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Kauffman CEO: New Venture Capital Structure Needed

Tom McDonnell (A. Kotok)

Tom McDonnell (A. Kotok)

Kauffman Foundation CEO Tom McDonnell called for a new relationship between venture capital financiers and high-growth start-up enterprises to better reflect the long-term needs of these companies. McDonnell made the remarks in a speech on the state of entrepreneurship in the U.S. at the National Press Club in Washington, D.C. The Ewing Marion Kauffman Foundation in Kansas City, Missouri studies and supports entrepreneurship worldwide.

McDonnell (pictured left)  noted the emergence of a “national consensus that encouraging entrepreneurship can help revive our sluggish economy,” as well as new financial innovations for start-ups. “But for the financing innovations to pay dividends,” added McDonnell, “there will need to be a variety of regulatory reforms, particularly related to the country’s capital markets, on both the debt and equity side.”

He listed the sharp job in new business creation between 2008 and 2010 that has not yet rebounded, as well as a corresponding drop in new job creation that often accompanies entrepreneurial activity. In addition, McDonnell listed a lack of bank financing that had not revived since the recession, and uncertainty over implementation of the Dodd-Frank financial reform law.

McDonnell pointed out that venture capital (VC) finances a small slice of new business, about one-tenth of one percent, but enterprises funded through venture capital tend to be fast-growing companies that account for five to seven percent of employment in the U.S. He said the goal of finance in these cases should be to “create a company with enduring economic value.” (Companies based on scientific discoveries often require VC financing to fund their growth.)

To meet this goal, said McDonnell, VC financiers should take a longer-term approach than the standard 10-year fund with a four- to five-year funding period. He also recommended new incentive structures that better align VC fees with performance that now tend to reward short-term returns, and better transparency and metrics going beyond a fund’s initial rate of return.

Among the new financial innovations is crowdfunding that makes it possible for start-ups to finance their ventures from a large number of small donors and investors. McDonnell said more than 200 crowdfunding platforms have begun in the U.S. alone, and he urged the Securities and Exchange Commission to accelerate completion of its regulations of crowdfunding, required under the Jumpstart Our Business Startups (JOBS) Act of 2012.

McDonnell noted that most start-up companies are funded through debt rather than equity financing, but bank lending to small companies dropped by $100 billion between 2008 and 2011. He called for more flexibility by bank regulators and urged the Federal Reserve to reinstate its Survey of Small Business Finances that stopped prior to the 2008 financial crisis.

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