Printed on Oct 31 2011 in The Economist

1. The Babson Entrepreneurship Ecosystem Project
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Seeding Entrepreneurship: How to Build a Venture-Finance Ecosystem
Daniel Isenberg, Babson Entrepreneurship Ecosystem Project, Babson Global
October 31, 2011
New York Mayor- entrepreneur Michael Bloomberg, not known for shyness, recently proclaimed New
York City as America’s new entrepreneurship capital, roaring past Boston in venture capital and soon to
leave Silicon Valley in the dust as the “go to” destination for entrepreneurs. Indeed, the world media are
awash with proposals to kick start entrepreneurship as a strategy for economic revival, with support for
venture finance at the heart of many programs. Yet the title of Harvard’s Josh Lerner’s recent book,
“Boulevard of Broken Dreams,” is no coincidence, because proclamations are one thing, actual success is
quite another.
Fortunately, there is a lot of experience around the world about what works and what doesn’t. Here are
some practical principles that the Babson Entrepreneurship Ecosystem Project have been identifying and
developing for public leaders who have, correctly in my opinion, identified entrepreneurship as an
essential plank in economic policy.
1. Be clear that the objective is to foster an entrepreneurial finance ecosystem, not to directly
provide capital to entrepreneurs. Over time, a healthy entrepreneurship ecosystem over time
makes available capital to ventures that deserve it, while denying it to ventures that do not.
This does not mean that governments need to revert to selecting the deserving. This idea has
regained currency recently, but we learn time and again (Solyndra anyone?) that it does not
work. It does mean that the availability of capital, and other resources, needs to be part of a
natural process in which the ecosystem elements – in this case, deal flow and capital—
continually evolve and adjust to each other, a concept that is consistent with Smith’s “invisible
hand.” But the concept goes further by suggesting that enlightened and skillful leadership can
play a critical role in encouraging the evolution of a self-sustaining ecosystem, but leaders have
to understand how and when to get in, and how and when to get out.
________________________________________________________________________
revolution@babson.edu
+1 (781) 239-6290

2. The Babson Entrepreneurship Ecosystem Project
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2. Stimulate financing, but stay off of ventures’ balance sheets. Presence of government and
government-owned entities as direct debt or equity holders of ventures should be a red flag.
The only reason government should be on a venture’s balance sheet is in the rare case when it is
absolutely necessary to entice private, profit-oriented entities to get involved as the natural
selector of investment targets, and in those cases, government should have a clear plan to get
out. Governments can, as have Israel, Finland and some other countries, provide smart, offbalance sheet funding in the form of repayable grants, matching grants and so forth. But
presence on ventures’ balance sheets ultimately leads to a conflict of interest between
governments’ social priorities and obligations, and the need to provide a positive return to
invested capital. Overall, there is evidence that a moderate amount of this kind of financing can
be beneficial, but as it gets to be too great, the benefits rapidly turn into liabilities.
3. Make sunset clauses for financial support programs the rule, not the exception. Permanent, or
evergreen programs of government-supported venture capital, loan guarantees, startup grants,
angel tax credits and so on, risk becoming white elephants and/or political assets, not economic
ones, and in the process risk squandering public funds. Sunset clauses, or “sell-by dates,” help
focus policy-implementation programs on (a) achieving results, and (b) creating selfsustainability by building capacity and mutually reinforcing systems (for example, by showing
private sector players that they can actually make profits.)
4. “Pulse” incentives to foster discovery. An implication of sunset clauses, in general, is that if
providers and consumers of risky capital can “discover” that it is profitable to engage, then they
will accelerate self-interested behavior when the “visible hand” is removed. Seeing if providers
and consumers of entrepreneurial capital “discover” the correct pricing mechanisms to allow
them to engage in a profit-seeking transaction is one test as to whether the problem is really a
market failure or not, and is not just an excuse for hiding behind the “market failure” mantra to
gain political power. If governments are serious in judiciously using public resources to address a
market failure, they should welcome such discoveries.
5. Subject financial support programs to the market test. When Yozma, the successful 1990’s
Israeli venture fund of funds, gave the private managing partners the option to buy out
government’s stake in each fund at an agreed upon annual return, Yozma not only recouped the
government’s investment (with about a 50% gain); more importantly it proved that it had
permanently stimulated something of demonstrable value. This was a powerful signal to other
potential venture investors that there was money to be made. Requiring matching funds by
equity providers, royalty-based grant paybacks, and outright sale of government’s stake, are all
ways to responsibly use public funds by testing them in the market place of profit-seeking
investors.
6. Regulate-in easy failure, the quicker the better. To risk using an analogy, one of the major
recent biological discoveries is how essential protein death is to protein synthesis and life,
because the protein components get recycled and reused. Similarly, venture failure allows
people, ideas, and capital to be recycled and applied more productively, IF there is an ecosystem
that fosters this natural selection. As I have written in the Harvard Business Review, bankruptcy
laws, transferring unemployment protection to unemployment insurance as Denmark has done,
and credit reform all make it easier for entrepreneurship ecosystems to naturally dispose of
their own “toxic assets.”
________________________________________________________________________
revolution@babson.edu
+1 (781) 239-6290

3. The Babson Entrepreneurship Ecosystem Project
__________________________________________________________________
7. Build venture “chimneys,” not silos. The regulatory support of failure makes it much easier for
entrepreneurs to take risk: Paradoxically, easy exit actually is a powerful stimulant for easy
entrance. This circulation of entrepreneurial assets, which I liken to that of a chimney, also helps
create and sustain the blaze of entrepreneurship.
Of course, there is no panacea—constant stakeholder dialog is essential, experimentation is
necessary, learning from mistakes is necessary. It is not necessary to get things perfect, and it is very
possible that from time to time, conscious violation of one or more of these principles might work
because of other mitigating factors. But there is no substitute for having an appropriate set of policy
guidelines.
Daniel Isenberg is the founding Executive Director of the Babson Entrepreneurship Ecosystem Project and Professor
of Management Practice at Babson Global. Professor Isenberg has taught at Harvard, Columbia, INSEAD, Technion,
and Reykjavik. From 1987-2004 he lived in Israel and contributed to the entrepreneurial revolution there as an
entrepreneur, venture capitalist, consultant, and educator. A frequent Harvard Business Review contributor, in
June, 2010 Harvard Business Review featured Professor Isenberg’s “How to Start an Entrepreneurial Revolution” as
the “Big Idea” lead article. His popular blogs have appeared in Forbes, Huffington Post, Economist, and Harvard
Business Review Online.
________________________________________________________________________
revolution@babson.edu
+1 (781) 239-6290