Chip Shots by Chip Griffin

Government Plays a Bigger Role in Entrepreneurship and Investing Than You Think

Most of us think about taxes when we think about successful businesses. Some of us contemplate basic regulations. But few of us consider just how much government action inspires, influences, and impedes innovation, often unintentionally.

As entrepreneurs and investors we need to better understand the role the government plays — intentionally and otherwise. They may not overtly pick winners and losers (most of the time), but the actions that they take certainly affect the outcome.

Take the fundamental underpinning of the world of startups: funding. The federal government, through securities laws, decides who can and cannot invest in your great idea. We often hear the stories about entrepreneurs who got started in their garages with nothing more than credit card debt and perhaps some money from Mom and Dad.

But most really successful companies end up turning to others for money at some point to overcome an obstacle or accelerate growth. The government has decided to determine who should be able to fund those ideas. If you’re not directly involved in the company, then you had better be an “accredited investor.” That’s a fancy term for someone that the government deems wealthy enough to be able to carefully judge the risk and absorb any losses that come along with the investment.

Fail to follow these rules and you could run into some new roadblocks as you seek to take your company to the next level.

The federal government itself serves as an investor in innovative ideas. Many people may think of DARPA – the Defense Advanced Research Projects Agency – that was created in 1958 as a response to the Soviet Union’s surprise launch of Sputnik. The agency continues to put billions of dollars each year behind high-tech ideas, many of which spur further innovation. Perhaps the most famous DARPA innovation was the Internet itself, beginning life as ARPANET in 1969.

In the same year that Congress created DARPA, they also passed the Small Business Investment Act of 1958. This law created Small Business Investment Companies that established a public-private investment partnership. Although less well-known than some of the big venture capital firms, SBIC’s have invested in some big-name companies during their early years – names like AOL, Apple, and Intel, to cite just a few.

The federal government is even more directly involved in the venture capital business through a VC firm known as In-Q-Tel. Although technically incorporated as a nonprofit, it receives its funding from the Central Intelligence Agency and other similar government agencies and places bets on startups that could be beneficial to the intelligence community. While some of these companies remain in the dark, others provide services that benefit the private sector as well. For example, In-Q-Tel invested in Keyhole, Inc., a satellite mapping company ultimately acquired by Google and transformed into Google Earth.

The millions the government invests indirectly through In-Q-Tel are dwarfed by the $48 billion that private U.S. venture firms invested in startups in 2014. Yet despite their private status, their growth as an economic engine relies heavily on how Congress has structured tax and securities laws. For example, as the capital gains tax went from a high near 40% in 1977 to 15% today, the annual inflows to venture funds has increased more than 500% in inflation-adjusted dollars.

Perhaps even more important than the shifting tax rates, however, was the decision of regulators in the U.S. Department of Labor to allow pension funds to invest in private equity and venture capital funds. Estimates suggest that public pension funds account for between 20 and 25 percent of all venture capital funding. We will never know what would have happened if it weren’t for these bureaucrats changing their interpretation of federal law, but it seems clear that the world of venture capital investing would have been much different.

Clearly government action has played an important role in shaping investments in entrepreneurship.

But what about the ideas themselves? Surely the government has no role in the ideas that shape startup companies and influence their growth.

Or does it? The New York Times recently wrote about a provision in the Affordable Care Act that has spurred growth in “for-profit diet clinics overseen by doctors.” It turns out that the health care reform law requires insurers to pay for certain nutrition and obesity-related services that could fuel innovation and growth in this arena.

As Congress has tightened and eased regulations in various sectors, it has caused countless companies to be founded or to fail. The airline and telecommunications industries, in particular, have witnessed substantial changes to their entrepreneurial landscapes as a result of the rules put in place in Washington, DC.

Meanwhile, as the government adopts new rules, startups crop up to address the challenges and opportunities that they present. Businesses have come into existence to help companies comply with a wide array of financial and privacy-related regulations, for example. These ventures would likely never have come to be without government action that caused a related private sector reaction.

Unfortunately, sometimes government also gets in the way of innovation and entrepreneurship. Change frightens many people, especially successful industry incumbents reluctant to recognize a changing marketplace.

Perhaps the most high-profile current battle between entrepreneurs and regulators is over the future of ride-sharing services like Uber. Old-fashioned taxicab companies find themselves being disrupted by a tech-driven firm that wants to upend the existing business model. Since many cab companies paid substantial amounts of money for their existing licenses, the tension is somewhat understandable.

But these government officials who oversee taxi and livery services must now decide just how companies like Uber can operate – and what choices consumers can have.

Uber will likely survive, but sometimes the government takes action that draws an innovative idea to a close. Such was the case with a company known as Aereo that attempted to provide access to over-the-air broadcast TV signals via a centralized antenna farm and delivered through the cloud. A series of regulatory and judicial setbacks ended up forcing the company into bankruptcy in 2014.

Although we often think about entrepreneurs as independent innovators striving to make the most out of a good idea, the reality is that the government has a much greater say in success or failure than most of us appreciate. Laws and regulations shape the environment in which investors and innovators exist and often end up inspiring, influencing, and even impeding great entrepreneurship.

The investing and entrepreneurial community does itself a disservice when it fails to understand just how deeply intertwined innovation and public policy are intertwined. We may not always appreciate what government does to our businesses, but we should all understand its significance. We all have a role to play in the future of these laws and regulations and should better position ourselves to influence the outcomes.

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