Venture Capital Is Shrinking In America

Posted: Mar 09, 2012 12:01 AM

If you have been following the venture capital (VC) news in America over the recent year, you might have noticed that several funds were able to make some money recently on initial public offerings. However, that’s the headline. Under the surface, the VC industry in America is continuing a contraction.

In a short speech yesterday, Professor Robert Metcalfe said venture capital is a 65 year old industry in America. Metcalfe invented the ethernet. He knows what he is talking about when it comes to VC. VC’s are changing. They are raising bigger funds but there are less of them.

That’s bad for America.

What is causing this big sucking sound when it comes to VCs? The bursting of the internet bubble back in 2001 didn’t help them. A lot of them had foolishly given money to companies that couldn’t make it. So, shame on them for doing poor diligence. However, if we go back to 2001, there was another seminal event that changed the venture capital world forever. It was the enactment of Sarbanes Oxley. Sarbox put such onerous terms on companies that virtually no company had an incentive to go public. Since that’s the way many VCs earn a rate of return on their money, they had no choice but to fold up their funds and quit.

In typical Congressional zeal, Congress and bureaucrats responded to public outcry over the Enron scandal with a poorly thought out regulatory bill. Congress never acts correctly when it acts speedily. They never take time to think about the economic consequences of laws, and many of them don’t care as long as it pushes their agenda.

Many populists might applaud. Those rich venture capitalists shouldn’t be making all that money on the backs of the entrepreneurs. However, those entrepreneurs find it much more difficult to raise larger sums of money to grow their companies without the rich venture capitalists. Not being able to start or grow companies means that less innovation happens, marketplaces are less competitive, and existing corporations get fat. It also means there is less job creation since small to medium size companies create the lion’s share of the jobs.

Dodd Frank, passed when the Democrats had control of both houses and with the cheerleading of President Obama will make the climate even worse. Dodd Frank has huge holes where regulators can fill in the blank. It also leaves a lot of uncertainty as to how fund managers will be regulated. Along with that, the movement to inappropriately tax gains in fund holdings at high tax rates creates disincentives to form funds and invest. Dodd Frank is a job killer too.

If people want to see a flurry of lending again, the vapor lock that has trapped financial markets for three years to go away, then we need to repeal Dodd Frank and Sarbanes Oxley sooner rather than later. Both of these laws are killing innovation, and killing jobs. They are slowly strangling the American economy.

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