Thursday, April 9, 2009

Politicians: You All Look the Same to Us

When wielding a large regulatory hammer, sometimes everything looks like a nail.

In the quest to identify and regulate 'systemic risk' and increase the tax base, our politicians have decided they don't want to be in the business of defining 'what is a hedge fund, what is a private equity fund, what is a vc fund', etc. So they are seeking to apply a broad prophylactic that will only further damage a fragile dynamo of economic activity.

It has been written that venture capitalists, while representing something on the order of .02% of annual US GDP, have backed businesses that now represent nearly 18%. Whether that's a stretch or not I do not know; the point is, this is not about a small 'adjacent' asset-class that is simply collateral damage in the war on systemic risk, as some politicians would have us believe. It is a direct assault on the future industrial outputs of our nation. Competitor countries will not wait for us to discover how misguided these efforts are and reverse them; they will rush in and capitalize on the opportunity, filling the vacuum.

Far more than simply an issue of debt levels and systemic risk, the very nature of the venture business is fundamentally different than that of its 'cousin' enterprises in private equity, leveraged buyouts, and the hedge fund world. VC funds are small (rarely more than low to mid-nine digits and usually quite a bit smaller). Their partners do not get rich off of fees irrespective of ultimate outcomes. Funds do not have meaningful – or even measurable – debt leverage ratios. The companies in which they invest almost never have more than a handful of employees and negligable (or zero) revenue.

In sum, it is an industry that by definition exists on the left side of Schumpeter's curve; that is, the creation part of 'creative destruction', where job growth, tax roll contribution and economic output (including significant positive trade-surplus) curves move up and to the right.

Politicians fretting over falling victim to the 'game theorists' and thus avoiding the ‘definitions' conundrum are doing a great disservice to our country; unfortunately, by the time they realize - and reverse, amend or except - various policies, it may be too late.