The Beatles, "The Office," James Bond and Kate Beckinsale are some of my favorite British imports. But there's one British innovation I really wish we'd import that would significantly revive and accelerate our economic growth - venture capital trusts, or VCTs. They're certainly not as sexy as Kate Beckinsale, but for investors and public policy makers seeking economic arousal, VCTs might just do the trick...
Just like traditional venture capital funds, VCTs provide equity capital to fast-growing small and mid-sized businesses. However, unlike traditional venture funds, the underlying investors are not large institutions but individuals, like you and me. (Just as we are able to invest directly into mutual funds which are managed by professional fund managers, VCTs would enable us to invest directly into venture capital funds which are managed by venture capitalists). Thus, this individual investment creates both a new source of capital for private companies and an efficient, organized mechanism for individual investors to do so which does not currently exist in the U.S., as non-accredited individual investors (i.e. nearly every American) cannot invest into venture funds.
Before getting all Anglophile on you in proclaiming my love of VCTs, let me put this bizarre proclamation into context. As we enter 2010, U.S. political leaders continue to blame the lack of bank financing for the collapse of many small and mid-sized businesses and are pursuing policies that would expedite a return to the days of "easy money" lending practices.
However, my colleague, Charlie Rothstein and I contend that the loose lending standards adopted by the banking sector were a major reason for the financial industry meltdown itself and should not be revisited in policy or practice. Businesses which typically wouldn't have qualified for loans under more stringent regulations were granted unaffordable amounts of credit because the underlying loan officer compensation system was set on the basis of the volume lent, not on the performance of the loan portfolio. To encourage these organizations to resume those practices is like giving matches to an arsonist.
The real problem is not a lack of debt financing but rather a lack of equity capital. The last thing struggling companies need is more debt on their balance sheet. Unlike debt financing, which can choke a business when the economy stalls, equity is capital for all seasons. Equity allows a company to capitalize on a business opportunity, expand a product line, increase R&D or hire new employees without the pressures of principal and interest repayments that strain a business's cashflow or creates a risk of default - which, in turn, causes debt-financed management to be more cautious in pursuit of growth. Suffice to say, cautious businesses are rarely the engines of economic growth that will pull us out of a recession. So, as opposed to pressuring banks to "lend, baby, lend," We suggest we foster the flow of equity capital into small and mid-sized companies, changing our mantra to "build, baby, build." In order to accomplish this, we need to develop a new source of capital.
It makes sense for the U.S. adopt a U.K.-style VCT model which has successfully spurred private capital investment in the United Kingdom. In addition to offering 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 that can be claimed in the year in which they invest. Because the businesses receiving VCT backing are better capitalized, grow faster, and employ more workers in a variety of sectors, the cost of the tax credits offered by the government to VCT investors is more than offset in the long run.
Also, since the funds are managed by experienced venture capitalists who are paid based on the returns generated for their investors, 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. Since the mid-90's, billions have been raised and ultimately invested in a new generation of emerging UK businesses.
Yes, there is a credit crunch. But, no, it's not an entirely bad thing. It is a dynamic of a market driven too far in one direction. Now is the time for us to respond in a thoughtful, long-term manner. The new paradigm should center on equity and business building, rather than debt; and we believe a government initiative meant to spur venture capital investment, like a VCT, could be the solution we've all been waiting for.
In full disclosure, our firm's London office has managed several VCTs for the past decade so we are familiar with the solution. But, as a result, we have first-hand experience in seeing the VCT model serve as a brilliant "win-win-win-win" for individual investors, small businesses, the government and overall UK economy. We, as Americans, should not hesitate to adopt this British innovation - if we have no shame in Susan Boyle sitting atop U.S. album charts, we certainly can swallow our "Not-Invented-Here" public-policy pride and embrace VCTs.
Our economic recovery is not a trivial problem. Situations like this call not just for thinking outside the box but also thinking outside the map - even if it does mean borrowing a successful idea from our witty, musically-inclined friends on the other side of the pond...