Category Archives: National Economy

Will voters split The Golden State into Three Californias?

“Cryptocurrency Billionaire” Tom Draper is trying, once again, to split California; and as of this morning, his “Cal3” initiaitve has officially earned a spot on the November 6 ballot.

This time he’s proposing 3 states; last time he pitched the idea it was 6.  What we said then:

These pages have often extolled the virtues of doing business in the Southeast and Texas, the best climate for entrepreneurs and where we have focused our investment efforts for over twenty years.  Along the way we may have poked gentle fun at our friends in California whenever the state’s business environment fared poorly in surveys or did something like retroactively tax entrepreneurs.

So we can try to imagine the frustration engendered when a large and diverse geographic area strains under distant and schlerotic governing institutions…  Hard to see how this becomes a political reality though.

With the mood of the electorate today, anything might be possible.  But whatever one thinks of the notion, he has his work cut out for him. A May 8 article in Bloomberg points out that CA’s differences run deep, making it difficult to structure the break-up in a fashion that would be politically palatable across-the-board.

***

In related news…

The Orange County Register writes that California lacks a job-friendly economic policy.  The letter Gov. Jerry Brown wrote to Amazon CEO Jeff Bezos, pleading the case for “HQ2” to be located in his state, promised a long and complicated list of incentives, breaks and assistance.

“It reads like a confession of everything California is doing to kill businesses” and “(would be) a useful list for the next governor, and for anyone who wonders why there’s no gold rush of businesses moving to California.”

The migration of talent and capital to the high-tech corridors of the Southeast

Good article from Technet about how the startup economy has spread across the country:

This is the most recent item in a long run of stories describing a geographic analog to the process of creative destruction.  Those states who spray “startupicide” on the economy –  suffocating regulations, inflated business taxes and fees, lawsuit-friendly legal environments, and political classes uninterested in business concerns, if not downright hostile to them – lose economic clout as people and capital migrate to other states with more favorable environments in which to work and live.

Local evidence of this trend can be found in this story, in which the U.S. Census Bureau reports

Three metro areas in Florida were among the nation’s 10 biggest gainers in the number of people moving there last year, and another three Florida metro areas were in the top 10 for overall growth rates.

Our hometown Tampa was #5 in the nation in 2016 population growth.

This migration of economic clout within the US has been more subtle than the California Gold Rush or Irish Potato Famine but is just as significant.  Some states are chasing away their earners, workers, and entrepreneurs; this is their tax base.

The growth corridors of the high-tech South would have a mercantile-like advantage but for the fact that employers can (and do!) simply move in order to thrive under our growth-oriented tax policies, lower public sector debt burdens, stronger job creation, excellent climate for entrepreneurs, and a superior overall business climate.  (The actual climate happens to be conducive to a great quality of life as well.)

The NVCA’s letter to the President-elect

The National Venture Capital Association (NVCA) has sent a letter to President-elect Donald Trump outlining how the entrepreneurial ecosystem is the key to creating new jobs and economic opportunity for Americans who feel left behind by the modern economy.

The letter outlines an agenda crucial for supporting entrepreneurship and building a strong economy in all areas of the country, including: a tax policy that encourages new company formation; making capital markets work for small-cap companies; encouraging talented immigrants to build or work at American startups; making life-saving medical innovation a reality; increasing basic research investment; and other key policies that would bolster the entrepreneurial ecosystem and foster new company creation.

The NVCA’s letter opens with a brief paean to entrepreneurship:

Entrepreneurship is the key to expanded economic opportunity in the United States.  From FedEx to Genentech, entrepreneurs have fueled growth and expanded opportunity across the American economy.  America’s venture capitalists have been hard at work supporting these startups with tremendous growth potential in areas like personalized medicine, next-generation computing, 3D printing, and synthetic biology.

Young companies, many of them venture-backed, create an average of 3 million new jobs a year and have been responsible for almost all net new job creation in the United States in the last forty years.  In addition, venture capital has backed nearly half of all companies that have gone public since 1974, which have collectively been responsible for 85 percent of R&D investment during this period.  In short, while a small industry by relative standards, venture capital is mighty in its outsized role in supporting economic activity and creating growth and economic opportunity.

27,000 U.S. venture-backed startups have received $290 billion in funding—and 11,000 of those received funding for the first time—since 2012.  To put this into perspective, that calculates to about $170 million invested into 15 startups each day.  An underappreciated truth is that startup activity has proliferated in the middle of the country in recent years.  Since 2012, nearly half of all startups receiving venture capital backing have been based outside of California, Massachusetts and New York.  Specifically, about 12,900 venture-backed companies in the other 47 states have raised $83 billion in funding since 2012.  What’s more, the collective annual growth rate of companies receiving funding in these states (10.1%) has exceeded that of the top three states.

We highlight/excerpt three of their recommendations below, but we also encourage all our readers to check out the NVCA’s letter in its entirety.  (We also provide a few links to some of the relevant Greatest Hits here at Navigating Venture.)

1. Support tax policy that encourages new company formation.  Since the Reagan Administration, our tax code has been relatively effective at encouraging patient, long-term investment, but on net has been hostile to entrepreneurial companies.  For example, punitive loss limitation rules punish startups for hiring or investing in innovation, while benefits such as the R&D credit are inaccessible to startups.  Unfortunately, tax reform conversations in Washington have ignored these challenges while at the same time proposing to raise taxes on long-term startup investment to pay for unrelated priorities.For instance, carried interest has been an important feature of the tax code that has properly aligned the interests of entrepreneurs and venture investors since the creation of the modern venture capital industry.  Increasing the tax rate on carried interest capital gains will have an outsized impact on entrepreneurship due to the venture industry’s longer holding periods, higher risk, smaller size, and less reliance on fees for compensation.  These factors will magnify the negative impact of the tax increase for venture capital fund formation outside of the traditional venture regions on the coasts.

• Where are the start-ups?
• The love of taxes is the root of unhappiness
• Job creation and the carried interest: venture capital firms are different from hedge & buyout funds
• Is the secret to national prosperity large corporations or start-ups? 
• The incredible VC jobs machine
• Lost:  $1 trillion

2. Reform the regulatory state to bolster startup activity.  When Washington piles on new regulations it is startups who are most adversely affected because these young, high-growth companies do not have the resources to navigate the regulatory state like large companies.  At the same time, government red tape is inhibiting government entities from tapping into venture-backed innovation in fields such as cybersecurity due to challenges with the government acquisition process.

• Regulation of complex adaptive systems
• This is the disclosure gap the SEC is worried about?
• Manage to the rules (only) and you’ll tiptoe right up to the hot red line

3. Make life-saving medical innovation a reality.  The future has never been brighter in terms of scientific and health care discoveries that are on the horizon.  Venture capital is investing in revolutionary medical innovation and groundbreaking treatments and cures that are aimed at diagnosing, treating, and curing the deadliest and costly diseases.

Unfortunately, medical innovation is at risk unless policymakers adopt modern approaches to development, regulation, and reimbursement for medicine and medical devices.  Progress has been made to streamline the regulatory approval process at the Food and Drug Administration, particularly for novel technologies, but more improvements are needed.  In addition, we need to establish pro-innovation approaches to reimbursement at the Centers for Medicare and Medicaid.

• Medical progress, please
• The wizards of American medicine
• The dignity of innovation

Thanksgiving: the forgotten entrepreneurial tale

Every child in America learns of the hardships endured by the Pilgrims as they established Plymouth Colony.  Some lucky ones even learn how the Pilgrims found salvation via private property, division of labor, and capitalism.  The luckiest ones of all learn about capital preservation when a venture capital investment fails.

Mayflower with shallop – William Halsall, 1882

When a group of Puritans known as “Separatists” fled England they first settled in the Netherlands, where they took menial jobs and over time grew to miss their native culture.  They lacked the resources for a passage to North America, so they sent two entrepreneurs from their congregation to London to seek financial backing – a successful merchant named John Carver and Robert Cushman, a “wool comber of some means.”  While those two were in London, an ironmonger (a dealer in metal utensils, hardware, locks, etc.) from that city named Thomas Weston was visiting one of Carver’s in-laws in the Netherlands and learned of the Pilgrims’ need for funds.

Whether we call that serendipity or opportunistic networking, it resulted in Weston putting together an investor group to back the voyage.  Weston and his London Merchant Adventurers put up 7000 pounds and also recruited experts to assist with the enterprise:  roughly 50 additional settlers with the vocational skills to help build a colony in the new world.  These “non-Separatists” crammed aboard the Mayflower with the Separatists and together became known as the Pilgrims.

What happened to that £7000 investment, you ask?  Here is the story as told at encyclopedia.com

Weston and his fellow investors were dismayed when the Mayflower returned to England in April 1621 without cargo. The malnourished Pilgrims had been subjected to “the Great Sickness” after the arrival at Plymouth, and the survivors had had little time for anything other than burying their dead and ensuring their own survival. Weston sold his London Merchant Adventurer shares in December, although he did send a ship, the Sparrow, in 1622 as his own private business venture.

The Pilgrims attempted to make their first payment by loading the Fortune, which had brought 35 additional settlers in November 1621, with beaver and otter skins and timber estimated to be worth 500 pounds. The ship was captured by French privateers and stripped of its cargo, leaving investors empty-handed again.

A second attempt, in 1624 or 1625, to ship goods to England failed when the Little James got caught in a gale in the English Channel and was seized by Barbary Coast pirates. Again the London Adventurers received nothing for their investment. Relations, always tempestuous between the colonists and their backers, faltered.

Facing a huge debt, the Pilgrims dispatched Isaac Allerton to England in 1626 to negotiate a settlement. The Adventurers, deciding their investment might never pay off, sold their shares to the Pilgrims for 1,800 pounds. Captain Smith, of the failed Jamestown venture, felt the London Merchant Adventurers had settled favorably, pointing out that the Virginia Company had invested 200,000 pounds in Jamestown and never received a shilling for their investment.

By our back-of-the-envelope calculation, the investors got back 26% of their invested capital.  If only they’d kept their long-term perspective…

On a more serious note, that outcome fits into the first category of entrepreneurial failure listed in Fail the Right Way and reflects well on those involved:

• Liquidate all assets, investors lose most/all money: 30-40%
• Not realizing the projected return:  70-80%
• Falling short of initial projections: 90-95%

With “failure” this common, he urges executives to distinguish between business failure and personal failure.  It’s vital to not let the former, which can be a valuable learning experience, pressure you into the latter, which can become a career-damning ethical lapse:

Although the original backers did not get the return for which they’d hoped, the endeavor ultimately succeeded thanks to the intrepid settlers who displayed many of the noble traits found in entrepreneurs:  flexibility (they had to settle further north than intended), persistence (through brutal hardships), the value of good partners (Squanto and the Wampanoag tribe), and the courage and optimism necessary to accomplish the impossible and stupid.

“All great and honorable actions are accompanied with great difficulties, and both must be enterprised and overcome with answerable courage.”

– William Bradford, 2nd, 5th, 7th, 9th & 11th Governor of Plymouth Colony

Our business – like every business – has its ups and down, but we have much to be thankful for.  Much.   So we’d like to take this opportunity, here at NVSE, to give thanks for the trust and patience of our Limited Partners, the initiative and dedication of our entrepreneurs, the support provided to them by the many friends in our network, and the nation that offers the freedom to pursue happiness.  We love our work, have been blessed with terrific successes and honorable failures, and get to do it all with great people in beautiful weather.   God Bless you and your families – we hope you have a wonderful Thanksgiving.

Florida Basks in a Texas-Style Resurgence

In case you missed it in last weekend’s Wall Street Journal, Florida is now “the showcase of America’s red-state prosperity.”  Hit especially hard by the collapse of real estate values in the last recession, the state…

(C)ut a variety of taxes, including those on businesses and property, no small feat in a state without an income tax. [The state government] also slashed 3,000 regulations and shrunk state payrolls by 11,000.

The WSJ article is entitled “Florida Basks in a Texas-Style Resurgence” and those of us fortunate enough to live in the growth corridors of the high-tech South easily recognize the reasons:  growth-oriented tax policies, lower public sector debt burdens, stronger job creation, excellent climate for entrepreneurs, and a superior overall business climate.  (The actual climate happens to be conducive to a great quality of life as well.)

Southern Comfort

New figures from the Census Bureau show that, in 2015, Florida gained more people (365,703 – more than 1,000 a day) than California.

This is the most recent item in a long run of stories describing a geographic analog to the process of creative destruction.  Those states who spray “startupicide” on the economy –  suffocating regulations, inflated business taxes and fees, lawsuit-friendly legal environments, and political classes uninterested in business concerns, if not downright hostile to them – lose economic clout as people and capital migrate to other states with more favorable environments in which to work and live.

This migration of economic clout within the US has been more subtle than the California Gold Rush or Irish Potato Famine but is just as significant.  Some states are chasing away their earners, workers, and entrepreneurs; this is their tax base.

The growth corridors of the high-tech South would have a mercantile-like advantage but for the fact that employers can (and do!) simply move in order to thrive under our growth-oriented tax policies, lower public sector debt burdens,stronger job creation, excellent climate for entrepreneurs, and a superior overall business climate.  (The actual climate happens to be conducive to a great quality of life as well.)

‘Twas the Overnight Before Christmas: The Merry Tale of How Air Cargo Deregulation Led To Amazon

Professor of Public Policy at George Mason University Kenneth Button shares the story of how air cargo deregulation in the 1970s paved the way for low-cost, reliable overnight shipping, which in turn allowed for groundbreaking new e-commerce businesses like Amazon and eBay.

The Dignity of Innovation, part II

Innovation was once a dirty word because it upset the established order; now the word is a form of high praise.  It’s also, as we’ve often argued, the source of virtually all of the improvements that make our lives happier, healthier, and more convenient.

In The Great Enrichment, Deirdre Nansen McCloskey writes that “contrary to the conviction of the ‘clerisy’ of artists and intellectuals,” entrepreneurs are “pretty good” and responsible for the “gigantic improvement” in life since roughly 1848, when society as a whole underwent “a startling revaluation of the trading and betterment in which the bourgeoisie specialized.”

(T)he modern world was made not by material causes, such as coal or thrift or capital or exports or exploitation or imperialism or good property rights or even good science, all of which have been widespread in other cultures and other times… [and it] cannot be explained in any deep way by the accumulation of capital, despite what economists from the blessed Adam Smith through Karl Marx to Thomas Piketty have believed, and as the very word “capitalism” seems to imply.

The word embodies a scientific mistake. Our riches did not come from piling brick on brick, or bachelor’s degree on bachelor’s degree, or bank balance on bank balance, but from piling idea on idea. The bricks, B.A.s, and bank balances — the “capital” accumulations — were of course necessary. But so were a labor force and liquid water and the arrow of time. Oxygen is necessary for a fire, but it does not provide an illuminating explanation of the Chicago Fire. Better: a long dry spell, the city’s wooden buildings, a strong wind from the southwest, and, if you disdain Irish immigrants, Mrs. O’Leary’s cow.

The modern world similarly cannot be explained by routine brick-piling, such as the Indian Ocean trade, English banking, canals, the British savings rate, the Atlantic slave trade, coal, natural resources, the enclosure movement, the exploitation of workers in Satanic mills, or the accumulation in European cities of capital, whether physical or human. Such materialist ways and means are too common in world history and, as explanation, too feeble in quantitative oomph…

The magnitude of the improvement stuns. Economists and historians have no satisfactory explanation for it. Time to rethink our materialist explanations of economies and histories…

(W)hat mattered were two levels of ideas: the ideas for the betterments themselves (the electric motor, the airplane, the stock market), dreamed up in the heads of the new entrepreneurs drawn from the ranks of ordinary people; and the ideas in the society at large about such people and their betterments — in a word, liberalism, in all but the modern American sense. The market-tested betterment, the Great Enrichment, was itself caused by a Scottish Enlightenment version of equality, a new equality of legal rights and social dignity that made every Tom, Dick, and Harriet a potential innovator.

The only thing he ever made fly was government money

On this day in 1906, the Wright Brothers were granted a patent for their “flying machine.” In honor of the anniversary, we reprint this – one of our most popular, most-read pieces.  

(Original publish date: April 17, 2013)

The process of productive capital allocation is a critical ingredient of innovation and job growth.   Entrepreneurs spending their own (and their partners’) money will create more jobs, more innovation, and a more vibrant economy than politicians picking winners and losers based on cronyism, campaign contributions, and constituent pork.

When government strays out from funding basic research into either applied research or the means of production, the results range from poor to scandalous.  Ideas are infinite, and in the absence of competent execution, they are worth nothing.  Even if the idea has merit, the true expertise is crowded out.  There are better ways policymakers can help encourage innovation.

The invention of the airplane provides an excellent example.  While we’re all aware it was the Wright Brothers, many interesting details about funding the innovation don’t make it into school textbooks.  In A Tale of ‘Government Investment’  Lee Habeeb & Mike Leven recount the race between the bicycle shop owner/operators and the government-backed head of the Smithsonian.

Who better to win the race [to powered flight] for us, thought our leaders, than the best and brightest minds the government could buy? They chose Samuel Langley. [The War Department gave Langley $50,000, an enormous sum at the time, which The Smithsonian augmented with taxpayer funds of its own.]  You don’t know him, but in his day, Langley was a big deal. He had a big brain and lots of credentials. A renowned scientist and a professor of astronomy, he wrote books about aviation and was the head of the Smithsonian.  It was the kind of decision that well-intentioned bureaucrats would make throughout the century — and still make today. Give taxpayer money to the smartest guys in the room, the ones with lots of degrees. They’ll innovate and do good for us.

For that Solyndra-type investment the country got the “Great Aerodrome,” which “fell like a ton of mortar’ into the Potomac River – twice.  Representative Gilbert Hitchcock of Nebraska remarked, “You tell Langley for me that the only thing he ever made fly was government money.”

Samuel Pierpont Langley’s Aerodrome and launching apparatus.

Nine days after that second failed test flight, a “sturdy, well-designed craft, costing about $1000, struggled into the air in Kitty Hawk.”

How did two Ohio brothers accomplish what the combined efforts of the War Department, The Smithsonian, and other people’s money could not?  The authors cite James Tobin’s To Conquer the Air: The Wright Brothers and The Great Race for Flight (2004) to provide a few answers:

• Langley saw the problem as one of power:  how to go from zero to 60 in 70 feet, the stress of which was too great for the materials used.  The Wright Brothers, inspired by the practical skills and insights gained from tinkering in their bike shop, understood the problem was one of balance (on a bike, balance+practice = control).  They invented the three-axis control (pitch, yaw, roll) still standard on fixed-wing aircraft today.  Their entrepreneurial technical expertise was an advantage neither the government nor other private competitors (Alexander Graham Bell) could match.

• Since they couldn’t afford repeated test flights the Wright Brothers were forced to develop a wind tunnel to test their aerodynamics.  This saved money and time, since they weren’t bogged down repairing the wrecks of a flawed design.

• No government money also meant no government strings.  They were freer to experiment and innovate without worrying about non-essential requests and hidden agendas.  They also managed to do more with less since they couldn’t afford subsidy-induced waste.

Habeeb & Levin also offer this fascinating, if not unexpected, coda:

Though the Wrights beat Langley and the Smithsonian, the race didn’t end there. Powerful interests vied for the patent to this revolutionary invention and, more important, for the credit for it. With Smithsonian approval, a well-known aviation expert modified Langley’s Aerodrome and in 1914 made some short flights designed to bypass the Wright brothers’ patent application and to vindicate the Smithsonian and its fearless leader, Samuel Langley.

That’s right. The Smithsonian’s brain trust couldn’t beat the bicycle-shop owners fair and square, so they used their power to steal the credit. And then they used their bully pulpit to rewrite history. In 1914, America’s most esteemed historical museum cooked the books and displayed the Smithsonian-funded Langley Aerodrome in its museum as the first manned aircraft heavier than air and capable of flight.

Orville Wright, who outlived his brother Wilbur, accused the Smithsonian of falsifying the historical record. So upset was he that he sent the 1903 Kitty Hawk Flyer, the plane that made aviation history, to a science museum in . . . London.

But truth is a stubborn thing. And in 1942, after much embarrassment, the Smithsonian recanted its false claims about the Aerodrome. The British museum returned the Wright brothers’ historic Flyer to America, and the Smithsonian put it on display in their Arts and Industries Building on December 17, 1948, 45 years to the day after the aircraft’s only flights. A grand government deception was at last foiled by facts and fate.

As for Samuel Langley, he died in obscurity a broken and disappointed man. Friends often noted that he could have beaten the Wright brothers if only he’d had more time — and more government funding.

Some things never change.

The Wright brothers’ airplane business never took off (groan) due to a combination of poor business decisions and sloppy patent work.  Wilbur sadly died young (in 1912 at age 45, of illness that some suspect was contracted due to exhaustion from the patent battles) and Orville sold the company in 1915.  So the industry grew under the leadership of other companies and other men.  (Although the Curtiss-Wright Corporation remains in business today producing high-tech components for the aerospace industry.)   One can’t help but wonder what the original inventors might have done had they been the beneficiary of a strong partnership with a VC fund…

Google can’t save us (anymore)

History of Google Acquisitions

Great piece by Robert J. Samuelson in last Sunday’s Washington Post about how innovation resulting from M&A activity may lift corporate profits, but only the innovation generated by fast-growing start-ups broadly raises national prosperity.

(A) larger issue transcends individual deals. The popularity of M&A actually involves economic weakness. Unable to expand internally — by creating products or entering new markets — companies rely on M&A for growth. However, what works for the firm may work less well for society. Although buying another company may enhance the acquiring firm’s innovation, it doesn’t add much to society’s. And society’s capacity to innovate is crucial. It generates the wealth needed to raise incomes and dampen social conflicts…

In our mind’s eye, the economy is swarming with entrepreneurs. Competition is intense. Old-line firms adapt, or die. Just the opposite may be happening: Evidence suggests that entrepreneurship is in decline and that U.S. firms are becoming older, more entrenched and less dynamic…

American capitalism is middle-aged. Older firms, conditioned by success, are more rigid. They’re invested, financially and psychologically, in existing markets and production patterns. They can adapt and innovate, but it’s hard. The M&A surge is one way older firms strive to overcome internal stagnation.  What’s worrisome is not the success of the middle-aged businesses; it’s the weakness of young firms and the apparent erosion of entrepreneurship. As other research has shown, start-ups ultimately account for a disproportionately high share of new job creation and innovation. The vigor of these new firms is essential for the economy to revitalize itself.

We don’t know what explains their slide, though the sheer mass of government regulations is one candidate. Older firms have the lawyers and administrators to cope with the red-tape deluge; many small new firms drown. But that’s just a conjecture illuminating the larger question. If the economy discriminates against young firms, we will all be paying the price for many years.

Samuelson’s piece fits nicely with what we wrote last July in Not All Innovation Is Alike:

Some politicians think “innovation policy” means spending taxpayer money on promising young firms favored by bureaucrats. Rather, innovation policy means ensuring that the status quo is continuously challenged by upstart rivals and threat of failure. Those are the keys to the Schumpeterian “gales of creative destruction” that drive innovation, which in turn drives long-term economic growth and improvement in living standards.

National prosperity is generated by the start-ups who innovate and challenge entrenched incumbents. Anyone who’s worked for a large corporation – especially in an R&D department – would not rely primarily on that model for innovation. Anyone who’s worked for a large corporation – especially in a dying industry – would not rely primarily on that model for job growth. Yes, start-ups lack the economies of scale and R&D budgets of larger firms; but that’s the support venture capital provides. Those start-ups that do gain traction are able to raise capital, and, with hard work and a little luck, become large companies… and then face the next generation of innovators.