1. JOSH LERNER HARVARD BUSINESS SCHOOL The Promise of Venture Capital

2. Why is venture capital important? Venture capital is still very young:  First fund in 1946. Venture capital is still very small:  In largest market, U.S.:  Only about 4000 professionals.  Average of 1,500 companies funded for first time annually, 2000- 2008. Relative to 1 million businesses started annually.  Considerably less elsewhere.

5. But importance far beyond its size The backdrop:  Young high-tech and restructuring firms pose many challenges:  Uncertainty.  Information gaps.  The nature of the firm’s assets.  Market conditions.

6. “I realize, gentlemen, that thirty million dollars is a lot of money to spend. However, it’s not real money and, of course, it’s not our money either.”

8. General Doriot’s insight Difficult for traditional financiers to fund these firms: – Banks. – Public markets. A new organization could address with three key mechanisms: – Sorting: picking the right entrepreneurs. – Controlling: limiting “agency” problems, through a mixture of incentives and monitoring. – Certifying: developing a tradition of quality and fair dealings.

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10. The evolution of venture capital Venture capital has developed many tools to address challenges:  Intensive scrutiny of business plans.  Restrictions in preferred stock agreements.  Staged financing.  Board service and monitoring.  Informal advice.  Not surprising that dominant funding source.

11. Venture capital has had a profound impact Between 1972 to 2007, ~2500 venture-backed firms went public in U.S.:  13% of all public firms at end of 2008.  8% of market capitalization ($2.0 trillion).  6% of total employees.  Particularly true in high-technology industries.

13. Supporting evidence Hellmann and Puri [2000]:  Look at 170 Silicon Valley firms.  Venture capital-backed firms seem more innovative on several measures.  Unfortunately, hard to control for causality:  Does VC spur innovation or does innovation spur VC?

14. Supporting evidence (2) Kortum and Lerner [2000] look at industry level:  VC appears to have a strong positive effect:  Even after controlling for corporate and government R&D spending.  Use 1979 ERISA shift to address causality issues.  In 1983-95 period, while VC <3% of corporate R&D, accounted for 10-12% of innovations. Mollica and Zingales [2007] also demonstrate strong relationship with different appproach:  State pension fund holdings.

15. Why a government role? Increasing returns to scale  Much easier to do 100 th deal than the first:  Knowledge and expectations of entrepreneurs.  Familiarity of intermediaries.  Sharing of information among peers.  Comfort level of institutional investors. Economists term these “externalities.” In these cases, government can frequently play a catalytic role.

16. Also historical precedents In the U.S.:  Critical role of SBIC program.  Established in 1958.  Many early VC firms started as SBIC awardees, then opted out.  Building critical “infrastructure”: Lawyers, data providers, etc. Similar insights from Israel, Singapore, etc.  Suggests that some of funding should be directed to growing industries!

17. Particularly in light of boom in emerging market private equity fundraising ($Bs)

18. But history also suggests need for care But many pitfalls from earlier efforts. Three key points from report:  More than money is needed: entrepreneurship is not in a vacuum.  The virtues of market guidance.  Getting details right important as well. Need for patience!

19. Josh Lerner Rock Center for Entrepreneurship Harvard Business School Boston, MA 02163 USA 617-495-6065 josh@hbs.edu www.people.hbs.edu/jlerner