As we await President Obama’s post-Labor Day jobs speech, one can only hope his plan puts adequate and effective emphasis on growing the innovation economy. We have all heard small businesses create a disproportionate share of new jobs. Yet, not enough has been done on a federal level to catalyze growth in this sector. As venture capitalists know well, there is no lack of entrepreneurial spirit or exciting young businesses looking for money. The problem is a lack of equity capital to fund growth, enable R&D, create new products and of course, hire new employees.
This lack of capital can be traced to a shift away from venture capital as an asset class by the traditional L.P. investor base. As a result, many venture firms now struggle to raise new funds thus leaving our innovation economy short of cash. In response, maybe the U.S. should adopt a model which has successfully spurred venture investment in the United Kingdom and elsewhere—venture capital trusts (VCTs).
Just like traditional venture capital funds, VCTs provide equity capital to fast-growing small and mid-sized businesses. However, rather than relying on large institutional investors, VCTs are typically subscribed to by individual investors who can understand and afford to take the risk—similar to a group of angel investors. In addition to offering investors access to the potentially lucrative returns that can be generated from venture capital, this program has another enticing aspect – investors are granted a significant tax credit, sometimes as much as 40% of the amount they put into a fund as well as tax relief on dividends and capital gains. Because the businesses receiving backing are better capitalized, grow faster, employ more workers and support professionals in a variety of sectors, the cost of the tax advantages offered to VCT investors is more than offset. Since the funds are managed by experienced venture capitalists who are paid based on the returns generated, there is a built-in discipline not found in a government run program. By combining the prospect for premium returns with the certainty of federal tax incentives, the UK government has encouraged the capital raising process. In the end, billions has been raised and invested in several thousand emerging UK businesses since the program’s inception in 1995. Imagine the corresponding economic activity that could be generated in our economy which is six times larger and even more entrepreneurial.
A VCT program in the United States could serve as the proverbial shot in the arm to the innovation economy. It could solve many of the challenges plaguing the entrepreneurial ecosystem, putting equity capital in the hands of professional investment managers who are then able to find, fund, and help grow exceptional businesses. It would also provide an encouraging, welcome mat for entrepreneurs from other countries, confident that adequate investment capital is available should they be willing to build their businesses and create jobs here in the U.S.
Sure, a government initiative meant to spur venture capital investment is a novel approach to rebuilding our entrepreneurial ecosystem and thereby ensuring innovative individuals from around the world choose to build their business in the United States. But this problem calls for thinking not just outside the box but outside the map.
Charles Rothstein is the senior managing director and co-founder of Detroit-based Beringea. The opinions expressed here are entirely his own.