Role and Impact of Venture Capital Exposed
VC: An American History
VC: An American History by Tom Nicholas (Harvard University Press – 400pp – $18.35 – ISBN 978-0-6742-4826-7)
Size matters. Two of Europe’s largest new tech firms, Spotify and Zalando, boast a combined market value of some $42 billion – a pittance in today’s world of behemoths. To put things in perspective: China’s Alibaba is worth north of $480 billion whilst the market cap of Facebook hovers around $550 billion. Apple and Amazon are close to the $1 trillion mark.
According to numbers crunched by boutique investment bank GP Bullhound, the cumulative valuation of major US tech firms founded after 2000 now exceeds $1.4 trillion. For European and Asian tech start-ups this number amounts to an estimated $240 billion and $675 billion, respectively – not bad, but nowhere close to the performance registered by (relatively) new US tech businesses.
The European Commission is now determined to redress the imbalance and create ‘industrial champions’. The commission was spurred to action earlier this year after the Federation of German Industries (BDI) issued a strong warning that China has now become a ‘strategic competitor intent on using all state levers’ in order to attain technological supremacy.
The bold statement was squarely aimed at EU Competition Commissioner Margarethe Vestager as she weighed the pros and cons of the proposed merger of the rail assets of Siemens and Alstom. She ultimately decided to withhold her approval, citing concerns over diminished competition in rail signalling systems and very-high-speed trains.
Manifesto
Though Mrs Vestager’s decision killed off an industrial champion of sorts, it also kickstarted a continent-wide discussion over the need for, and possible uses of, an industrial policy – an unfashionable term long despised and confined to the fringes of economic discourse.
The German and French governments, which had given their blessing to the Siemens-Alstom merger, jointly tabled a Manifesto for a European Industrial Policy for the 21st Century. The paper argues that such a policy should rest on three pillars: the pooling of resources to facilitate massive investments; the implementation of a foreign investment screening framework to keep out predators; and, the re-evaluation of EU rules on competition to allow for the emergence of truly heavyweight European corporates. Please take note Mrs Vestager and do not let the door hit you on the way out.
Again some perspective is called for: Siemens and Alstom currently compete in a market that absorbs about 35 high-speed trains annually. Chinese rolling stock manufacturer CRRC employs over 180,000 workers and each years sells more than 230 high-speed trains. The industrial champion Mrs Vestager was fearful of would only have played in a minor league.
Europe’s squeamishness when it comes to Big Business is remarkable. The EU’s $17 trillion economy is comparable in size to the US’s and quite a bit larger than China’s. Yet Europe remains home to comparatively modest-sized corporations. As such, it runs the risk of becoming the domain of boutique businesses offering excellence in quality but limited in quantity and corporate heft.
Tom Nicholas claims he has diagnosed the patient and found the root cause of the ailment: the absence of a native venture capital (VC) culture. In Europe, corporate growth, he surmises, has traditionally been fomented by the state. Thus, the current might of the old-style German industry is the product of a post-war compact between the state and private enterprise within the ordoliberal framework developed by the Freiburg School of economic thought. French industry prospered in a similar dirigiste environment, whilst the Italian and Spanish states clung to their corporativist inclinations for decades after the world had moved on.
Only in America were businesses allowed to prosper or fail at will without any noticeable interference from above – or below. Only the United States managed to move and stay in the goldilocks zone that unleashes the awesome power of a particular kind of capitalist – one that provides seed money to countless promising start-ups, betting on the long tail. Most of the outfits underwritten are expected to fail. However, the odds are that, in due time, one will eventually succeed spectacularly, wiping out losses sustained elsewhere and delivering a windfall of superior magnitude to the investor.
Historically, VC tends to seek out technology companies for with them the potential of a breakthrough – and outsized returns – is greatest. Mr Nicholas notes that wealthy families have always invested at least part of their fortune in risky commercial ventures. However, that is not an exclusively American phenomenon. Some of the richest European monarchies owe their wealth to the commercial foresight of their royal forebears. For example, King William III of The Netherlands (1817-1890) helped provide the seed capital for what was to become Royal Dutch Shell.
In VC: An American History, Prof Nicholas’ pushes the starting point of his topic back to the early 19th century whaling industry of New England. As it befits a professor of Harvard Business School, the author avoids larger theoretical (and speculative) narratives and sticks to well-documented events and trends. He offers the reader a surprising insight, often overlooked by other economic historians: the behaviour of VC and that of its financiers has changed little since the days when New Bedford, Massachusetts, was transformed from a sleepy backwater into the hub of a new industry.
Specific risk and return profiles, organisational forms, and compensation models, plus tolerance for failure and illiquidity, continue to define VC today just as they did some 200 years ago. Additionally, Prof Nicholas notes that VC tends to involve a relatively small number of firms and people whose focus is trained on a single city or region best described as the epic centre of a promising new business dynamic. Thus, VC gradually moved from New England to Silicon Valley via Detroit in the Midwest – leaving behind decadence (and rust) where it had once created opulence (and gold).
Exposing the Myth
However, VC: An American History moves well beyond the myth that only daring financial swashbucklers, risking all, made Silicon Valley possible. Moneyed buccaneers played a role for sure, but so did Uncle Sam. In 1958, a year after the Sputnik-scare, the US government introduced legislation that offered generous tax breaks and cheap money to newly minted Small Business Investment Companies (SBICs) – essentially VC funds that were expected to invest in start-ups. Most of these SBICs received ‘guidance’ from the Pentagon and consequently directed their money towards semiconductor development.
Prof Nicholas maintains that, useful though it proved, VC played but a minor role in sparking the tech revolution up to 1979 when the federal government scrapped the ‘prudent man’ rule that had prevented institutional investors, such as pension funds, from partaking in risky ventures or speculation. This decision opened the floodgates and gave venture capitalists access to previously unthinkable volumes of capital which they promptly deployed in and around Silicon Valley. It spawned both Microsoft and Compaq – and many others in their wake.
The lessons, if any, that the European Commission may draw from this fascinating history centre on the role of the state as a catalyst of growth and innovation – a notion that will undoubtedly please governments reluctant to leave markets to their own devices.
The crucial difference that helps explain the absence of ‘Big Tech’ companies in the EU is that venture capital was never properly funded in Europe. Venture capitalists have remained a footnote and are not usually thought of, much less engaged, when industrial policy is being cobbled together.
Prof Nicholas’ book, published by Harvard University Press, is a welcome contribution to an already well-appointed field of study. Earlier work by Robyn Klinger-Vidra and Mariana Mazzucato helped dispel some of the myths surrounding the role and impact of VC in the ascendancy of Big Tech. Prof Nicholas expands the topic and shows how states have exploited the particular character and expertise of venture capitalists – daring, foresight, and other traits not usually associated with the ‘establishment’ – to channel growth in the direction desired: the one most convenient to the interest of the state. In other words: latter-day VC is not so much a romantic pursuit of vast riches by financial daredevils, but merely an instrument and expression of industrial policy.
Cover photo: A replica of the New Bedford whaling ship Pagoda on a 1:2 scale.
- © 2011 Photo Margarethe Vestager by Johannes Jansson
- © 2017 Photo replica whaling ship by Pb55
