During the 1990s venture capitalists transformed entrepreneurs into corporate entities, and these companies in turn have funded increased productivity that has helped to accelerate U.S. economic growth. This success has spawned an interest in tracking information about the industry. These new resources provide an important perspective for understanding how venture capital works.Venture capital ; Productivity ; Technology ; Economic development

Anna Copeland Wheatley

English

Research Papers in Economics

i Federal Reserve Bank of Atlanta ECONOMIC REVIEW Fourth Quarter 2002
D
uring the 1990s, a new kind of economic
hero emerged. Venture capitalists, par-
ticularly the pioneers from Silicon Valley,
transformed renegade entrepreneurs
into productive corporate citizens. The
companies they funded increased pro-
ductivity, which, in turn, accelerated economic
growth. Their success in securing high rates of return
for their limited-partner investors created a frenzy to
get in on the game—climaxing in 2000 with fund-
raising of more than $92 billion. 
The decade of success also spawned a critical,
if unintended, consequence. Traditionally, very little
data have been available regarding venture capital
transactions. The details of venture-backed deals—
as private equity investments—were rarely disclosed.
The dramatic increase in both venture capital funds
and venture capital investments, however, created a
concurrent interest in tracking information about the
industry. This new resource provides an important
perspective for understanding how and why venture
capital works—or, as importantly, does not work. 
In order to examine the impact of venture capital
on technological innovation, economic growth, cor-
porate development, and market conditions, among
other topics, the Federal Reserve Bank of Atlanta
and New York University’s Stern School of Business
sponsored a conference titled “Venture Capital and
Technology: What’s Next?” The three-day event,
held at Sea Island, Georgia, May 2–4, 2002, brought
together academicians and practitioners to explore
Preface—Venture Capital and
Technology: What’s Next?
ANNA COPELAND WHEATLEY
The author is the executive editor of Innovation Review, 
published by the Berkley Center for Entrepreneurial Studies at the
Leonard N. Stern School of Business at New York University.
both operational and policy challenges facing the
venture capital industry. Among the highlights was
a teleconferenced address by Federal Reserve
Chairman Alan Greenspan. In his remarks, the chair-
man offered a strong statement regarding the
accounting practices used for expensing stock
options. The issue of stock options is, of course, par-
ticularly relevant to the venture capital industry,
which uses options to lure key executives to the
management teams of its portfolio of companies. 
However, options are only one of many issues
facing a relatively young industry that remains unreg-
ulated and, surprisingly, under- (and inaccurately)
reported. The papers presented at the conference
tackled issues ranging from the problem of “dirty data”
to the replication of the U.S. venture capital model
abroad.1 Impressive and thought-provoking as the
presentations were, they were perhaps less remark-
able than the passionate debates that took place
during the question-and-answer portion of the pro-
gram—conversations that continued during breaks,
over lunch, and throughout dinner. What kind of
accountability should venture capital firms have? Is
there any way to moderate boom-bust cycles? To what
extent, as one participant phrased it, will analytically
“lovely” models prove to be empirically challenged? 
External versus Internal Venturing
M
any venture capitalists dismiss corporate ven-
ture investing as a contradiction in terms.
Funded solely by a corporate “parent,” these fundsii Federal Reserve Bank of Atlanta ECONOMIC REVIEW Fourth Quarter 2002
partners in the funds in which they invest poses a
risk that could be mitigated by imposing some stan-
dards on how the venture capital industry operates.
Innovation and Economic Growth
T
hat venture capital spurs innovation and inno-
vation spurs economic development seems a
given. But is it? Josh Lerner, Jacob H. Schiff Professor
of Investment Banking at Harvard Business School,
examines the effects of the decline in venture capi-
tal investments. Stressing the cyclical nature of the
venture capital industry, Lerner suggests that inno-
vation can be equally affected by policy issues, such
as the Bayh-Dole Act of 1980 and the Federal
Technology Transfer Act of 1986, both of which
eased entrepreneurs’ ability to access early-stage
research. Similarly, the Department of Labor’s clarifi-
cation of the Employee Retirement Income Securities
Act in 1979 allowed pension funds to make limited
investments in venture capital.
Lerner makes an interesting distinction between
entrepreneurial activity and innovation, arguing that
while the level of venture activity may dramatically
affect entrepreneurial enterprises, it does not nec-
essarily follow that it similarly affects innovation. For
instance, venture financing for such areas as advanced
materials and micromanufacturing languished dur-
ing the boom of 1998–2000 as money was poured into
telecommunications and the Internet, yet innovation
was, and is, still taking place in these areas.
Conclusion
B
y the end of the conference, it was evident that
the venture capital industry—under the
intense scrutiny of media coverage—has grown up.
Maverick intuition is no longer sufficient due dili-
gence. Numbers count. It was also evident that,
even in the wake of the burst of the bubble, venture
capital remains a dynamic asset class in the United
States, contributing significantly to economic devel-
opment and technological innovation. It is therefore
important to examine the issues that have an
impact on the operation and management of this
asset class. Because academicians and practitioners
offer different perspectives, ongoing conversations
regarding the nature of the industry are essential if
it is to remain a strong and vibrant resource for
entrepreneurial innovation.
often lack the flexibility of an independent fund.
According to Paul Gompers, a professor of business
administration at Harvard Business School, corporate
venturers actually enjoy a higher success rate than
independent venture capitalists do. Gompers’s paper
stresses the need for corporate investors to “keep
close to their knitting.” Corporate investing works best
when it maintains a highly focused strategy to lever-
age the company’s brand as a value-added asset. It is
also important for corporate venture arms to work in
concert with various corporate divisions, which might
otherwise feel threatened by the fund’s portfolio com-
panies. Along the same lines, Gompers contends that
the most common cause of failure was lack of exec-
utive commitment. Because a corporate fund is, by
definition, funded by the corporation, it is as subject
to the whims of management as any other division.
Having a strongly strategic and well-articulated focus
can mitigate the problem of parental apathy.
Valuation and Performance
I
n spite of the dramatic collapse in venture capital
financing during the past two years, the develop-
ments of 2001 are, according to Stanford University
Graduate School of Business professors Thomas
Hellmann and Manju Puri, “a mere kink in an other-
wise exceptional growth curve of the venture cap-
ital industry.” Hellmann, who presented the paper
coauthored with Puri, examines the difference
between short- and long-term performance in order
to ascertain what changes have taken place within
the venture capital industry.
Noting that “good data are extremely hard to
find,” Hellmann discusses the findings from the
Stanford Project on Emerging Companies, an inter-
disciplinary research project that analyzed 170 tech-
nology start-up firms. Hellmann and Puri use this
information to examine the effects of venture capi-
tal on both the market position of the start-up and
on internal operational issues. For instance, the
presence of venture capital increases the likelihood
that a start-up will bring a product to market by
79 percent. Not surprisingly, Hellmann and Puri’s
research supports the conclusion that venture capi-
talists provide value-added services. These ancillary,
or support, services enhance the value of their port-
folio companies. More controversial was their con-
clusion that the relative lack of oversight by limited
1. The conference paper by Ronald J. Gilson, “Engineering a Venture Capital Market: Lessons from the American Experience,”
draws on a decade of theoretical and empirical literature to address the practical problem of whether the U.S. experience can
provide guidance in fashioning a venture capital market in other countries. The paper does not appear in this issue of
Economic Review. It is forthcoming in the April 2003 Stanford Law Review and is available on the Federal Reserve Bank
of Atlanta’s Web site at <www.frbatlanta.org/filelegacydocs/policy_gilson.pdf>.

Preface--Venture capital and technology: What's next?

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