or CEDA, to help the most promising innovations reach the marketplace.
The intersection of intellectual property, cyber security, and the Internet has emerged as an uneasy nexus for policy makers, particularly after the dramatic defeat of the Stop Online Piracy Act/Protect IP Act (SOPA/PIPA) intellectual property legislation earlier this year. While those measures are unlikely to reemerge for the rest of the year, cyber security is taking a front seat, and has also, for lawmakers, created a surprising stir in the privacy and Internet communities. To a certain degree, all of the cyber security bills under consideration face considerable scrutiny in these three main areas:
Finding compromise on all three facets will be difficult and time consuming, which could lead to stalemate as the most likely short-term outcome. However, unlike in the SOPA/PIPA debate, cyber security threats present a strong national security concern that both political parties understand is real and that must be addressed. NVCA will be monitoring activity in this area closely.
In the aggregate, the prevailing investment climate, like those of the past, has its respective challenges, and embedded therein are great VC investment opportunities. That said, the current urgency and baseline to implement a forward-looking constructive investment climate is now dangerously high and short, at a time when the VC growth engine is needed more than ever.
As discussed in prior chapters of this book, there are presently immense and untapped reserves of potential investment opportunities for VC sector investors. Public policy allowing the market to flourish is the best way to enable a VC-friendly investment climate that is a catalyst to small business creation and job growth—it’s a win-win formula for everyone!
The need is clear. Why wait for disaster? The future is now.
Notes
1. J. Lerner, A. Leamon, and F. Hardymon, Venture Capital, Private Equity, and the Financing of Entrepreneurship: The Power of Active Investing (Hoboken, NJ: John Wiley & Sons, 2012), 306.
2. J. Maudlin, “Can It Get Any Better Than This?” Frontline Newsletter, August 3, 2013.
3. C. Cox and B. Archer, “Why $16 Trillion Only Hints at the True U.S. Debt,” Wall Street Journal, November 28, 2012.
4. Federal Reserve Economic Data (FRED), “Federal Debt: Total Public Debt as Percent of Gross Domestic Product,” Federal Reserve Bank of St. Louis, August 2, 2013, http://research.stlouisfed.org/fred2/series/GFDEGDQ188S.
5. K. Hall and R. Rankin, “What Should We Do about the National Debt and When?” McClatchy Newspapers, August 17, 2010, www.mcclatchydc.com/2010/08/17/99285/what-should-we-do-about-national.html#.Uf_l_JvD_bg#storylink=cpy.
6. Vermont and Indiana do not currently have balanced budget requirements in their state constitutions.
7. The Committee for a Responsible Federal Budget and Fix the Debt Coalition, “Summary of the New Simpson-Bowles Plan,” blog post, April 23, 2013, www.fixthedebt.org/blog/summarizing-the-new-simpsonbowles-plan_1#.UgAOoZvD_bh.
8. Joel Palley, “Impact of the Staggers Rail Act of 1980,” Office of Policy: Office of Rail Policy and Development, Federal Railroad Administration, March 2011.
9. H. Nothhaft and D. Kline, Great Again: Revitalizing America’s Entrepreneurial Leadership (Boston: Harvard Business Review Press, 2011).
10. J. Corsi, “Here’s the Real Unemployment Rate,” WND: Money (August 2013).
11. “Entrepreneurship and the U.S. Economy,” Business Employment Dynamics, Bureau of Labor Statistics, United States Department of Labor, 2013, www.bls.gov/bdm/entrepreneurship/entrepreneurship.htm.