In Favor of Risk

Risk capital made this country great--that and an amazing foundation of founding principles. But we're getting ready to send risk capital overseas.

The uniquely American combination of market capitalism, extraordinary universities, and risk capital--specifically venture capital and growth equity--are the engine behind a century of remarkable progress.

Risk capital funds new, high-growth businesses--highly speculative investments in exceptional people and breakthrough ideas. It was, until recently, a uniquely American phenomenon: widely imitated, but unsuccessfully replicated. But a few years ago we began to see venture investment and entrepreneurial talent migrating to Asia. What began as a trickle is now a torrent. While risk capital for startups in the United States is hard to come by--some say harder to come by than ever before--investment in China and India remains on the rise, up another five percent over last year. Risk capital also requires a vibrant market for exits, another area the U.S. owned until extremely recently. London has taken over as the IPO capital of the world, due in part to poorly designed legislation in the United States.

The current financial crisis was caused by companies taking on the wrong kinds of risk combined with lax oversight. The myriad of proposals proffered by the White House and Congress will, in the words of the Consumers Union "make sure that this never happens again". In the process, however, they may wring out much of the good risk along with the bad. Risk capital, like all capital, will go where it is best treated. If we are not careful, we will accelerate the exit of risk capital and entrepreneurial talent to Europe and Asia and with it our best hope for sustained future economic growth.

The paradox of recovery is that we need more risk, not less risk. We know that this is hard to hear, but it is nonetheless true. Yes, there were some overheated segments that led to this crisis, but we will not recover until banks and venture funds start financing great entrepreneurs and breakthrough ideas.

We will not reform our way to leadership in education, crucial to success in the global market. If we have learned anything in the past two decades, we know that we will only get there through risk capital funded innovation. Expanding health care while simultaneously reducing costs won't come through reforming what we have, but by finding and funding people committed and capable of game-changing impact. And we will not regulate our way to a sustainable green economy--this will also require fundamental breakthroughs in materials and business models.

Our national innovation system has successfully integrated wave after wave of technological change and converted it into sustained economic growth. This is a domain in which the US is truly the best in class. And we are in danger of squandering that hard-won gift.

Yes, banks should make sensible loans. Yes, banks should operate with reasonable amounts of leverage. And yes, we should have a fair tax system. But nearly everything good that this country has accomplished was the direct result of a risk taken. And we will not recover by eliminating risk--we will recover by encouraging and rewarding smart risk taking.

Note: Rob Wuebker, a venture capital thought partner, co-authored this blog. Rob is completing his PhD in Management at Rensselaer Polytechnic Institute. His research examines the impact of the globalization of finance, talent, and entrepreneurial opportunity on U.S. venture capital investment.

Comments

[dsws]

"Risk capital, like all capital, will go where it is best treated."

Not true. It will go where overall conditions are the best for it. If it has a choice of location A where it can expect to be wined, dined, flattered, and killed by a hurricane; or location B where it can expect to be required to obey the traffic laws, treated like an ordinary mortal, and evacuated if a hurricane hits, it will go to location B.

"If we are not careful, we will accelerate the exit of risk capital and entrepreneurial talent to Europe and Asia and with it our best hope for sustained future economic growth."

It's not a zero-sum game. We're better off as peers of healthy trading partners than as king of a rubbish heap. We don't need a race to the bottom. If you think certain regulations are a bad idea, make the case on the merits, not by conjuring up foreign bogeymen.

[timm0]

Anyone using xenophobia to draw people to their side of an argument is rarely ever on the same side of the argument that I find myself.

[Tom Vander Ark - Huffpost Blogger]

No xenophobia intended. It's great for all of us to see a Chinese and Indian venture community develop. And we agree that capital will follow 'overall conditions'--by 'treated' we agree the larger context of tax treatment, economic health, level of entrepreneurship, and academic health all matters a great deal. The inefficiency of the learning market, the one I follow most closely, is the primary reason that innovation capital is flowing overseas.
It's not a zero-sum, but the US is at risk of having a smaller piece of a global investment pie with the current all-things-investment-related backlash.

[dsws]

But the benefits of good regulation are diffuse, whereas the benefits of defects in regulation are often very concentrated. It takes political will to get regulations enacted. So instead of needing to rid of the outrage at the failure of the financial system, we need leadership to focus that backlash into support for effective regulation.

Some of that leadership will come from President Obama, Barney Frank, Tim Geithner, and so on, but much of it needs to come from ordinary people like us.

[dgscol]

What happens if you default on a Chinese loan? Secret Chinese agent abducts you, brings you back to China, and lops off your head for being a thief.

Only 30:1? How bout 50:1 ? I am not speaking about leverage here, but the ratio of defaults to successes. Now besides Mexico defaulting there is MExico again, Ireland, Equator, and Bulgaria (and maybe the US). Possibly many others. Is the problem a lack of venture capital?

[RoloTomassi]

Let me post a link to a guy in the realm of economics who actually knows what he is talking about:

http://www.nytimes.com/2009/03/27/opinion/27krugman.html?_r=1

[swift goat pet for truth]

You beat me to it.

I'll believe Krugman.

[dsws]

Krugman is often right, and sometimes wrong.

I'll give disagreeing experts their due consideration, but I'll think for myself.

[Sundialsvc4]

Unfortunately, this article smacks of sophistry. The words are good and pleasant, and appealing to their face, but the lines of reasoning that lie beneath the words are empty. I am disappointed.

"Risk" is one thing, but ... "swindling" is quite another. Risk-taking turns into crime either when you take reckless risks with other people's money (when the people or the institutions in question did not contemplate taking such risks), or when you lie and misrepresent what you have done in order to facilitate what you have done.

Within a very, very limited context, "risk taking" is indeed an admirable thing. But selling the same supposed security-interest, in a nonexistent or grotesquely-misrepresented loan, thirty or forty times over, is nothing more than a swindle of the highest order. In such a situation, the person who thought he was "taking risks" was simply "getting fleeced." He probably assumed that the laws of the land were protecting him: little did he know that the law of the land actually forbade(!) regulation.

People who walk into a Las Vegas casino ought to know that the games are rigged. (They don't pay for all those bright lights with credit cards...) But people who invest or who do business, even if they call themselves "risk takers," are entitled to the truth about what they are doing.

[Tom Vander Ark - Huffpost Blogger]

Your response is what worries me--it seems to lump all investing together and suggest it should all be highly regulated. Venture investors create new business and new jobs. However, they are about to be penalized by new regulation because of a overheated housing and derivative market. We need to start by enforcing the regulations we have and be very thoughtful about new regulations. We need to make sure we don't eliminate good risk (ie venture investment) with bad risk (the swindling you refer to).

[RoloTomassi]

"...it seems to lump all investing together and suggest it should all be highly regulated."

Indeed, and that is as it must be, as individuals in your industry CANNOT BE TRUSTED. That is the bottom line, that's all there is, and given the curent environment, you will be hard pressed to find ANYONE outside of your industry willing to let you free market fundies have your way with the markets again.

Free market fundamentalism is an irresponsible mode of operation, and for all of your squawking about what you gained in your recently passed unfettered era, your near instantaneous and seemingly bottomless losses have proven your faith-based economic dogma to be socially dispicable and conpletely without merit for anyone other than Randian-minded criminals. Your claims of innovation are utter nonsense, as they refer to financial instruments that should never have been a possibility, and in the end proved to be disasterous.

You and your ilk represent all that is wrong with Wall St.

[timm0]

I wasn't allowed to publish an innocuous comment, but I'll try conveying a piece of the rejected one here because you noted the pleasant words from the author.

Did you also note the appeal to xenophobia in the text? Surrounded by high-mindedness takes the edge off them. But the 'if we don't leave venture capitalists un-regulated, then non-white, non-English-speaking people will get all the money and jobs' riff is unmistakable.... and putrid....

[swift goat pet for truth]

Risk is fine. Venture capital is fine.

Just not with MY money. Not guaranteed with my money. Not leveraged so my money is at risk.

And failure should not be bailed out with any public money.

[metropixie]

Not sure what it exactly is you're asking for. Venture capitalists can be as supportive of the new economy that will emerge as they want to be. If great American talent and opportunity is going to be skipped over in favor of foreign investment in same than so be it. If you want to preserve capitalism as the only (other) God, than be prepared for how it behaves, like an irresponsible, greedy, destructive, resource-devouring beast.
Perhaps now is the time to look at a better use of capital than purely squeezing profit from it. Money is a natural resource as well, in a way, that helps make things possible. Wonderful things, sustainable things, innovative things, that may nourish us and excite us without creating toxic by products that smother the environment and in the end our dreams and hopes. Perhaps the new investor will look upon our efforts to recreate the economy with the brave foresight of the risk taker who sees not only opportunity and profit, but also understands that what we all want is to live in harmony. Yes, that investor may not yet have emerged, but those are the ones we're all waiting for. Who goes first?

[Tom Vander Ark - Huffpost Blogger]

There are actually a lot of us investing for sustainable return as well as social impact--most in green tech, but a growing number in the social and edu sector.