The Pas de Deux of the State and Venture Capital
By Nicolas Colin, co-founder of The Family
It’s become fashionable to rail against the poor allocation of the savings held by the French. As a nation, we are said to love real estate and government bonds, whereas we won’t finance entrepreneurs and startups. Politicians regularly announce that they’d like to improve the situation, and this is one of the explicit objectives of the PACTE bill (Plan d’action pour la croissance et la transformation des enterprises), which is still waiting to be brought before the council of ministers. Unfortunately, these same politicians are unaware of pretty much everything that has to do with venture capital, as for them it is foreign at best and suspicious at worst.
William H. Janeway’s book, Doing Capitalism in the Innovation Economy (Cambridge University Press), whose second edition appeared in May, would serve them as a worthy guide. Trained in Keynesian economics and an astute reader of Marx and Braudel, together with George Soros Janeway co-founded the Institute for New Economic Thinking (INET) in order to reconstruct economic thinking following the crisis of 2008. Key to the book is the fact that Janeway himself is a venture capital veteran, with an exceptional track record from 1988 to 2006 at the legendary firm of Warburg Pincus.
Janeway’s core thesis is the following: Economic growth is driven by innovators who move from failure to failure until, at some point, they find success that goes beyond all expectations. Keeping in mind the prevalence of failure, supporting these innovators means renouncing a priori any expectation of realizing a financial gain on an investment. That only happens in two cases: when the state allocates capital in the pursuit of a mission serving the common good, and when financial markets are free to run into speculative bubbles that will, inevitably, end up bursting.
Oftentimes, these two phases overlap. The state begins with massive investments and the speculators then move in to take part in the bonanza. This virtuous sequence, seen over and over since the dawn of the Industrial Revolution, is responsible for key technological revolutions including the railroads, the personal computer, and certainly the Internet.
The first lesson to remember is that the state is not a financier like all the others. It doesn’t need to show a quantifiable profit on its investments, but should rather have a different rationale. Its role is to correct the short-term thinking of other economic agents, making massive investments without any regard for the return, in order to furnish innovators with what Janeway terms a “platform”.
The second lesson is that venture capital is simply the downstream link of the startup financing chain. For it to prosper, the terrain must have been prepared upstream through a phase of public investment followed by a speculative bubble. That’s how the “platform” is built on which innovators (entrepreneurs and investors) can then freely “dance”. And at that point, venture capital funds must see returns on their investments. To do that, they need to be able to count on IPOs in public markets or startup acquisitions made by large corporations.
All of this demonstrates why Europe is lagging in the Innovation Economy. First, our venture capital funds have liquidity problems. Their shares cannot be easily IPO’d in New York, far from their European bases. And we don’t have the Googles, Tencents, Amazons or Alibabas to purchase their startups by the dozens, all at elevated prices. Yet this liquidity is absolutely necessary for venture capital to play its role in the Innovation Economy.
Most importantly, Janeway reminds us that Europe, as individual states, missed the call after 2008 by converting to austerity. Meanwhile, China is speeding things up to innovate in the green economy, at the same time as the United States is pulling back from the Innovation Economy. Isn’t it time for Europe to step into that breach?
Originally published in Le Monde (in French), May 15, 2018