A few weeks back, a friend mentioned an idea he had heard suggesting that the government consider entering the VC (venture capital) business as part of the overall stimulus plan. Specifically, the argument was made for the government to provide excess venture capital funding to the green sector. At first, I assumed this was just one individual’s idea, but the noise level has risen to the point where it is reasonable to assume there is a group pushing or lobbying for this outcome.

Last week, Thomas Friedman jumped on the bandwagon in a New York Times article titled Open Door Bailout. Friedman noted: “I would have loved to have seen the stimulus package include a government-funded venture capital bank to help finance all the start-ups that are clearly not starting up today — in the clean-energy space they’re dying like flies — because of a lack of liquidity from traditional lending sources.”

Clearly, there is a group of individuals that believes the government should enter the venture business.  With all due respect to Mr. Friedman – and by the way I am a huge fan of The World Is Flat – this is a remarkably flawed idea. Startups and VCs simply do NOT need bailout dollars.  Allow me to provide more detail:

1) No Lack of Venture Capital.  Simply put, there is no shortage of venture capital dollars. In fact, if you talk to anyone in the business, or perhaps even the limited partners who provide capital to VCs, they all believe the industry has been substantially over-funded for the past fifteen years. According to the NVCA, the venture capital industry has averaged approximately $30 billion in investments each of the past three years. Even in Q4 of 2008, when everyone was supposedly hiding under a rock, venture capitalists invested $5.4 billion in 818 deals. Most interestingly the NVCA notes, “The Clean Technology sector, which represented seven of the ten largest deals of the year, experienced significant growth in 2008 with $4.1 billion invested in 277 deals. This investment level represents a 52 percent growth in dollars and a 16 percent growth in deal volume over 2007 when $2.7 billion was invested in 238 companies.” The remarkable disconnect between Friedman’s cry of desperation (“dying like flies”) and the indisputable fact that is the hottest sector in venture capital is both confusing and curious.

2) VCs Don’t Deserve a Bailout. It’s hard to imagine that venture capitalists or startup executives are eager to submit themselves to the scrutiny and the compensation restrictions that are now part and parcel of any stimulus package. If American citizens were truly appalled with John Thain’s bathroom and the GM executive’s private plane, then they should find plenty to abhor in the well-compensated VC community. One could only assume that any potential venture fund package would include similar restrictions on any venture capitalists whose investments are “buoyed” by this kind of stimulus.

3) Lender of Last Resort.  Warren Buffet is noted for saying, “There is a fool in every market, and if you don’t know who it is, it is probably you.” The government will undoubtedly find its way into deals where every single player in the already over-funded VC community has said “no.” This is not because these VCs are sitting on their hands as Friedman implies (once again VCs put out $5b in Q4 alone). Any companies that are not getting funded are simply failing to meet the basic requirements of a rather open-minded green investment community. Separately, it is quite unclear how the government would attract the talent needed to separate the good deals from the bad (remember quality VCs are handsomely paid). The more likely scenario is that a government VC would invest behind the companies and investors with the best lobbyists and Washington networkers.

4) Excess Capital Hurts Markets. One thing that has become particularly evident over the past fifteen years is that excess capital in any market has a consequential and negative impact. First and foremost, excess capital keeps third-tier competitors in the market longer. This has a subsequent negative effect on pricing and, as a result, makes it harder for the first-tier players to reach profitability and sustainability – a falling tide lowers all ships. It is healthy and a requirement for the less competitive companies to fail in an emerging market. Second, when an overfunded market comes crashing down, the result is a negative self-reinforcing spiral. The press jumps on the broad-based failure and then capital really does dry up in the industry. Skepticism weighs on the effectiveness of the market leaders and the whole industry – and therefore the general mandate – suffers.

5) Good Companies Do Not Lack for Capital. This seems brain-dead simple, but great companies do not have a hard time raising capital, especially in an over-funded venture market. If you have a great team, a compelling idea, and a demonstrable probability of success, then you simply will not go unfunded. Just because a company may have an inspirational goal, does not mean that it deserves unfettered funding. An anti-gravity machine would be a nice thing to have, but it doesn’t demand venture investment.

6) Do Not Reinvent the Wheel. If you want to ensure that green technologies are successful, use the government dollars to employ subsidies rather than wasting them on third tier venture investments. Japan and Germany are the clear world leaders when it comes to solar, and they both achieved this leadership status through customer subsidies. What solar needs in the U.S. is not more dollars for companies producing a product which is then exported, but a fair, predictable, and profitable local market. A viable customer subsidy would create a market that is suitable to attract any amount of private investment dollars into the companies that are seeking to serve it. And this approach would not favor VC backed companies over large established, high-employment participants. This form of market approach is proven and dependable (Japan and German). Why would the U.S. try something different?

Great ideas have never suffered from a lack of capital availability. Bringing extra government dollars to the investment side will only ensure that marginal and sub-par companies get more funding dollars, which historically has had a perverse and negative effect on the overall market. Put aside whether the government wastes money or not – if you want to see these green technologies successful in the marketplace, it would be a disservice to support a government venture fund. It simply will not work.

Bill Gurley has been a partner with Benchmark Capital since 1999. This post originally appeared at his blog.

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