More Capping

Another voice in my crusade (such as it is) to stop paying exorbitant salaries to everyone on the government dole.

In the hubbub surrounding President Obama’s decision to cap salaries of commercial-bank CEOs at $500,000 (if they receive future federal funds), the salaries of college and university presidents have been flying under the radar. Some reconsideration is due, particularly because substantial taxpayer dollars go into their services, with more funds coming via the stimulus package. State and federal taxpayers subsidize public universities substantially, but even private schools benefit from things like tax-subsidized student loans and tax-funded faculty research...

The 184 public research universities [in The Chronicle of Higher Education's survey of college and university presidents’ compensation packages] had 59 presidents whose 2007-2008 compensation packages were worth more than $500,000. The average for this $500,000-plus club was $654,000... Of the 32 research-intensive private universities, 31 had 2006-2007 presidential compensation packages worth more than $500,000, the average being $895,000.

HT: Alex Tabarrok, Marginal Revolution.

Money to Grow

The quote from Shane's book yesterday could be taken to imply that somehow it is the venture capitalists that create jobs. Correlation, not causation. As the title tried to convey, it is growth companies that create jobs, and since venture capitalists try to invest in growth companies, their investments are a good proxy for growth companies as a whole.

Internet startups these days don't need much money. It's generally believed that web companies can get to beta for a few hundred thousand dollars max. As a result venture capitalists perceive deals differently: if the startup needs next to nothing to get going, they are eager to put a couple of million dollars in; if it needs a couple of million dollars, they pass. The old canard about bankers--they'll only lend you money if you don't need it--has become true of VCs.

That said, I think the VCs are still a critical player in creating successful growth companies. Even though there are notable examples to the contrary, almost all growth companies need to raise a substantial amount of money at some point in their life-cycle to scale.

The only thing about my angel investments that keeps me awake at night is whether--when they need the bigger institutional round--the VCs will be in the mood to step up.

To Encourage Growth We Need to Invest in Growth Businesses

My friend John K. and I disagree about how to create jobs by encouraging more startup formation. I think the disagreement comes from John wondering how to create more startups and me wondering how to create more jobs. There's a difference, as explained pretty well in Scott Shane's article in The American, The Startups We Don't Need.

Shane first systematically takes apart the received wisdom that startups are the engine of job creation. He shows that the average startup doesn't create many jobs at all and that the jobs created are worse than jobs in corporate America. But we all know that our economic growth is dependent on startups, right? Well,

A tiny sliver of startups accounts for the vast majority of the contribution to job creation and economic growth that comes from entrepreneurial activity. According to data from the National Venture Capital Association, since 1970, venture capitalists have funded an average of 820 new companies per year. These 820 startups—out of the more than two million companies started in this country every year—have enormous economic impact. A report posted on the Venture Impact website explains that, in 2003, companies that were backed by venture capitalists employed 10 million people, or 9.4 percent of the private sector labor force in the United States, and generated $1.8 trillion in sales, or 9.6 percent of business sales in this country. Moreover, in their book The Money of Invention: How Venture Capital Creates New Wealth, economists Paul Gompers and Josh Lerner report that in 2000, the 2,180 public companies that received venture-capital backing between 1972 and 2000 comprised 20 percent of all public companies in the United States, 11 percent of their sales, 13 percent of their profits, 6 percent of their employees, and one-third of their market value, a figure in excess of $2.7 trillion dollars.

Instead of just believing naively that all entrepreneurship is good, policymakers need to recognize that only a select few entrepreneurs will create the businesses that will take people out of poverty, encourage innovation, create jobs, reduce unemployment, make markets more competitive, and enhance economic growth. Therefore, as unfair as it might sound, policymakers need to “stop spreading the peanut butter so thin.” They need to recognize that all entrepreneurs are not created equal. They need to think like venture capitalists and concentrate time and money on extraordinary entrepreneurs, and to worry less about the typical ones.

Shane expounds on this and cites the research in his book The Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live By. It's an interesting read in many ways, especially if you're interested in what the data actually show.

Return on Venture Money is Not the Bottleneck

I think the bottleneck to increased startup formation is people, not exits or tax rates.

If exits were the problem, then LPs would stop putting money into venture funds as expected returns diminish. Fred Wilson (and many others) have said that lack of money is not the problem. I believe them. So exits can't be the problem (For startup formation, that is. Exits are certainly a problem for the VC funds.)

From the point of view of the money, lowering capital gains taxes--much as I personally enjoy lower rates--is not going to increase the rate of startup formation. As previously noted, there is already plenty of money looking for a home with the current returns. Increasing the returns would only draw more money into an already overly funded pool.

From the entrepreneur's point of view: while I hate to depart from economic orthodoxy and I do believe that incentives matter, I don't think that the entrepreneur we want to encourage (the one creating a large company that employs a lot of people, not home-based businesses and restauranteurs) thinks much about the after-tax difference in the amount of money he'd make in a success. Ventures are generally binary: the company fails or the company succeeds. In a success the entrepreneur hopes to come out of it with quite a bit of money, and whether it's $10 million or $12 million is not really the point. The change in after-tax return is completely swamped by whether there is a return at all.

Advertising in a Downturn: Other Opinions

I get a lot of hits from people searching for "marketing in a downturn" or "advertising in a downturn." I haven't blogged on that for over a year because there's no point in trying to predict the present.

But for all you searchers, here's a great resource: the FT's Advertising in a Downturn page. Supports my contention that putting marketing money to work when times are bad is a great investment. I know I said it a year ago and god help those who took my advice then--especially the car manufacturers--but I still think I'm right.

Let's Not Pretend There's No Problem and There's Nothing We Can Do About It Anyway

I don't agree with government sponsored venture capital, as I've said before*. So I wasn't enchanted by Tom Friedman's NYT Op-Ed proposing that the government give bailout money to the top VC firms to invest. On the other hand, I thought it a constructive proposal, an addition to the debate. One of the primary concerns with the various government rescues is that the government will buy things for inflated prices and then, having bought them, won't know how to run them. Friedman addresses this by proposing that the government hire the VC firms to do it.

There are a ton of practical problems with this. But I applaud Friedman for floating an idea. A lot of commentary I've read, though, is like Fred Wilson's:

Please leave the venture business alone. It's working pretty well as it is and it certainly doesn't need more money or some kind of stimulus plan.

This almost perfectly illustrates my complaint that we ignore our own flaws while easily seeing others'. The venture business is a piece of the finance system--the system of turning savings into investment. Fred can't possibly be arguing that the finance system is serving society well, so I assume he's arguing that venture capital is systemically apart from the rest of finance.

It's not.

There are more cogent commentaries, like Roger Ehrenberg's quoting of Matt Harris' criticism of and constructive alterations to Friedman's idea. I don't agree with Matt, but he and Roger are on the right track: early stage investors need to put up some ideas.

The current Panic highlights how finance can be used either to create growth or to finance consumption. There needs to be some of both, but current events show that in the last six or seven years finance has overfunded consumption to the point of crowding out growth financing. As the part of the finance industry that finances growth, we can't just say that the other part (the part that finances consumption) was wrong and out of control and needs to be reined in and leave it at that. We need to figure out how we can do more and better and what we need the government to do to support us in that. If it's not money we need, then what? There will always be competition between these two types of finance for investable money: what can we do to win more often?

Here are my ideas.

Really bright, tech savvy, self motivated risk takers are the bottleneck in the venture creation business, not money. This is why Friedman's idea won't work (and, I think, the root cause of the conditions that Fred describes when saying it won't work.) To increase the formation of more early stage companies we need to increase the number of these people. There are two ways to do this: (1) make people smarter and more tech savvy, and (2) lower the risk to individuals of starting a new company and failing.

My specific prescriptions:

(1) We should pay for college, for everyone. This would be the best use of government money ever. If the US did this and did it right, we would remain the global tech powerhouse for the next century.

(2) Universal health care. Health insurance is expensive. It's one thing to not have it when you're young and single, it's something else when you have a family. Working out of your garage for a year while living on your savings is an acceptable risk, not being able to pay your kid's doctor bills is not.

In general, I think we need to support company creation by enabling the company creators, not the financiers. I may be wrong about my specific ideas, of course, so I'd love to hear other constructive opinions.


* As a follow-up to that post, I'll note that Owen Davis--who is running the NYC Seed Fund--allayed much of my cynicism about that project: he's smart, independent and will definitely make a difference in the NYC early stage community if given enough and continued support by his backers. I can't imagine a better person for the job. The fund should be thrilled to have him and work hard to keep him, IMHO.

Rent vs. Buy

Saul Hansell's article in the NYT, Why Are iPhone Users Willing to Pay for Content?, tells the obvious part of the story:

Apple has created an environment that makes buying digital goods easy and common. With an infrastructure that supports one-click purchases of songs and videos, it was easy to add applications in the same paradigm. Paying for software, especially games, is not new to Apple customers. So when you see the iPhone manual or the Frommer’s Paris guidebook, it feels natural to click. (And of course, your credit card is already on file with Apple.)

But Lauren Rich Fine's article in PaidContent, Micropayments? Won’t Work, makes the crucial, non-obvious point:

When someone buys a song, that person keeps it forever and plays it many times. News is fleeting, it changes by the second.

I would take it another step. People are clearly willing to put up cash for purchases that seem like one-time investments. Buying a $2.99 iPhone app that I end up using for a couple of days is far more palatable than paying $1/day.