Crisis of Confidence in Our Entrepreneurs

The entrepreneur, the much ballyhooed hero of U.S. business in the 1980s, is in for tough times in the years ahead and, in fact, hasn’t had it too good lately.

The flow of seed money that wealthy families and corporate pension and development funds invest in new companies declined last year to $2.6 billion, according to Venture Economics, a Wellesley Hills, Mass., research firm. That was down from a $3-billion-plus average for 1983 to 1988 and well down from the $4.2 billion of 1987--the year the stock market crashed.

The crash clobbered small company chances. Only 203 new companies sold stock to the public in 1989, according to the trade magazine IPO Reporter, down from almost 700 companies in 1986. And the decline in enterprise extends to private companies. Openings of new businesses are probably down 20% from the mid-’80s, according to an informal estimate by Dun & Bradstreet.

The outlook is not optimistic, say venture capital firms nationwide. “It’s tough to raise money,” says Eric Schiffer, a partner in Los Angeles’ Oxford Partners, which helped launch computer retailer Businessland in the early ‘80s.

So what? So plenty. Entrepreneurial companies are what this system thrives on. In small business of every variety, some 250,000 new companies spring up each year--with perhaps one company in 25 surviving. Yet out of that teeming activity come most of the new jobs in the U.S. economy.

And venture capital-backed entrepreneurs hold special honor for creating not simply companies but whole new industries, from electronics in the 1970s to biotechnology in the 1980s.

That there’s less money around for such heroes today is ominous for the economy, casting a shadow on expectations of strong new growth in the 1990s and reflecting a worrisome lack of confidence in the present.

It’s not really that risks have changed in venture capital; it has always been a reach for the brass ring. An entrepreneur raises an initial stake from family and friends--or a second mortgage on the house. And venture capital funds help at the next stage with money and expertise to develop the young company’s product or service. If successful, the fledgling may be acquired by a larger firm or it may sell stock to the public. Either way, the initial backers win big: Venture capital funds such as Boston’s 22-year-old TA Associates have earned 25% to 30% a year compounded. That is, one or two winners out of the 10 or 12 companies that they back each year more than offset the losers.

A big winner is the kind of payoff that Pathfinder Venture Capital Funds of Minneapolis had when it backed Advanced Cardiovascular Services (ACS) with $700,000 in 1981. ACS developed balloon angioplasty, a life-saving method of keeping veins and arteries open in heart attack victims. The company was immediately successful and was acquired by pharmaceutical giant Eli Lilly in 1984, with ACS’ venture capital backers getting a $10-million return on their $700,000 investment and three times that much if they held on to the Eli Lilly shares that they received in the buyout.

So why, with gains like that, isn’t everybody rushing to back new companies? Lack of confidence dating to the crash of 1987.

The crash scared investors more than has been generally acknowledged in the past two years as the big institutions have put money back into stocks and the market has recovered. But in that recovery, investment has favored the big companies, even though big firms declined as much as small ones two years ago. Why is that? Because big companies, as well as having size to weather economic storms, also tend to have large numbers of shares outstanding--meaning that investors can sell quickly if necessary. So the tendency has been to invest with an eye on the exit door, not to invest with confidence.

Similarly, though money has been scarce for venture capital funds, it has been available until recently for spurious investments--like the leveraged buyout takeover funds of Kohlberg Kravis Roberts. Such schemes promised venture capital-type returns without the effort needed to develop new products or create new industries. Instead, they steered money to seemingly risk-free, if wasteful, activities like splitting whole companies into parts and selling them--as butchers do with pigs and chickens.

Now LBOs and junk bonds are failing--and good riddance. But their collapse may only cause investors to further avoid venture capital and small business investments.

So what can be done to revive support for the entrepreneur? “Pass capital gains tax reduction,” says Howard Cox, partner in Greylock Management, a Boston-based venture capital firm. And to be sure, a cut in the capital gains tax has spurred new business before.

But a tax measure won’t be enough to do it. What U.S. business, and government and society, too, must do is recover confidence--easier said than done--and a sense of priorities. A recognition that an investment in angioplasty is inherently more valuable than one to break up a tobacco company might be a good start. A recollection that it was real scientific knowledge and commitment--not card-shark investment banking--that gave us advances in electronics and biotechnology would be helpful, too.

But needed most of all is a renewed willingness to take risks for the kind of rewards that only entrepreneurial ventures can bring. The country of the entrepreneur, in short, needs to recover the spirit of enterprise.