(MENAFN- The Conversation) What is the secret sauce in Silicon Valley's success? It doesn't hurt to have a high concentration of brilliant minds in one place, but perhaps the biggest factor is the high concentration of angel investors — successful, cash-rich entrepreneurs who provide crucial early-stage support for unproven startups.
In fact, data from AngelList suggests that these entrepreneurial angels make about 74 per cent of all investments in Silicon Valley. The wealth created by one generation of entrepreneurs therefore determines the supply of angel capital for the next generation of entrepreneurs in Silicon Valley.
Policy-makers, in particular, are eager to foster entrepreneurial ecosystems by promoting entrepreneurship, with the hope to foster economic growth, employment and innovation. Some even try to imitate Silicon Valley. Examples can be found worldwide: Silicon Forest (Oregon), Swamp (Florida), Gorge (U.K.), Glen (Scotland), Fjord (Norway), Wadi (Israel) , Savannah (Kenya) and many more. However, very different approaches can be taken by governments to achieve these goals.
The question becomes how to foster entrepreneurship?
Some policy-makers focus on encouraging more founding, facilitating entry into entrepreneurship and promoting the establishment of companies. Such policies come in a wide variety of forms, such as training, access to mentoring and expertise or a reduction of bureaucratic red tape.
In the United States, the Small Business Administration (SBA) offers a large variety of training programs for entrepreneurs, and the I-Corps program of the National Science Foundation (NSF) provides entrepreneurship training for scientists and engineers.
Boosting startup funding
A very different set of policies focuses on supporting the funding of entrepreneurial ventures. These policies use a variety of methods to encourage investors to channel more funding into startups. In the U.S., the SBIC program supports the funding of early-stage startups, and according to the Angel Capital Association , more than half of all U.S. states have some tax credits for angel investing.
In a recent research article I co-authored with Thomas Hellmann on the University of Oxford, we raise the fundamental question of how different entrepreneurship policies compare in terms of their impact on entrepreneurial ecosystems.
We tackle this question with a formal theory that derives and contrasts the impact of different government policies. Specifically, we ask how different policies promote entrepreneurial activity. We distinguish between founding policies that affect what is often called the 'demand-side' — for example, the number of entrepreneurs demanding capital — versus funding policies that affect the supply of funds to new ventures.
Our analysis acknowledges that the financing of entrepreneurial ventures is different from standard financial investments and requires 'smart money.' The means there must be tacit knowledge about the entrepreneurial process that is mostly acquired by going through the entrepreneurial process itself.
We view so-called 'angel' investing as the natural process by which experienced entrepreneurs pass on their knowledge to the next generation of entrepreneurs.
Angel investors helped Facebook, Google
In practice, the first cheque to ultimately successful startups often comes from angel investors who were successful entrepreneurs before — think Andy Bechtolsheim , co-founder of Sun Microsystems, who wrote the first cheque to Google, or Peter Thiel , co-founder of PayPal, who wrote the first cheque to Facebook.
Our theory therefore accounts for the accumulation of expertise in an entrepreneurial ecosystem. Early in their careers, entrepreneurs start new ventures that may succeed or fail. Successful entrepreneurs accumulate both the expertise and the wealth to then fund the next generation of entrepreneurs.
This creates dynamic connectivity among generations of entrepreneurs, where the supply of angel capital is a function of the number of past entrepreneurs and the wealth they accumulated.
Promoting entrepreneurship is not a short-term endeavour. Silicon Valley took decades to become what it is today. Governments trying to imitate Silicon Valley had to learn how long it takes to create an entrepreneurial ecosystem.
Funding beats founding
Our research therefore focuses on the long-term impact of entrepreneurial policies on the financing and formation of startup companies. We find that founding policies, rather than funding initiatives, create a competitive dynamic where more entrepreneurs seek a limited supply of funds, resulting in less favourable investment terms for entrepreneurs, that is lower company valuations.
By contrast, funding policies create a more abundant supply of capital, leading to more favourable investment terms for entrepreneurs, that is higher valuations.
Research shows supporting angel investors, rather than giving startups 'founding' help, results in a higher rate of success. Rawpixel/Unsplash
Our central finding is that for increasing entrepreneurial activity, funding subsidies are more effective than founding subsidies. Funding subsidies generate wealthier successful entrepreneurs, who then, as angels, often provide the capital for the next generation of entrepreneurs. Simply put, they pay it forward.
This means governments should consider using funding policies that deepen the pool of angel investments rather than founding policies, targeted at getting more entrepreneurs to start businesses.
Unfortunately, this policy approach is a very hard sell for politicians, for a number of reasons. First, it's focused on the long term and offers less favourable political optics than initiatives aimed at entrepreneurs themselves (tax credits versus ribbon-cutting events).
And in the present climate, it's difficult to argue that rich people need more sweet deals to support a new generation of entrepreneurs.
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