Why would the VC industry refuse government money?

A suggestion by NYT writer Tom Friedman that it is better to give bailout cash to sunrise rather than sunset industries and thus to Silicon Valley et al, was pooh poohed in Techmeme yesterday. The interesting question to me is why. Friedman:

G.M. has become a giant wealth- destruction machine — possibly the biggest in history — and it is time that it and Chrysler were put into bankruptcy so they can truly start over under new management with new labor agreements and new visions. When it comes to helping companies, precious public money should focus on start-ups, not bailouts.

You want to spend $20 billion of taxpayer money creating jobs? Fine. Call up the top 20 venture capital firms in America, which are short of cash today because their partners — university endowments and pension funds — are tapped out, and make them this offer: The U.S. Treasury will give you each up to $1 billion to fund the best venture capital ideas that have come your way. If they go bust, we all lose. If any of them turns out to be the next Microsoft or Intel, taxpayers will give you 20 percent of the investors’ upside and keep 80 percent for themselves.

This drew ire from Silicon Alley's Fred Wilson:

But 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. You don't even need to ask them. They are taking money out of the sector because the returns have been weak.

And 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 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.

He continues with the view that its the crap VCs that wll take the money, and instead it should be used as way of stimulating the Angel sector:

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 you take a look at all of the economically targeted investment programs that have been built and managed over the past twenty years in the venture capital industry, you'll see this plain and clearly.

There are some good ideas out there. My friend Brad Feld told me about a new legislative effort in Colorado to give angel investors a 50% tax credit for making investments in early stage companies. That makes better sense to me. Let the market work but lubricate it a bit with tax credits, particularly for the angel sector which has been the most hurt in this downturn.

I'd second the need to get the Angel sector back in the saddle. Anyway, adding froth to Fred's Latte day saintliness comes Sarah Lacy:

What’s more, there was never a shakeout in venture firms after the year 2000 crash—it’s only now working its way through the system. So the firms that may be finding themselves short of cash? Those are our own version of the “loser” firms – to borrow Friedman’s phrase—that should be shaken out of the venture economy. Not only do the top 20 venture firms have plenty of money, the top 100 firms could find a way to raise more capital if they needed to. But odds are they don’t, because funds work in multi-year cycles, and not everyone is forced to fundraise in 2009.

In short: The core assumption to Friedman’s argument just isn’t reality. And call me crazy, but if you are throwing my tax dollars after an industry, shouldn’t the so-called “need” be based on– oh, I don’t know– an economic reality?

Leaving aside just who is calling whom on "economic reality" here, methinks this article is indirectly pointing to the real issue behind the reluctance - government money coming in would break the cosy world, in 2 ways:

- Firstly, VC's make money by rejecting a whole bunch of startups that don't meet their criteria but are still perfectly viable businesses. Government money would let many more of those see the light of day........and thus reduce the value of their own bets by introducing more competition

- Also, we suspect the "top 20" et al are very pleased by the thought of the weaker ones going to the wall....last thing they want is more VC competition in a downturn

A possibly valid argument that the industry could make is that there are just not enough good ideas to back - but as neither of the above authors make the point, I suspect the VC industry is probably aware that there are far more backable companies to invest in than they do back, but that would of course reduce the potential multiples on their backed ones.

Nonetheless, its still probably a bad idea to "bail in" VC's, as they are probably using the wrong models and as pointed out above, such programmes do not have a great history. As Fred suggested, co-investing or subsidising - ie risk sharing - at the Angel "next level" down is possibly a more useful way to stimulate innovation and employment.

Update - I see Don Dodge has had some similar thoughts to mine.

Update 2 - it would see, according to PE Hub, that those top 20 VC's may not be that well sorted after all - which makes Mr Wilson & Ms Lacy's calls even more interesting...

Update 3 - surprisingly for SAI they indulge in cr*ponomics, arguing that because most small companies bomb, there is no point investing in the sector overall. In that case, one wonders how the VC's afford their mansions, Mercedes and mistresses Also, it is well known that nothing produces jobs per $ like small companies.