All small businesses are not the same. Until this is registered and embraced by our legislators, this country will not succeed in its efforts to promote economic growth through innovation or unleash our full capacity to compete globally.
As a participant in Treasury's Access to Capital Conference held Tuesday in Washington D.C., I was invited to speak on a panel about fostering growth and innovation for high growth small businesses, with a specific focus on the role that debt can play. I was appreciative of the opportunity to represent the needs of truly innovative companies that contribute substantially to U.S. GDP, U.S. competitiveness and U.S. job creation.
When the agenda arrived, I was surprised. The conversation about innovation was set up once again as a general conversation about funding small business -- any small business.
High-growth small businesses are fundamentally different from "Main Street" small businesses. Main Street small businesses -- businesses that, even if successful, intend to stay small and grow at a slower pace -- are important to the health of our communities and are an important part of our overall economy. But the needs of "Main Street" small businesses require different support and regulatory reform than high-growth, mainly venture capital-backed companies.
High-growth small businesses are critical to our nation's economy for a host of reasons. Using companies that receive venture capital backing as a proxy for the high-growth sector more generally, the data clearly demonstrates that relatively small investments -- on the order of 0.2 percent of GDP -- have generated roughly 11 percent of all U.S. private sector employment and the equivalent of 21 percent of U.S. GDP.
Venture-backed companies outperform the broader economy, whether measured in terms of job growth or revenue growth. They create new, long-lasting companies and industries: from information technology, biotechnology, semiconductors and online retailing to emerging industries such as clean technology, social media and cloud computing. They are an important source of growth for more mature businesses, across the broader economy. The innovative technologies they develop and commercialize contribute to U.S. productivity growth and economic competitiveness. And they improve Americans' quality of life by expanding access to information, providing higher quality goods and services, improving health care quality and access, and fostering a more sustainable environment.
As discussed in a letter I gave to Treasury secretary Geithner's team and during the Treasury Conference today, we believe that there are five areas policymakers should focus on as part of an innovation agenda: promote a culture of entrepreneurship by providing an environment that is conducive to risk taking; develop our talent pipeline through a combination of sound education and immigration policies; create a robust idea pipeline by funding research and development and focusing on commercializing new innovations; ensure that there is adequate, appropriate risk capital to meet the needs of growing companies; and develop policies that promote sound, predictable, competitive markets.
In addition, I provided three specific actions the administration can take immediately to support entrepreneurs and foster growth of our nation's most innovative companies:
1) Treasury should work with the Federal Reserve, the SEC and other agencies to ensure that the Volcker Rule is implemented in a way that does not artificially restrict the flow of capital into innovative companies.
Congress included the so-called "Volcker Rule" in the Dodd-Frank financial services reform bill in order to get banking entities out of activities it saw as highly risky. Specifically, it prohibited banks from engaging in proprietary trading and from investing in or sponsoring hedge funds and private equity funds, other than as specifically set forth in the statute.
When one reads the legislative history, it is clear Congress did not intend for the Volcker Rule to artificially restrict the flow of capital to venture capital funds and, through these funds, to startup companies. Venture capital drives the innovation sector, and does not present any of the risks the Volcker Rule was designed to address. However, Congress failed to explicitly distinguish venture funds from private equity/buyout and hedge funds in the statute.
In January of this year, the Financial Stability Oversight Council issued its Report and Recommendations on the Volcker Rule. The Council noted that "a number of commenters suggested that venture capital funds should be excluded from the Volcker Rule's definition of hedge funds and private equity funds because the nature of venture capital funds is fundamentally different from such other funds and because they promote innovation."
It stated its belief that "the issue raised by commenters in this respect is significant" and recommended that the regulatory agencies charged with implementing the Volcker Rule carefully evaluate the range of funds and other legal vehicles that fall within Volcker's definition of private equity and hedge funds, and consider whether it is appropriate to narrow the statutory definition by rule in some cases.
Regulatory agencies should take up the Council's recommendation and implement the Volcker Rule in a way that does not restrict the flow of capital from (and through) banks to venture capital funds and through these funds to startup companies.
2) The Administration should urgently address the FDA approval process and the broader regulatory environment affecting life science companies.
The delay, cost, and uncertainty of the FDA approval process and the overall burden of the U.S. regulatory environment for life science companies have grown significantly in recent years. This trend is having a strong, negative effect on the life sciences sector. Investors and entrepreneurs are increasingly less likely to start, grow, and fund new businesses in the United States, electing to re-focus their efforts overseas (including in Europe) and/or on other less capital intensive, less risky sectors of the innovation economy.
The results of a recent survey of Silicon Valley Bank's early stage technology companies clearly illustrate the negative impact the regulatory environment is having on life sciences companies. When compared to their peers in the software/internet and hardware sectors, life science companies are: less optimistic about their business outlook in 2011, significantly more likely to report challenges to their business growth, less likely to say they will hire new employees in the coming year, and significantly more likely to cite regulatory/political issues as a major challenge.
In fact, 64 percent of life science companies sector listed the regulatory/political environment as a challenge. For life science companies, it was a bigger issue than finding talent, accessing equity or debt financing, competition, and a bigger problem than scaling their operations for growth. And when we asked what makes it appealing to keep their businesses in the United States or move them overseas, life science companies were two to three times more likely than hardware and software/internet companies to cite the regulatory environment as a reason to move abroad.
There is a real risk that, if we do not take steps in the very near term, our regulatory system will drive innovation and investment in medical technologies overseas, leaving U.S. entrepreneurs and investors focused on more capital efficient and/or less risky sectors. This will have a serious, negative effect not only on the robustness of the innovation sector per se, but on our country's leadership in medical technology and its ability to use these technologies to address our health care challenges.
3) The Administration can work with Congress to adopt a meaningful, effective co-lending program to meet the needs of clean energy companies.
One of the pockets in which there is a clear shortage of capital is the clean energy sector -- in particular, in capital intensive areas such as energy generation, and for capital intensive projects such as the construction of commercial-scale facilities. These projects present regulatory, commercial, market and operational risks that place them beyond the risk appetite of commercial lenders.
For the past two years, we have tried to work with the Department of Energy to create a co-lending program within DOE's overall loan guarantee program that would help meet the needs of smaller, more innovative companies in the clean energy sector. To date, DOE has declined to go down this path. As a result, in our view, the DOE loan guarantee programs have not addressed the very real needs of smaller clean energy companies in a meaningful way.
Treasury could work with the Office of Management and Budget and other relevant federal agencies to implement a co-lending structure for smaller clean energy companies and projects. We believe the government can build upon the Export-Import Bank's very successful co-lending approach to leverage -- rather than try to replicate -- private sector lending expertise. Such an approach would help ensure that taxpayer funds are used wisely; provide a framework within which credit scoring could be done rapidly and responsibly; and dramatically increase the impact the loan guarantee program could have on the United States' efforts to promote energy innovation.
Our policy makers are pursuing the right goals. We just need to make sure they have a special focus on those companies that can make a substantial impact and create an environment in which they can actually make it.