Reid Hoffman - Let Start-Ups Bail Us Out

UPDATE: Reid expands on his ideas in this TechCrunch piece. He still hasn't won me over on point 3 though.

Here is a great column by in the Washington Post making the point that entrepreneurship is a major engine of growth for this country and it deserves some stimulus.

Entrepreneurs are the fertile soil for job growth and recovery. Small companies represent 99.7 percent of all employer firms, Commerce Department data show. They pay nearly 45 percent of U.S. private payroll and have generated 60 to 80 percent of net new jobs annually over the past decade.

There are few people who are more credible or smarter when it comes to technology entrepreneurship than Reid, who has PayPal and LinkedIn on his resume and, as he mentions in this piece, has invested in over 60 companies. I should also mention that he is an investor and board member of Six Apart -- and a friend.

I think he is right on when he makes the point that although there is some focus in the stimulus package on scientific research, that "new ventures -- not merely new technologies -- need to be championed as the course to stability."

As for Reid's proposals, I would support some and I am more skeptical of others (this would not surprise Reid :) ).

First, he proposes that we "encourage small business with loans. Apply to the United States the micro-lending model that has proved successful in developing countries, extending credit lines of up to $50,000." I would like to hear more about this. There are parts of this I like. The costs of starting a tech business -- an Internet business especially -- are now relatively low and it would be great to have more start-ups get financed by small loans. VC is in a sense the most expensive form of financing, but it has come easy in the past and so entrepreneurs haven't relied on raising money from banks or, heaven forbid, customers (i.e. selling something!) as a means of funding operations as much as they should. So I like the general idea.

However, I'm a bit wary because we saw what artificial incentives for banks to lend to those that couldn't afford mortgages did to the overall credit market, and I wouldn't want this $50k incentive to similarly distort markets. If there is a way to free up lending to start-ups by lowering barriers but without artificial distortions in the credit market, I'm all for it.

Second, he would "welcome foreign innovators" by urging lawmakers to remove "the cap on H-1B visas while imposing a 10 percent payroll tax above and beyond the benchmark salary for any position being filled by holders of such visas." This is the subject for much more discussion but I am strongly in favor of eliminating the cap on H-1Bs. I think it's crazy that this country is severely gating our ability to attract the best and brightest from around the world and Reid is right to focus on this as a severe hindrance to entrepreneurship in this country. I don't like his 10% payroll tax increase, but I'd accept it if it were the only way politically to remove the cap.

Third, "match funds for venture capital and angel investments. Venture firms and investors need financial incentives to invest in companies that create U.S. jobs. What if firms with credible histories could receive as much as $100 million in federal matching funds if their investments create jobs in the United States?" This is my least favorite of his proposals. In the first place, my sense of the angel and VC markets is that there is in fact plenty of money out there still, though this may be changing, and investors don't really need artificial incentives to invest. What they need are returns.

And it's on the liquidity side that investors are having the biggest challenges with unstable and plummeting public financial markets and regulations such as SarBox making it ever harder and expensive for companies to go public. Companies from around the world are now looking elsewhere to list when they used to look only to the NYSE and Nasdaq. There is a whole lot that could be done to improve liquidity options for companies and I'd like to see more focus on this.

Also, I am very skeptical of injecting the federal government into private investing. It will undoubtedly come with strings attached, as so much of the recent government intervention has, and frankly it's not needed. And once a system gets hooked on federal funds, it rarely weans itself off. Finally, "credible" venture funds as a class have not had a challenge raising capital, so this seems to be a solution in search of a problem. The scarce commodity is not private capital but the time and talent of capable investors who should want a full return on their effort rather than giving half of it away. Such a system would actually lower the returns on investors time, which is a zero sum, and probably not be in the best interests of the industry.

(Fred Wilson has a more detailed and eloquent take on this which I endorse.)

If the goal were to infuse more capital into private investing, I'd prefer a different approach. Right now there are a huge number of impediments for individuals to invest in private companies. Reid can invest in 60 companies because he is experienced and is an accredited investor, but most people simply can't invest in these companies by reasons of law, regulation, legal cost, and sheer logistics. Many of these limitations are imposed on people to "protect" them from themselves. Thank goodness we've been preventing people from private investing so that they can keep their money in the public markets! Another classic example of a system that punishes the responsible in an attempt to protect the irresponsible.

I am sensitive to the need to protect less sophisticated investors from shams, but it strikes me that there should be some middle ground between the public market which is easy and open for investors but difficult and expensive for companies and the private market, which imposes fewer restrictions and costs on companies but is much more challenging and restrictive for investors. This, more than anything, restricts the flow of capital to start-ups.

The very purpose of a financial market is to provide capital and liquidity to businesses -- they are not an entitlement for individual investors -- and when they stop serving that purpose effectively we should ask what we can do to fix things. Whether this means lessening the burden on public companies, or loosening the restrictions on private investors, or coming up with a middle way, perhaps by freeing up personal investment in venture funds or creating mutual fund like vehicles -- or all three -- we should be exploring these avenues.

And finally, I have to say that I'm a bit disappointed that there is no comment here on the Obama tax increases. Whether you are for or against the income and capital gains tax increases and the massive implied taxation on the energy sector put forward by President Obama, we should not kid ourselves that these don't come at a cost to entrepreneurship. These taxes will hit many wealthy individuals who fund a lot of start ups and many SMBs that file as individuals -- and capital gains is the return on their investment so higher taxes here will further impede growth. Rather than take this money out of the financial system, and then use the political system to dole funds back to favored constituencies, how about leaving it there in the first place?

Finally, as Internet companies grow we depend on energy (how much does LinkedIn spend on power in its data centers?) and so I believe this heavy regulation on energy will come at a real cost to growth in the Internet sector.

I think this is a good conversation that Reid has started. I support much of it, but I would love to have more discussion not on what the government can do to play favorites but instead what it can do to remove impediments for people like Reid to do what he does best -- grow companies and create jobs.