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February 23, 2009

A VC Says No to VC bailout

"Thanks but no thanks" is Fred Wilson's prompt response to Tom Friedman's column suggesting that $20 billion in bailout funds be made available to the top 20 VC funds so that they can invest in the future rather than the past of failed banks and auto manufacturers. Fred says:

"…the top 20 firms in the venture capital business are the least in need of a bailout of any group I've ever thought about. These firms, the Sequoias and Benchmarks and Accels and Kleiner Perkins [Fred modestly didn't add his own Union Square Ventures but could have] etc etc can raise a fund anytime they want. Accel raised a ton of money last fall in the midst of the worst global financial meltdown in my lifetime…

"The worst firms, on the other hand, will gladly accept government money. And that is what is going to happen with all of these government efforts to pour more money into the "innovation sector". That money will go to bad investors and weak entrepreneurs and management teams for the most part. It's a problem of adverse selection."

If anything, Fred is understating the danger in flooding the venture market with government money. It's a corollary of Gresham's law that bad investment drives out good. Suppose you're thinking about investing in software or green tech or something else…. and suppose you know the government's about to dump a lot of dumb money in the field, well then you don't invest because someone who's good at grants but probably not good at software or green tech or whatever is likely to wipe out the market for whatever you were going to invest in. If you're going to invest at all, you try to figure out who's going to get the government money and you put your money there. In other words, the smart money ends up front running the dumb money. Not good.

Of course the damage from government "investment" isn't limited to venture funding. Governments around the world have carefully been "investing in" the very banks which should get out of business and out of the way of better run and smaller (and less dangerous) banks. The better and smaller banks can't get investor money in this climate because the investor money would be competing with government money. Same, of course, in the manufacturing sector.

There is one part of Fred's post where he and I do have a slightly different POV: "… the venture capital business, thankfully, does not need any more capital. It's got too much money in it, not too little. Just ask the limited partners who have been overfunding the venture capital business for the past 15-20 years what they think." From an entrepreneur's POV, we like the VCs to be what they consider over-funded – more chance for entrepreneurs to get funded themselves on better terms than otherwise even though we then run the risk that our competitors will get funded as well. But neither as an entrepreneur nor as a limited partner in VC firms would I want to see government money poured or even dribbled in at the top. "Thanks, Tom Friedman, but no thanks."



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