John Kerry’s Misadventures in Venture Capital

I hardly know where to start with this John Kerry letter to the Small Business Administration. In it he calls for an increase in the amount of SBIC money (i.e., state venture capital) going to minority-owned and women-owned businesses.  While I would love to see more businesses run by women and/or minorities — and everyone else, for that matter — Kerry’s arguments are awry.

For starters, greed is blind, so the whole idea that any remotely rational venture investor cares about gender, color, creed, or tracing skills is dubious at best. They want financial returns, and if it’s five-handed, blue-skinned hermaphrodites from Alpha Centauri who have the best deals, then, damn it all, five-handed, blue-skinned hermaphrodites from Alpha Centauri will get the preponderance of the venture money.

Second, the period is absurd. Comparing what happened in 2000 in venture capital to any other period is a recipe for nonsensical results. Take out 2000 and you see that the percentage of SBIC money to women-owned businesses has increased from 1.4% (2001) to 2.2% (in 2004), and the percentage of money to minority-owned business has increased from 3.3% (2001) to 5.2% (2004). Those are significant increases, even if the overall percentages are not huge as a percentage of the overall risk capital pie. Nevertheless, a) they are increases (contrary to Kerry’s assertion), and b) the numbers are representative of the number of VC-centric minority-owned and women-owned startups out there.

Let’s just say it’s another reminder why politicians need to be kept far from the venture industry.

Related posts:

  1. Pining for the Glory Days of Venture Capital
  2. The Venture Capital Overhang
  3. Newbies Flood Venture Capital (Again)
  4. Pouring, Drinking, and the Allocation to Venture Capital
  5. Hearing on Venture Capital in Biotech

Comments

  1. SomeCallMeTim says:

    “For starters, greed is blind, so the whole idea that any remotely rational venture investor cares about gender, color, creed, or tracing skills is dubious at best.”
    This argument misses the point. The argument is that we aren’t great at determining good deals ahead of time, and so we end up making decisions based on (often subconscious) irrelevant factors like physical appearance. Once over the hump, investors will start disregarding irrelevant and worrisome characteristics. See, e.g., black quarterbacks and NFL head coaches.

  2. Fair comment, but one premised on an incorrect analogy. The market for NFL head coaches and quarterbacks does not have free entry, while the market for entrepreneurship does.
    John Kerry was not, I don’t think, suggesting that women and minorities are prevented from starting businesses. You might stretch your argument to say that women and minorities can’t get venture money, thus preventing them from starting businesses, but that would be mistaken too. A low single-digit percentage of new businesses in the U.S. each year get venture, and many of those firms that do not get venture money do just fine, thanks very much.
    And how about those established businesses run by women or minorities that come looking for venture capital? Well, now we’re into a place where results are all that matter. If any VC consistently underinvests in top-performing companies he will likely not be a VC for very long.

  3. Michael Robinson says:

    It seems to me that the argument you make in this post is diametrically opposed to the argument you make in this earlier post:
    http://paul.kedrosky.com/archives/001443.html
    Clearly psychology and sociology have a demonstrable role in limiting investment returns.
    And this: “If any VC consistently underinvests in top-performing companies he will likely not be a VC for very long.”
    It seems is contradicted by this:
    http://paul.kedrosky.com/archives/001591.html
    It seems at least half the venture industry is dominated by serially-underperforming fund managers benighted by a lack of psychological and sociological insight into the “gut feelings” that dominate their investment strategy.

  4. Michael — I take your point, but neither of those prior posts are on issue.
    The first one says that venture investors, like most investors, commit behavioral errors in investing. Nowhere in that short list, however, does it say VCs look at well-performing companies and dismiss them for reasons that have nothing to with said performance.
    Smiilarly, the notion of skewness and serial persistence in venture returns actually argues against the Kerry hypothesis. It points out that some funds are actually good at this stuff and maintain their “goodness” from period to period, unlike the regression to the mean you see from mutual funds. Some of the out-performance can be attributed to better picking, and some from picking from a better-stocked pond, but the effect is the same.
    Anyway, we’re still dancing around the main point. John Kerry argued that there has been a worrisome decline in venture investing in firms run by women and minorites, but there has actually been a significant increase. We can argue about whether that increase is enough, but questions of sufficiency rapidly turn into debates about angels on the head of a pin.
    Finally, it is saying nothing to say that venture investors make investing mistakes. I have documented that here many times. I’m simply arguing that it is wrongheaded to use flawed data to redeploy venture capital for social engineering purposes.

  5. Michael Robinson says:

    Paul: “Nowhere in that short list, however, does it say VCs look at well-performing companies and dismiss them for reasons that have nothing to with said performance.”
    I understand your point, but you’re looking at the wrong end of the distribution. Of course superstar companies run by women and minorities will get funded no matter what. The question is what happens out in the more populous long tail of mediocre to bad companies that get VC funding. Do marginal companies run by women and minorites need to clear a higher qualitative bar than companies run by the golfing buddy of the college roomate of the fund manager (I recognize these are not necessarily disjoint sets, but you know what I’m saying)?
    Based on my admittedly limited personal experience, I’m hard pressed to think of any financial activity more susceptible to exactly this sort of market failure than venture capital.
    Paul: “I’m simply arguing that it is wrongheaded to use flawed data to redeploy venture capital for social engineering purposes.”
    Of course, but for the sake of argument, assuming the existence of good supporting data, would it be wrongheaded to redeploy venture capital to counteract systematic social bias?
    (Full disclosure, and ironically enough, years ago I was a co-founder of a venture-funded company that was successfully funded precisely because of the personal rapport between the female, non-white CEO and the female, non-white VC partner.)

  6. brian says:

    Another aspect that I think Kerry misses is that he does not include in his discussion of minorities Asians/Indians. There have been plenty of these groups of entrepreneurs who have gotten VC money, but to Kerry I guess it doesn’t count because they don’t have someone like JJackson/ASharpton to whine to get attention.

  7. Lucinda says:

    As a woman CEO who has successfully raised venture capital for 4 companies, I think that I have a good view into this situation (and no chip on my shoulder). From the beginning, I felt that I had an advantage over my male peers because I stand out, while feeling comfortable, after years of atheletics, in the VC environment. But I don’t think that comfort is typical for women.
    I think that the “it’s all about performance” perspective is scarily naive. Venture investing is largely a game of trust – the investor has to trust the entrepreneur to do what they say they will. The nature of people is to trust those who are like us more than those who aren’t. And that hurts the typical woman trying to raise capital.

  8. Lucinda — I don’t disagree that trust is important in raising money from venture firms. And yes, VCs sometimes, all else being equal, tend to trust people more like us than people that are different. But all else is so rarely equal. We are truly talking at the margin of the margin.
    Again, however, my main argument was that a) Kerry’s figures were wrong, and wrong in a direction that helped his social engineering argument; and b) to the extent that venture firms consistently skew toward overlooking qualified investments for non- performance-related reasons it will come back to bite.
    Finally, I should return to Michael’s argument, that if the data were there to show bias, “would it be wrongheaded to redeploy venture capital to counteract systemic bias?” We have now entered the world of affirmative action and pure politics, where there is likely no basis for us to reach agreement. I generally believe that the state that rules best rules least, and the best way to deal with these issues is through transparency, anti-discrimination legislation, and education, and that venture capital is blunt and inappropriate tool for healing society’s ills, real or perceived. Others, I’m sure, will disagree.

  9. michelle heuer says:

    Paul: What are your thoughts on data that shows women and minority businesses face discrimination from lenders. In other words, a bank is willing to lend to a majority-owned company but denies a similarly-situated women or minority-owned company.
    You seem to address this by declaring “[a] low single-digit percentage of new businesses in the U.S. each year get venture [sic], and many of those firms that do not get venture money do just fine, thanks very much.”
    But does that really mean anything? That’s kind of like saying it’s hard to get a promotion so glass ceilings don’t matter and, by the way, many of these women “do just fine, thanks very much.”
    Isn’t Kerry’s real point that women and minority-owned businesses face more hurdles than majority-owned businesses? Are you really disputing this?
    Also, would love to hear more about your thoughts on “the best way to deal with these issues… through transparency, anti-discrimination legislation, and education…” on your blog. Sometimes it seems as if those who criticize specific proposals as the wrong way to “deal with these issues” don’t genuinely care about “these issues” to begin with, and I would hate for your readers to be left with that impression.

  10. Michelle: I have seen many studies on discrimination in lending practices to women and minority-owned firms. I side with Gary Becker, however, in saying that today the data shows it is infrequent, at best, far lower than might be imagined from the claims of policy advocates. Granted, discrimination is _always_ unacceptable, but the question you have to answer is what you’re prepared to do about it in the real world given the blunt tools of public policy, let alone the even blunter tool of venture capital (or bank) financing practices.
    You may be right. Kerry’s real point may very well be that minority- and women-owned firms face obstacles. If so, then he should make that point, not twist Kauffman data to make it for him. Again, brow-beating venture firms into creating more female and minority entrepreneurs seems wrong-headed. While VCs are high profile and an obvious target for politicians looking for spoils — and the SBIC program in particular is a low-hanging pinata for politicians — venture firms are profit-seeking outfits that account for a vanishingly small percentage of new firms each year.
    Finally, with respect to “these issues”, I’m not sure what to add. Throughout this thread I’ve said multiple times that I want there to be more women entrepreneurs, more minority entrepreneurs, and more entrepreneurs in general. To the extent that discimination is preventing that from happening, actions should be taken to change it. I’ve said that existing anti-discrimination laws, combined with education and transparency, are my policy choices, while cherry-picking data into bullying venture firms is not.

  11. michelle heuer says:

    Paul: No one (especially an esteemed senator) should twist or misrepresent data to make a point. That much is true.
    I’m not sure it’s fair to characterize Kerry’s suggestions as “bullying venture firms”:
    “One way to solve this problem is by getting minority- and women-owned venture capital firms involved in the process,” said Kerry. “The SBA needs to change its tune and start welcoming these companies.”
    Are there limits on the number of qualified SBICs that can be approved each year? If so, your point is well taken. If not, would new policies really matter to existing venture firms (beyond potentially having to compete with an even greater number of SBICs for the same pool of deals)?
    I applaud you for openly engaging in this discussion as it obviously touches on individual politics which tend to be sensitive for some.
    By the way— love your blog!
    michelle