When Bureaucrats Meet Entrepreneurs: The Design of Effective `Public Venture Capital' Programmes

Abstract

Recently public efforts to finance small high-technology firms have proliferated. We review the motivations for these efforts and make some preliminary observations about their design. We explore the underlying challenges that the financing of young growth firms poses, the ways that specialised financial intermediaries address them, and the rationales for public efforts to finance these companies. The final section makes a set of observations about the ways in which the structure of these efforts can most effectively complement private sector activity. A frequent fault in programme design is the presumption that technological criteria can be divorced from business considerations when evaluating firms. The federal government has played an active role in financing new firms, particularly in high-technology industries, since the Soviet Union's launch of the Sputnik satellite. In recent years, European and Asian nations and many US states have adopted similar initiatives. While these programmes' precise structures have differed, the efforts have been predicated on two shared assumptions: (i) that the private sector provides insufficient capital to new firms, and (ii) that the government either can identify investments which will ultimately yield high social and/or private returns or can encourage financial intermediaries to do so. In contrast to other government interventions designed to boost economic growth, such as privatisation programmes, these claims have received little scrutiny by economists. The neglect of these questions is unfortunate. While the sums of money involved are modest relative to public expenditures on defence procurement or retiree benefits, these programmes are very substantial when compared to contemporaneous private investments in new firms. Government programmes in this arena have been divided between those efforts that directly fund entrepreneurial firms and those that encourage or subsidise the development of outside investors. In this paper, I will focus on 'public venture capital' initiatives: programmes that make equity or equity-like investments in young firms, or encourage other intermediaries to make such investments. In some such programmes, such as the Advanced Technology Program and the Small Business Innovation Research programmes discussed below, the funds are provided as a contract or outright grant. While these efforts have proliferated, a consensus as to how to structure these programmes remains elusive. While the design of regulatory agencies has been extensively studied from a theoretical and empirical perspective, little work has