Why is Massachusetts Playing the VC Game?
This is the second post in a five-part series on the Massachusetts government’s role as a venture capitalist. The first post introduced the topic and covered the broader record of government performance in VC. Posts in the series will appear here as they are published.
Before we can begin to judge the success of Massachusetts’ venture programs, we need to determine their aim and gauge whether it’s worthwhile in the first place. The Commonwealth is in a somewhat unusual position, in that the state is already home to one of the largest concentrations of venture dollars and entrepreneurial activity in the world. So unlike many forays by governments into venture capital where the goal is jump-starting some modicum of startup activity, Massachusetts needs to justify its activity with reference to specific gaps in the state’s innovation ecosystem.
In the case of the Massachusetts Clean Energy Center (MassCEC), that gap is fairly straightforward. There is a recognized lack of seed and series A funding in cleantech, and promising technologies often face a “technological valley of death” in which they lack the capital required to hit certain “proof points” that would lower risk to the point where venture investors would be interested. This is far from the only market gap in the energy space, and perhaps not the only way in which MassCEC’s investments are adding value, but it offers a basic justification for the fund’s existence.
The justification for the Mass. Technology Development Corporation’s (MTDC) existence begins much the same. Its website points to a survey it conducted that claims to identify a capital gap for smaller investments under $3 million. As has been widely noted in the tech press, seed funding for web and internet companies has been plentiful lately, but broader VC trends offer some support for MTDC’s diagnosis. Venture investments are becoming larger and coming later. (Angels have partially filled this gap, but with an emphasis on internet and healthcare deals. And the Massachusetts angel community is much smaller than California’s.)
To that, MTDC adds a few other areas in which it tries to add value: by backing less experienced management teams and by investing in industries “out of vogue” with venture capitalists (it avoids energy and biotech which are covered via equity or grants by other agencies). As I’ll discuss, these roles are somewhat more suspect.
What Does Success Look Like?
The fundamental difficulty in assessing a government venture program is that to succeed, it must toe the line between investing in viable companies and filling a market gap. It shouldn’t be duplicating private sector efforts by simply joining in the most promising or lucrative deals; on the other hand, it shouldn’t be wasting taxpayer dollars by dumping money into nonviable companies.
To do this, it must aim to address a market failure large enough to justify its own existence, but small enough that, by bringing to bear some government capital, it can ultimately attract private investors to the companies it funds.
“There certainly is a balancing act there,” Josh Lerner, the HBS professor, told me. “When you look across public sector interventions in the public space, often you find investments which fail on both counts.”
One of the best ways to achieve this balance, according to Lerner, is to require the funds to co-invest with private investors, thereby ensuring that the government fund cannot become too divorced from the realities of the market.
But that’s hardly the only challenge government venture funds face. They must also work to attract highly talented staff, they must be set up with enough independence to avoid any political pressures in the investment process (like pressure to invest equally across geography to please legislators), they need to properly align incentives for fund managers, and they need to fundamentally understand the nature of venture capital, so that deals are structured in a way that invites rather than deters subsequent private investments.
Returns are an important metric, but unlike private venture funds they are far from the only one.
With these criteria laid out, we can now begin to evaluate the state’s venture activities in subsequent posts. The remainder of the series will run as follows:
Wednesday: We examine the MassCEC’s structure and record.
Thursday: We look at MTDC’s structure and record.
Friday: Concluding thoughts and summary.
To view all the posts published in this series, click here.
from BostInno http://bostinno.com/all-series/why-is-massachusetts-playing-the-vc-game/