Tom Hayes Stimulus Package

Our old friend Tom Hayes is at it again.  In an op-ed piece in yesterday's Wall Street Journal, he and Michael S. Malone critique the new administration's stimulus strategy, and offer suggestions for an innovation-based approach that certainly sounds more promising than propping up failed industries.

Readers of this page know that we have long argued that the best and most valuable jobs are created by entrepreneurs and the private investors who fund them.  And we've certainly celebrated the occasions when the public sector has recognized and supported entrepreneurial efforts, even while noting our disappointment in how little of that is evident.

Hayes and Malone rehearse the same catechism of entrepreneurship, innovation, private investment, and economic vitality, and go one to make some specific recommendations for policy makers to give serious attention.  Some highlights:

- First, kill Sarbanes-Oxley or make it voluntary. Right now.

- Allow entrepreneurs to more easily tap tax-free retirement accounts -- or better yet, let them create tax-free accounts specifically to fund themselves.

- Eliminate payroll taxes, which unnecessarily burden young companies. 

- Make the tax system more forgiving for Angel investors -- or allow the creation of tax-free investment vehicles similar to what we now see with nonprofit foundations or 529 college savings funds.

- Lower capital gains taxes on investments in early stage companies and higher taxes on later stage deals. 

- Help big business think small. 

- Convene a presidential summit on entrepreneurship and small business. The last president to do so was Ronald Reagan in 1982.

Hayes and Malone elaborate on these points, and we highly recommend their article as "required reading".  

In the "Q"

As long-time subscribers to McKinsey Quarterly's email newsletter, we enjoy the in-depth analyses featured on their website.  We'll continue to alert readers to useful and relevant content we encounter through this channel (links back to the Quarterly site require free registration for access to the entire article.)  We cited a report from the "Q" earlier this month, and now we are delighted that today's inbox brings credible third-party validation of one of our central theses: invention is science, innovation is economics.  

Excerpted from his recent book, Amar Bhidé makes a compelling case that despite falling behind rapidly emerging BRIC economies in secondary and higher education in STEM competencies and pure research generally, the United States enjoys a competitive advantage in applying discoveries from the laboratory to real-world uses.

Technological innovations, especially high-level ones, usually have limited economic or commercial importance unless complemented by lower-level innovations. Breakthroughs in solid-state physics, for example, have value for the semiconductor industry only if accompanied by new microprocessor designs, which themselves may be largely useless without plant-level tweaks that make it possible to produce these components in large quantities. A new microprocessor’s value may be impossible to realize without new motherboards and computers, as well.

New know-how and products also require interconnected, nontechnological innovations on a number of levels. A new diskless (thin-client) computer, for instance, generates revenue for its producer and value for its users only if it is marketed effectively and deployed properly. Marketing and organizational innovations are usually needed; for example, such a computer may force its manufacturer to develop a new sales pitch and materials and its users to reorganize their IT departments.

Bhidé makes these observations in the context of anxieties in the policy and media communities about America losing it's "edge", and his concerns about resorting to protectionism or diverting scarce resources to pure research activities, or "what the economists Sylvia Ostry and Richard Nelson call techno-nationalism and techno-fetishism".

Techno-nationalists and techno-fetishists oversimplify innovation by equating it with discoveries announced in scientific journals and with patents for cutting-edge technologies developed in university or commercial research labs. Since they rarely distinguish between the different levels and kinds of know-how, they ignore the contributions of the other players—contributions that don’t generate publications or patents.

They oversimplify globalization as well—for example, by assuming that high-level ideas and know-how rarely if ever cross national borders and that only the final products made with it are traded. Actually, ideas and technologies move from country to country quite easily, but much final output, especially in the service sector, does not. The findings of science are available—for the price of learned books and journals—to any country that can use them. Advanced technology, by contrast, does have commercial value because it can be patented, but patent owners generally don’t charge higher fees to foreigners. In the early 1950s, what was then a tiny Japanese company called Sony was among the first licensors of Bell Labs’ transistor patent, for $50,000.

In the current economic climate, it is critical that resources and regulations be more closely aligned with the successful commercialization of new science, rather than deep, long-range investments in adding to the store of human knowledge.  As we have seen, the economies that benefit most from commercial application of new technology are not necessarily the ones in which it was patented.  License revenue and royalties create few new jobs.

Since innovation is not a zero-sum game among nations, and high-level science and engineering are no more important than the ability to use them in mid- and ground-level innovations, the United States should reverse policies that favor the one over the other, and it should cease to worry that the forward march of the rest of the human race will reduce it to ruin.

Immigration policies that favor high-level research by preferring highly trained engineers and scientists to people who hold only bachelor’s degrees are misguided too. By working in, say, the IT departments of retailers and banks, immigrants who don’t have advanced degrees probably make as great a contribution to the US economy as those who do. Likewise, the US patent system is excessively attuned to the needs of R&D labs and not enough to those of innovators developing mid- and ground-level products, which often don’t generate patentable intellectual property under current rules and are often threatened by easily obtained high-level patents.

Even factoring in outsourced manufacturing and back-office services, the most (and best) net new jobs are created by innovators who find a crying need and fill it with creative solutions fashioned from new discoveries and existing technologies alike.  As we've pointed out elsewhere, an innovative company isn't necessarily introducing widgets, but is also applying novel thinking and imagination to improving established business processes for greater effectiveness or efficiency.  Cloud computing, for example, offers familiar software capabilities, but in a new form factor and delivery model.  That's not the sort of thing you invent in a lab.

Silver Lining Dept.

We wrote last week about the ComputerWorld item discussing big corporations acquiring smaller companies.  Cesar Rojas with ANTs Software commented on that item, pointing out that smaller companies aren't always looking to get bought out.

I think there are exceptions to the rule when it comes to small tech companies. In this down economy there are real needed innovations that are very critical to significantly reduce IT costs. That empowers smaller companies to negotiate with the big guys because the technologies they develop can really jeopardize critical revenue streams of these firms while providing huge OPEX reductions for customers.

We thought this was an interesting perspective, and when we inquired with Mr. Rojas, we got a call back from Ken Ruotolo, ANTs' CFO, who explained a little more about why ANTs is sanguine about remaining independent.

For one thing, the company is publicly traded (OTC:ANTS), and has gone through several episodes of repurposing.  They sold their high-performance database line of business in 2005, and are now delivering a middleware solution for migrating databases to new platforms without having to modify applications.

Having some experience in data migration (we worked on the team at SynOptics that migrated from Oracle Financials to SAP R3 in 9 months, and led the team at Bay Networks that implemented a Scopus-based call center database on top of Informix in 11 weeks), we were particularly interested in this solution.  As Mr. Rojas continued in his comment:

We recently moved a 3,000 user call center app for Wyndham Hotels from Sybase to Oracle where the customer didn’t need to change a single line of application code. The whole migration lasted one week compared to the multi-month/multi-year application migration process that Wyhdham might have embarked without deploying our product.

Very cool stuff, indeed.  So why wouldn't ANTs want to be acquired by a giant like Oracle, say?  Because they have the potential to become a big player in their own right.  Mr. Rojas again:

I truly believe that smaller/innovative companies that can significantly reduce IT costs in this economy are the exception to the rule and we will be in the driver seat when negotiating alliances with big IT vendors.

As Mr. Ruotolo explained to me, ANTs Compatibility Server product enables a company to migrate large enterprise-wide databases from costly proprietary platforms such as Oracle or Sybase to an open source platform like MySQL, reducing cost of ownership to a fraction of current operating expense.

As data center managers increasingly try to squeeze more efficiencies from operations through consolidation of hardware and software solutions, ANTs Compatibility Server bids fair to be enormously disruptive.  By employing platform companies as channel partners, they have every reason to expect that the potential for growth to be substantial.

California Business Ascent Announced

MEDIA CONTACTS:

Josh Morgan for Golden Capital

(916) 941-0901

josh@morgandorado.com

FOR IMMEDIATE RELEASE

Golden Capital Network, California Business, Transportation and Housing Agency, California’s Small Business Advocate, and California Association for Local Economic Development Announce Statewide Initiative to Help Growth Oriented Businesses Climb Out of Economic Doldrums

Private and State Groups Coming Together for California Business Ascent Statewide Business Mentoring and Competition

Sacramento and Chico, California - Feb. 18, 2009— Golden Capital Network (www.goldencapital.net), along with the California Business, Transportation and Housing Agency, California’s Small Business Advocate, and the California Association for Local Economic Development today announced the California Business Ascent (www.businessascent.com), a statewide competition and mentoring program to identify, assist and encourage innovation-based, locally-owned companies throughout California.

“Local-businesses focused on growth are the key for California to lead the way out of this economic downturn,” said Dave Sanders, chairman of Golden Capital Network and managing partner of WorldBridge Partners. “The Business Ascent is all about identifying the companies with the best chance of success and giving them as much help as we can, to try and make them successful, for the benefit of the companies, the employees and the people of California.”

The California Business Ascent will include regional competitions in up to 25 communities throughout California, culminating with the top two companies from each community competing in the California Business Ascent Finals to be held in San Diego at the Catamaran Resort on November 17-18, 2009.

"California has a long history of innovative entrepreneurs creating jobs and unparalleled prosperity driving new industries to global leadership, with entrepreneurs working in collaboration with government," said Secretary Dale E. Bonner, of California's Business, Transportation and Housing Agency. "It's going to take the collective effort of everyone in the state to rise out of our current economic situation and we can do it together by proactively supporting our next wave of innovative entrepreneurs."

The initiative is a unique new type of public/private partnership that includes both State government and local government leaders, and new types of private sector partners including entrepreneurs, angel investors, and venture capitalists. Through this process contestants will make important connections with investors, bankers, professional services providers, executives, policymakers and other entrepreneurs on a statewide basis. In-kind professional expertise and a substantial cash prize (amount TBD) will be provided to the winner of the competition.

“The California Business Ascent provides a new economic development tool for cities, counties and local economic development corporations to add value to their locally-owned growth companies,” said Wayne Schell, president and CEO of the California Association for Local Economic Development, ”These companies represent a critical and growing part of California’s local and regional economies, and until now have been difficult to assist with more traditional types of economic development activities.”

Wavepoint Ventures (www.wavepointventures.com) is participating in the California Business Ascent by helping to engage California's venture capital and angel investment community in the effort to accelerate economic recovery.

Cities and regions throughout the state including the Yolo region, Greater Stockton and San Joaquin County region, Greater Chico and surrounding counties, and Greater Redding and surrounding counties, have already begun scheduling events as part of the California Business Ascent.

Other cities and regions interested in participating should contact the California Business Ascent initiative organizers at Golden Capital Network, 530-893-8828.

For more information about the California Business Ascent, please visit www.businessscent.com.

ABOUT GOLDEN CAPITAL NETWORK

Golden Capital Network is a non-profit networking, training and consulting group that fosters growth entrepreneurship and early-stage investing as an engine for economic growth.

Since 1999, GCN has coached and showcased more than 1,000 companies to more than 500 active angel and venture capital investors. GCN’s venture capital showcases are the largest and most robust events of their type. The GCN event formula has resulted in more than $1.3 billion raised by presenting companies. More information on Golden Capital is available at www.goldencapital.net.

ABOUT THE BUSINESS, TRANSPORTATION AND HOUSING AGENCY

Led by Secretary Dale E. Bonner, the Business, Transportation and Housing Agency includes 13 departments and several economic development programs and commissions consisting of more than 44,000 employees and a budget of $20 billion, a budget larger than that of almost half the states in the nation. The Agency's portfolio is one of the largest and most diverse in the State of California. Its operations address myriad issues that directly impact the state's economic vitality and quality of life including transportation, public safety, affordable housing, international trade, financial services, tourism, and managed health care.

Corporate Liquidity Pools

The conventional wisdom since the dot com meltdown at the turn of the century is that the IPO is effectively a nonstarter as an exit strategy, and that M&A is the most probable means for an early stage company convert equity into yield.  While this is not news, there are some new wrinkles in the current economic climate.

Eric Lundquist, on his ComputerWorld blog, examines the emergence of the large technology companies as an important source of liquidity during the current economic distress.  The most dominant companies in this space are laden with cash, and quietly going on a buying spree as other sources of cash dry up and valuations decline.

When I look at some of the investment areas including digital medical records, energy management, transportation and infrastructure, the big four (Oracle, Cisco,Microsoft, IBM -- MICO), okay big five if you include Hewlett-Packard, are not strong across all those areas and do not have enough time to build that expertise in-house.

This is exciting not only because of the potential for exits in a tough climate, but also becuase these acquisitions are strategic, strenthening the parent company, and creating new opportunities for innovative firms to emerge.

While the returns to investors may be less than hoped for, it does free up capital for investment in other promising companies, and frees up the founders to start new enterprises.

All Your Face Are Belong To Us

Lots of churn on the interwebs about Facebook's new Terms of Service (TOS).  The new user agreement asserts an irrevocable, non-exclusive license for any content users add to the service.

The key change is that there used to be a clause about the user's right to remove content, and that's been removed.

It's probably not as sinister as many bloggers infer.  Because of Facebook Connect, content is being stored outside Facebook's span of control.  This new language absolves the service of liability if a user's content is misused elsewhere.  It's increasingly common on other social networking and search sites, including Google.

As ever, the prime directive of the net -- never post anything (including in email) that you wouldn't want to see on the front page of the New York Times tomorrow -- applies.  Discretion isn't just the better part of valor, it's a requirement in the neworked economy.

State of The Venture Capital Industry

Excellent analysis of the Venture Capital business on the NY Times site.  Alan Patricof of Greycroft Partners makes a compelling case that VCs need to innovate to compete in a dramatically changed investment landscape.  With angels increasingly sitting on the sideline, funds need to invest earlier, in smaller tranches, and with realistic expectations for smaller exits.  The good news is that they can exit sooner.

I believe that most of the companies that venture capitalists are funding today will find an exit through merger or acquisition. And if we expect to achieve a return in a reasonable time frame of three to five years, we are probably looking at a sale price of $20 million to $100 million. This is the valuation range where most young companies are being acquired.

To compensate for these lower gross return expectations, we must establish initial valuations, usually in the single digits, that can provide an adequate multiple return and internal rate of return. Inevitably, this suggests that a true venture capital firm should be reverting to smaller-scale funds and restricting individual investments in early-stage companies to accommodate the realities of the exit opportunity.

This strategy aligns well with both LP expectations and entrepreneurs' best-case scenarios.

Entrepreneurs themselves seem to be catching onto the new risk/reward equation and seem far more willing, at an early stage, to opt for a sale at a lower valuation and lock in their gains, figuring that they are young and can repeat the process later with another start-up.

If the scenario I have described strikes a chord of reality, then until someone solves the cost of going public and increases the liquidity in aftermarket trading, we as an industry have to downsize our expectation for exits as well as downsize the size of our funds.

Patricof's viewpoint is refreshing, even optimistic, in these uncertain economic conditions.  It's certainly a breath of fresh air, and we can only hope that VCs pay attention to his sage counsel.