“Vulture” Capital? Far From It
They say the first casualty of war is the truth. Based upon recent events in the U.S. presidential elections, it looks like the truth is a casualty in politics as well. Whether out of desperation, ignorance, or political convenience, current and former contenders for the Republican presidential nomination have been questioning the long-term economic value of venture capital and private equity, which has been wrongly and unfairly labeled “vulture capitalism.”
First, let’s be clear. Venture capital and private equity—while related in that they both involve pools of private capital striving to generate returns for their investors (typically non-profit pension funds, foundations and university endowments)—follow very different approaches in achieving their goals. But neither seeks to undermine employees. In fact, venture capital typically creates jobs over the long term and private equity minimizes job losses.
Venture capital—a key component of the financial foundation for Silicon Valley—is focused on leveraging creative talent, capital, the hard work of employees and entrepreneurial experience to create and grow new businesses based on disruptive ideas. When successful, new businesses and industries are the result—creating new jobs for employees and wealth for investors and contributing to the competitive posture of America. When unsuccessful, the venture capital investors involved and their employee partners bear the costs of the failed effort. There are no government bailouts here—unless the politicians become involved a la Solyndra, the clean tech startup that fell into bankruptcy despite a $535 million federal loan guarantee. A situation like Solyndra is rare, however.
Venture capitalists and entrepreneurs don’t always win in the marketplace, but they don’t quit, either. In many instances, the same investors and talented engineers who failed will form new teams and pursue new dreams—always looking to create value and opportunity from ideas. The innovation flywheel is often successful and very lucrative: According to a 2011 Global Insight study, venture-backed companies accounted for 11.9 million jobs (11 percent of U.S. private sector employment) and $3.1 trillion in revenue in the U.S. in 2010—21 percent of the total US GDP–all based on an annual investment equal to less than 0.2 percent of GDP.
By and large, these are jobs at the higher end of the spectrum with solid, innovative companies—and often those that become global industry leaders, such as Intel, Apple, Google, Genentech, Facebook, Twitter, to name but a few. Ironically, while countries around the world are replicating the U.S. venture capital model and working overtime to encourage innovation and support venture capital ecosystems, U.S. politicos, themselves devoid of any new or creative ideas, have chosen to attack the engine of U.S. technology leadership.
Private equity also plays an important, though different, role in the U.S. economy. It builds and restores established but usually faltering companies. While colorful robber baron images of Gordon Gekko, acquiring functional businesses and breaking them apart for pure financial gain, may still be a popular reference point in today’s media, it is an inaccurate analogy in the vast majority of cases. Like venture capital investors, most private equity investors are paid for building real value, for themselves and their investors, not simply to make a quick buck. They do this by investing in under-performing companies, often in or on the verge of insolvency, in hopes of engineering a turn-around of a corporation’s fortunes. They apply a fresh perspective, capital, creativity, and hard work to re-imagining and re-making these struggling giants. It’s true that job losses sometimes accompany these transformations as managers work to fine-tune a level of business activity that they can profitably provide and support a foundation for future growth.
But a successful corporate restructuring preserves jobs, creates the opportunity to add more jobs in the future, and rewards investors (again, those same largely non-profit institutions). When the task proves too monumental, the investment is lost and so are many jobs, but that’s the same outcome that would have been experienced if the business had failed without an attempted turnaround.
Make no mistake about it—high risk/high return investing is hard work and not always successful. But often it is successful, raising the question of how the U.S. would benefit as a society if managers were not prepared to assume risks with their time, talent, and capital.
There are some bad actors in all areas of endeavor, and venture capital and private equity investors cannot claim to be exempt. Private equity investors, in particular, may sometimes try to tweak the system for a quick return at the expense of workers. But they are the exception. The politics of class division and “us” versus “them” are the politics of self-destruction.
With a globalized economy, energized competitors around the world, and serious fiscal challenges at home, it is as important as ever to support promising entrepreneurs with venture capital, celebrate their success, and encourage those who have failed to try again. This is no time, either, to dissuade private equity investors from trying to turn around established companies. Fostering the creation of new companies and fixing big companies is the American Way. Failure to do so runs the risk of repeating the lessons learned by England in the 1960s, when class warfare and an assault on capital led to a prolonged depression and loss of stature in the global economy. At this critical point in the history of our country, it would be refreshing to see the energy being put into distorted and patently false attacks on the most creative elements of our economy placed instead in constructive ideas to grow our economy.