Entrepreneurs and Economic Recovery

Stephen DeAngelis

March 6, 2009

In almost every post that I’ve written that has touched on the current financial crisis, I have stressed the importance of creating jobs and the important role that entrepreneurs can play. My latest post on that subject [Fostering Innovation and Restoring America’s Competitive Edge] focused on President Barack Obama’s recent address before Congress. In a Washington Post op-ed piece, Reid Hoffman, founder and chief executive of LinkedIn, also refers to Obama’s speech as he discusses the importance of entrepreneurs for America’s future [“Let Our Start-Ups Bail Us Out“, 3 March 2009].

“President Obama noted last week that ‘we have lived through an era where, too often, short-term gains were prized over long-term prosperity.’ As the $787 billion stimulus is sorted out, we should consider not only what’s there but also what’s missing. Unless lawmakers move to jump-start key elements of sustainable economic growth, we may find ourselves worse off in a few years.”

Hoffman wants to concentrate on “what’s missing.” Surprisingly, he asserts that money spent on infrastructure, renewable energy and scientific research will promote short-term job creation without guaranteeing a “vibrant economic ecosystem required for sustainability.” Hoffman and I disagree on that point. I believe that investments in those areas will establish some of the necessary foundation on which long-term economic recovery can be built. On the other hand, I agree with Hoffman that investments in those areas are not, by themselves, sufficient to create all of the new jobs needed to end this crisis. Hoffman notes that “the credit meltdown, the mortgage crisis and the collapse of automakers have created a climate of fear around investment at precisely the time that new ventures — not merely new technologies — need to be championed as the course to stability.”

President Franklin Roosevelt understood the pernicious effects of fear as did President Ronald Reagan. As a result, they were swept into office on a message of hope. President Obama also rode the winds of change and hope into office. Overcoming fear and replacing it with hope is what Hoffman believes is missing from the current stimulus plans. He believes that hope can come riding over the horizon on the backs of entrepreneurs. As I have repeatedly written, one of the universal characteristics of a successful entrepreneur is optimism. Only an optimist can have a dream and sell it to others. Only an optimist can see hope during bad times — and these are bad times. That is Hoffman’s essential message. He writes:

“Products and services drive a healthy economy. To translate the stimulus into sustainable growth, we need incentives for business innovators. Entrepreneurs are the fertile soil for job growth and recovery.”

He goes on to cite well-known data about small businesses (e.g., that they represent 99.7 percent of all employer firms, pay nearly 45 percent of U.S. private payroll, and have generated most of the new jobs created over the past decade). He provides a list of the “start-ups” that have mainstreamed and now form a critical base of the current economy. Companies like: “Apple, Microsoft, MTV, CNN, FedEx, Intel, Hewlett-Packard, Burger King.” He selected those companies because each of them got their start during an economic downturn. It’s a point that Allstate Insurance has been making in its commercials. Allstate opened its doors in 1931. Hoffman’s point is not just that these companies managed to start in bad times and survive, but also that they were able to create lasting, good paying jobs for hundreds of thousands of people worldwide. Right now the world needs to create millions of new jobs and Hoffman believes that only new businesses can do that. “By empowering individuals and small businesses,” he asserts, “an innovation stimulus can help germinate stable industry players for the long term.”

“Stable” industry players are the key to Hoffman’s plan. We all know the awful statistics about how many businesses fail in their first three years. We saw the tech bubble burst when start-ups with poor business plans burned through venture capital and/or money raised through IPOs. Hopefully, we learned our lesson from such “irrational exuberance.” Hoffman believes that private funds are available for investment, but asserts that investors remain on the sideline because they are waiting for the economy to finally hit bottom. Investors, he insists, will enter the game when “they can get the most bang for their buck.” Hoffman believes that this is where the government can play a positive role. He offers three “incentives for entrepreneurship and innovation” that could help. First, encourage small business with loans. Second, welcome foreign innovators. Finally, match funds for venture capital and angel investments. Let’s examine each of Hoffman’s suggestions.

Hoffman recommends using a micro-finance model for lending to small businesses. He notes that such loans have been successful in developing countries and could prove successful here. My concern with that suggestion is that the model may not apply. Micro-loans are generally made for amounts ranging from a few dollars to perhaps a thousand dollars. Hoffman recommends establishing “credit lines of up to $50,000.” Micro-loan interest rates are also relatively high (normally around 25-30 percent). Those rates could very well cripple a small business. He also recommends helping “small businesses invest and grow, reimagine their products and services, and assess their strengths”; noting that “localized innovation develops the economy from the ground up.” I agree that providing business development services to small businesses is a good idea. It could help sort out good ideas from bad ones before people lose their life’s savings chasing ill-conceived dreams. Good ideas might qualify for loans, but such loans would have to be extended with fairly low interest rates.

Hoffman’s second recommendation (welcoming foreign innovators) builds on an idea also supported by New York Times‘ columnist Tom Friedman (see my post Globalization and Recovery). Hoffman bases his recommendation on a study by Harvard research fellow Vivek Wadhwa that claims “immigrants have founded more than half of all Silicon Valley start-ups in the past decade.” More importantly, “these immigrant-led, American tech companies employed more than 450,000 workers and grossed $52 billion in 2005.” Despite these startling statistics, Congress has continued to make it difficult for these entrepreneurs to find work in the U.S. As Hoffman notes, “for U.S. companies to employ a highly specialized foreign worker, the employee must hold an H-1B visa, but current law allows for the issuing of only 65,000 H-1B visas per year.” Hoffman and Friedman both assert that failing to welcome highly skilled and educated foreign workers in the name of job protection is cutting off our nose to spite our face. Hoffman recommends removing the cap on H-1B visas “while imposing a 10 percent payroll tax above and beyond the benchmark salary for any position being filled by holders of such visas. The proceeds of the payroll tax could be channeled into U.S. reeducation programs.” Businessmen aren’t the only people concerned about visa problems. Scientists are also concerned that visa difficulties are keeping some of the world’s brightest students from studying in America [“Scientists Fear Visa Trouble Will Drive Foreign Students Away,” by Cornelia Dean, New York Times, 2 March 2009]. Foreign students are as likely to be entrepreneurs with brilliant ideas as H-1B visa holders.

Hoffman’s final recommendation (providing matching funds for venture capital and angel investments) is aimed at prying loose capital that is now sitting idle at a time when it is desperately needed. He believes that venture firms are a critical piece of the financial puzzle when it comes to supporting new businesses and creating new jobs. His recommendation is not only aimed at sharing risk but sharing profits. He recommends that “investors could keep their normal return plus 50 percent of the returns on the matching funds, while the other half goes back to the government to revitalize further investment. This would give individuals an incentive to double down on investments they would make anyway, but sooner rather than later.”

Hoffman is both a successful entrepreneur and a successful venture capitalist (having invested in more than 60 start-ups since 2000). I believe that qualifies him as a subject matter expert and one who deserves to be heard. As an entrepreneur and investor myself, I agree with Hoffman that “financing strategy is key in keeping new ventures afloat. … Stable financing lets companies develop good product strategies and become self-sustaining — and that, on the micro level, is what we need to do with the economy.” Hoffman concludes his op-ed piece by noting that President Obama used a grass roots effort to get elected and that he should “take a page from his campaign playbook” and support new and growing businesses instead of “propping up failing, overleveraged institutions.” Hoffman, Friedman, and I agree that “by providing incentives to American ingenuity, we can innovate our way out of this recession.”