[Senate Hearing 107-484]
[From the U.S. Government Publishing Office]
S. Hrg. 107-484
ENTREPRENEURIAL COMPANIES: THEIR NEEDS
AND CHALLENGES IN TODAY'S ECONOMY
=======================================================================
FIELD HEARING
BEFORE THE
COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
__________
SEPTEBER 10, 2001
__________
Printed for the Committee on Small Business and Entrepreneurship
Available via the World Wide Web: http://www.access.gpo.gov/congress/
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COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP
.........................................................
ONE HUNDRED SEVENTH CONGRESS
----------
JOHN F. KERRY, Massachusetts, Chairman
CARL LEVIN, Michigan CHRISTOPHER S. BOND, Missouri
TOM HARKIN, Iowa CONRAD BURNS, Montana
JOSEPH I. LIEBERMAN, Connecticut ROBERT F. BENNETT, Utah
PAUL D. WELLSTONE, Minnesota OLYMPIA J. SNOWE, Maine
MAX CLELAND, Georgia MICHAEL ENZI, Wyoming
MARY LANDRIEU, Louisiana PETER G. FITZGERALD, Illinois
JOHN EDWARDS, North Carolina MIKE CRAPO, Idaho
MARIA CANTWELL, Washington GEORGE ALLEN, Virginia
JEAN CARNAHAN, Missouri JOHN ENSIGN, Nevada
Patricia R. Forbes, Democratic Staff Director and Chief Counsel
Emilia DiSanto, Republican Staff Director
Paul H. Cooksey, Republican Chief Counsel
C O N T E N T S
----------
Opening Statements
Page
Kerry, The Honorable John F., Chairman, Committee on Small
Business and Entrepreneurship, and a United States Senator from
Massachusetts.................................................. 1
Witness Testimony
Card, Jill P., president and founder, IBEX Process Technology,
Inc., Lowell, Massachusetts.................................... 5
Gnatovich, Rock Steven, president, Spotfire, Inc., Somerville,
Massachusetts.................................................. 11
Von Bargen, Patrick, executive director, National Commission on
Entrepreneurship, Washington, DC............................... 22
Gendron, George, editor-in-chief, Inc Magazine, Boston,
Massachusetts.................................................. 34
Hodgman, John F., president, Massachusetts Technology Development
Corporation, Boston, Massachusetts............................. 41
Comments for the Record
Amster, Marge, commercial areas coordinator, Economic Development
Office, Town of Brookline, Brookline, Massachusetts............ 50
Fancher, Terry, CCE., general manager, South Shore Chamber of
Commerce, Quincy, Massachusetts................................ 51
Khan, Siraj, vice president and chief operating officer, Kinoo,
Inc., Cambridge, Massachusetts................................. 53
Kispert, Robert, director of federal programs, Hubbard, Thomas,
vice president, Massachusetts Technology Collaborative,
Westborough, Massachusetts..................................... 54
Alphabetical Listing and Appendix Material Submitted
Amster, Marge
Comments for the Record........................................ 50
Card, Jill P.
Testimony...................................................... 5
Prepared Testimony............................................. 8
Fancher, Terry
Comments for the Record........................................ 51
Gendron, George
Testimony...................................................... 34
Prepared Testimony............................................. 37
Gnatovich, Rock Steven
Testimony...................................................... 11
Prepared Testimony............................................. 14
Hodgman, John
Testimony...................................................... 41
Prepared Testimony............................................. 43
Kerry, The Honorable John F.
Opening Statement.............................................. 1
Prepared Statement............................................. 3
Khan, Sira G.
Comments for the Record........................................ 53
Kispert G., Robert
Comments for the Record........................................ 54
Von Bargen, Patrick
Testimony...................................................... 22
Prepared Testimony............................................. 26
ENTREPRENEURIAL COMPANIES:
THEIR NEEDS AND CHALLENGES
IN TODAY'S ECONOMY
----------
MONDAY, SEPTEMBER 10, 2001
United States Senate,
Committee on Small Business and Entrepreneurship,
Washington, D.C.
The Committee met, pursuant to notice, at 9:30 a.m., at the
MIT Faculty Club, Sixth Floor, 50 Memorial Drive, Cambridge,
Massachusetts. The Honorable John F. Kerry, (Chairman of the
Committee) presiding.
Present: Senator Kerry.
OPENING STATEMENT OF THE HONORABLE JOHN F. KERRY, CHAIRMAN,
COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP AND A UNITED
STATES SENATOR FROM MASSACHUSETTS
Chairman Kerry. The hearing will come to order. I want to
thank everybody for joining us here this morning for this field
hearing of the Small Business and Entrepreneurship Committee.
This is actually the first field hearing that I have held as
Chairman, and I am delighted, obviously, to have it here in
Massachusetts, and to have it here at the Sloan School. I thank
MIT for receiving us here today, Dean Schmalensee and Chuck
Vest, and I am very appreciative for the use of these
facilities.
For most of the Committee's history, it has been the Small
Business Committee, and for better or worse, it has focused
almost exclusively, except tangentially when the new markets
venture concept came up a couple of years ago, but otherwise,
almost exclusively on the Small Business Administration (SBA).
Now, there is nothing wrong with focusing on the SBA and we
will continue to do that because it is the critical component
of our relationship with small businesses across the country.
It is the lending program, 7(a). It is the SBIR, SBIC,
technology transfer, the 8(a), all of those efforts and other
continuing programs that we have made to assist small
businesses. But, there is, in fact, a growing awareness
reflected in the curriculum of business schools. I know that
Harvard changed, I think, a year ago, what had been
traditionally sort of a business structure course into an
entrepreneurship course, and likewise, there is a national
study on entrepreneurship which is very interesting that lays
out some of the particularities with respect to entrepreneurs.
It is the National Commission on Entrepreneurship that did a
report in March of this year, ``Understanding How Businesses
Start and Grow.''
So, the title for today's hearing reflecting the new focus
of the Committee, itself, is ``Entrepreneurial Companies: Their
Needs and Challenges in Today's Economy.'' We have formally
changed the name of this Committee to include the concept of
entrepreneurship because we think it merits a special kind of
focus. An entrepreneurial company is different because of the
growth needs and because of the types of challenges it faces,
as a growth company, compared to traditional small business
that often might be mom and pop or have a different focus in
terms of growth than a company that we have come to know as an
entrepreneurial growth entity.
So, we really want to focus on that today. Though they
represent less than 5 percent of all businesses, clearly, they
represent the mass of substantial new jobs and of growth. Most
companies that become the larger players in our economy,
whether you are talking about, you know, Fed Ex or Cisco, they
often begin with some component of Federal input, but they
transition rapidly into a very different kind of player.
Needless to say, it is in our interest to maximize our capacity
to create and assist those kinds of companies.
Now, one of the legitimate questions today is ``What is the
appropriate Federal role here?'' Some people might suggest,
well, we have done very well for 50 years without a sort of
formalized understanding of this role, and companies have made
it, some have not. But, that is the nature of the
entrepreneurial activity and that is the nature of the capital
system. Indeed, that may well be true; but again, looming over
us is this question of whether or not there are things that
legitimately fall within the purview of government. Without
picking winners, without creating losers, with any kind of
command control or mandates or anything else, are there ways to
assist in making the framework more friendly? Are there ways
that we could deal, legitimately deal with some of the problems
of new start-up entities? That is really what we want to look
at today.
I do not approach this with a predetermined notion of
outcome. This is a hearing in the truest sense of the word. We
want to hear from folks, and that will help define for us what
the potential mission might be of the Small Business and
Entrepreneurship Committee or where we perhaps ought to be
careful to keep arms-length and not meddle.
So, with that quick introduction, let me welcome all of the
witnesses here today. We are particularly grateful to them for
coming. Ms. Jill Card, the president and founder of IBEX
Process Technology from Lowell, and Mr. Rock Gnatovich,
president of Spotfire, Inc., from Somerville, and then we will
move to our second panel to sort of talk more broadly about
some of what we hear in the first panel and some other issues,
also.
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So, Ms. Card, would you lead off, and thank you very much
for being with us this morning.
STATEMENT OF JILL P. CARD, PRESIDENT AND FOUNDER, IBEX PROCESS
TECHNOLOGY, INC., LOWELL, MASSACHUSETTS
Ms. Card. Right back at you. Thank you. I am Jill Card,
founder and president of IBEX Process Technology and developer
of the IBEX line of artificial intelligence controllers for
semiconductor manufacturing process tools. IBEX was
incorporated in March 2000, so I feel particularly equipped to
talk this morning about the trials faced by new companies in
the high tech market.
I have spent the last 20-plus years as an applied
mathematician working within computer systems and semiconductor
industries. Of those years, 17 were spent in the employ of very
large engineering companies, and of those, over three-quarters
of that time was spent within companies undergoing some form of
transition, reorganization, downsizing, layoffs. I was
fortunate in never having personally been downsized, but
energetic people with good ideas get tired of living under
conditions where job security has little or no correlation to
their personal ability to perform. I was not alone in
concluding that I would rather risk my future employment on my
own ability to react and learn, than to have my fate in the
hands of someone else's management decisions in a tough
engineering market.
So, today, within the computer and semiconductor markets,
there are a lot of technical people who, either through
downsizing or personal choice, find themselves on their own
with great ideas, nerve, energy, leadership, and organizational
abilities and the excitement that it takes to bring those ideas
to market. But, these people, like me, may have never imagined
that they would be in business for themselves.
As a woman in high tech, I had wrestled and struggled for
years with how to maintain a career and juggle a family
simultaneously, but would not have considered being a ship's
commander had the times not dictated this as a decidedly
worthwhile option.
So, in 1998, I set out from Digital Equipment Corporation
with a technology license for the product that I designed, and
I started a business. What I found was that despite all my
technology smarts and ability to think on my feet, the only two
things I had to use for barter were my mouth and my stock. For
the lowest possible cost and minimal stock, I needed to figure
out how to get services for writing business plans, finding
corporate and IP legal counsel, looking for investment banking
and venture capital, getting marketing and sales support, web
page design and collateral development, executive team search,
et cetera. I had a very strong technical network, I had a great
product, I had good access to my customer base, and I had no
clue on how to run the business.
Time is critical in high tech, and if the development cycle
for any new product is too long, you are out of business. So,
when you ask me what could have helped me then, last year, or
someone like me just beginning, particularly in a difficult
economy, I would say that any program that would speed my
ability to pinpoint quality professionals in all the above
categories, with incentives provided to those professionals to
encourage their participation in helping me launch my company
at reduced cost to me and reduced risk to them, to help me get
off the ground faster, with the right support, and still have
enough equity after the first year to make a strong and healthy
company. This would be a tremendous help.
As it turned out, in the fall of 2000, I approached the
Boston-based Center for Women in Enterprise, and they
introduced me to the Springboard 2000 initiative. For those who
do not know, Springboard is a national series of venture forums
for women entrepreneurs that helps women close on the funding
required to grow their businesses. The Springboard 2000 New
England Forum directly resulted in IBEX landing its first round
of funding with Battery Ventures as its lead investor. It gave
me, as a woman entrepreneur, and IBEX, as a company, a chance
to make it on our own abilities and products through exposure
to VC's, investment bankers, management consulting firms, legal
services, both through the actual VC presentation I was
selected to present and through the preliminary coaching
sessions with representatives from the various support service
areas. I started IBEX with my technical network in good order,
and Springboard dramatically enhanced my efforts to develop the
business network that I needed. The same concepts that gave
rise to Springboard for a select few women's organizations
could greatly assist the arena of high-tech start-ups,
regardless of gender.
So, now consider that you have a large number of high-tech
ventures that may have survived through infancy to a point of
actual product availability, such as IBEX today. We launch our
products having met our first year deliverables with stellar
performance. We have beta tests with top tier semiconductor
companies that have been excellent in the results. We have been
sponsored by the International Summit Tech Consortium on those
beta tests. Our customers are delighted with our products and
understand that it really is a milestone and a leap ahead of
what is available today on the market and advanced process
control.
Unfortunately, we hit the ground running during an awful
market downturn. Our customers want our products, but cannot
buy them right now, with no significant turn-around expected
for 6 more months, minimum. So, now the company has fixed
costs; we have staff, we have a roof above our heads; we have
established support services, field support, et cetera, and to
survive this slow time, we want to continue to seed the market
with our products at reduced price, if necessary, and continue
our new product development, so that when the market turns
around, we are still in the race, because our larger
competitors are not going to stop development in advanced
process control. This means that we need to economize and raise
a lot less money at a lower market valuation than we originally
planned. We are not a fat organization, we are as slim as you
can get right now. So, economizing is really going to be a
difficulty.
IBEX, the toddler, has not reached its critical threshold
of product or customer development to change the market with
its novel approach and vitality. Small businesses like IBEX
have the ability and the incentive to adapt quickly and
innovate in a dynamic new marketplace. I believe these
companies not only serve to seed
larger companies with solid new concepts and products, but also
help offer the field's maverick scientists healthy and
innervating environments in which to be creative and
passionate.
We have extraordinarily high productivity, and perhaps one
of the things that I have not bulleted up there that is very,
very important, is that we are building a corporate culture
that is based on professional and personal integrity and mutual
respect. There are only 10 of us right now, and hopefully, we
will be able to maintain that kind of corporate mentality as we
become 100 or 1,000.
All these things serve to revitalize the industry and go
back into bigger parent corporations, and we small businesses,
trying to compete in the high tech world right now, do need
some help, whether it be fast access to reduced-rate support
services or to cash.
I hope my thoughts are helpful in bringing some light to
the difficulties that we face as young companies, and I thank
you for this opportunity.
[The prepared statement of Ms. Card follows:]
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Chairman Kerry. Thank you, Ms. Card.
Mr. Gnatovich.
STATEMENT OF ROCK STEVEN GNATOVICH, PRESIDENT, SPOTFIRE,
INCORPORATED
Mr. Gnatovich. Thank you, Mr. Chairman, for the opportunity
to submit this testimony. Let me begin by introducing myself.
My name is Rock Gnatovich, and I have worked in the software
industry since 1978. I have been in a founding capacity in
three start-up companies, all of which remain in business and
employ nearly 2,000 people.
I am currently employed by Spotfire, Incorporated. Spotfire
is an interesting story. The company was originally founded in
Sweden based on Dr. Christopher Ahlberg's Ph.D. research
conducted at the University of Chalmers in Sweden and at the
University of Maryland. As a result of that research, the U.S.
Patent Office has awarded Spotfire a patent in software
technology. At the time that I joined Spotfire in early 1998,
there was one employee other than myself in the United States
and 15 software developers in Sweden. The company had just
received its first round of U.S.-based venture capital funding
from Atlas Venture here in Boston. Since that time, the company
has established itself as a U.S. company operating subsidiaries
in Sweden and Japan, and has grown to 179 people, 109 of which
are in the United States, 5 in Japan, and 65 in Europe. Of the
109 in the United States, 71 are here in Massachusetts.
Despite these rather difficult economic times, Spotfire has
thrived by focusing on the pharmaceutical and energy
marketplaces where there are large concentrations of highly
trained researchers, engineers, and other technical
professionals that are facing very challenging tasks of having
to make high-value decisions by analyzing and understanding
mountains of data in very foreshortened timeframes. We call
these analytic applications.
The customer adoption of our solution over the past 3 years
has been very rapid. We now have 400 customers worldwide and
20,000 users of our products. Included in those customers are
all of the world's top 25 pharmaceutical companies and
approximately 150 biotechnology companies. Other prominent
names include Chevron, Texaco, BP Amoco, AMD, Texas
Instruments, Proctor and Gamble, Unilever, Mitsubishi Chemical,
and many others.
Many times, I will ask our customers how did they do with
the thousands of decisions that their company had to make that
day. Did you have a good decision day? Did you have a bad
decision day? Do you even know? It is our mission as a company
to empower the users of our product and the companies and
enterprises that they work in to make great decisions, and we
have been rewarded with an army of true product enthusiasts.
Here are just a few examples of how the product is used.
These examples are featured in the August 13 edition of Fortune
magazine. At Anadarko, which is the largest independent oil
services company in the United States, their exploration and
production professionals use Spotfire to determine where and
how to drill for oil. A new well is drilled every 5 hours and
has an average cost of upward of $5 million per well.
Associated with that decision to drill a new well are multiple
terabytes of data and information that need to be analyzed.
At Eli Lilly and at all the other pharmaceuticals, the
enormous challenges that they face in developing new drugs and
the huge bets that have to be made on new drug candidates have
been well documented. Spotfire provides these companies with
invaluable assistance in selecting a new candidate to move
forward and discontinuing a failed project early to avoid large
sunk costs.
In the semiconductor market, as represented in this case by
Texas Instruments, the semiconductor market is faced with the
costs and market challenges of getting a new product to a level
of manufacturing efficiency quickly in order to release it into
the commercial market. In this case, Spotfire provides these
knowledge workers with the means to explore information in a
way that leverages their expertise to identify both problems
and opportunities.
As a company, we are both interesting and unique in that we
were a global company from the start. This has been both a
challenge and an opportunity for us. Many large companies
continuously strive to understand how to serve a global
marketplace. For us, it was a logistic necessity from the
beginning. Harvard Business School has written a case study on
Spotfire that has been taught multiple times at the business
school and also here at MIT at the Sloan school on this very
issue of how to manage a global start-up.
I wanted to also spend a minute on how an experienced
entrepreneur manages the financial outlook of a venture-backed
software start-up.
By the way, I could not agree more on the distinction
between small business and entrepreneurship, particularly in
this case.
Entrepreneurs go to venture capitalists for multiple
reasons, but obviously high on the list is the immediate cash
infusion that allows you to accelerate the growth and
development of a company beyond the level that you can do by
bootstrapping the business. This cash infusion accelerates your
paths to the critical mass. It accelerates your ability to
capture market share, the ability of the company to fully
develop its offerings without having the benefit of an
immediate revenue stream and to recruit and retain some of the
most talented employees.
Spotfire will not be a profitable self-sustaining company
until next year, but I want to emphasize that that is according
to plan. At this stage in our development, we manage our cash
balances and are putting in place the processes and discipline
to continue to thrive in the future as a self-sustaining public
company. We want to be able to take advantage of the time that
we are private to make the investments in our customers, in our
products, and in our channels. We could not have achieved what
we have achieved in the timeframe that we achieved it without
the assistance of the private equity market.
My final point is that the United States represents the
critical consumer or business market for nearly every
international enterprise. There is significant cost and
complexity in trying to operate on a global scale when, as a
company, you are relatively very small. But, it is a necessity
to be able to address the world market and to do it in a way
that is both successful and responsible.
Ethically and morally, we have made attempts, even as a
small company, to be a positive contributor to the communities
in which we operate. We hope to be a large part in the
transformation of Somerville into an exciting venue for
technology start-ups and have taken a prominent position in the
business and social structure of Goteborg. The United States
remains an attractive venue for entrepreneurial endeavors, and
at the same time, it represents a base to address the world
stage.
Thanks again for the opportunity.
[The prepared statement of Mr. Gnatovich follows:]
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Chairman Kerry. Thank you very much, Mr. Gnatovich.
Let me come back to the threshold question. Both of you
have described interesting journeys, not yet complete,
obviously, but the immediate question that I want to try to
understand in the framework of the Small Business and
Entrepreneurship Committee and the Federal Government is the
role it should play.
You have talked about, Mr. Gnatovich, the first round of
financing that you got. What do you say to somebody who might
suggest, well, OK, that is a very traditional entrepreneurial
journey. If you have a product that has market acceptance or
for which there will be ultimately a demand, and you are ahead
of the demand curve or you are riding the demand curve, your
product is going to gain acceptability, and you will do what
companies have done traditionally, ultimately have an IPO and
go public and your stock will measure your success and
viability as you go on. Many companies have done that without
ever looking to the Government for any component of that
journey. Whereas, more recently, we have obviously seen
emerging relationships where people say, ``OK, France, Germany,
China, other countries are more aggressive, sometimes even to
the point of significant ownership.'' We wind up competing in a
much freer, more or less a fair marketplace. They are in a more
assisted/targeted kind of marketplace.
What do you say to us as we formulate larger concepts or
principles about how to approach this? Is there a role within
the
traditional restraints and guidelines of how we do business in
this country for us to be more aggressive, more pro-active, or
are there simply things we can do along the way to remove
barriers? How would you describe that?
Mr. Gnatovich. I would say that the way in which you are
going to get money into the companies is really through two
avenues. One is going to be investment funded research and the
other is avoidance of cost. So, in the first case, funded
research provided by programs such as DARPA can be highly
valuable and accelerative to, you know, to promoting a product
and getting it into the marketplace.
In our case, on the cost side, our customers are global
companies and they expect us to operate along with them on a
seamless basis, and issues in terms of the complexities of the
tax codes and the difficulty in the immigration areas, are
things that require us to put cost into the companies that do
not lend themselves to highly productive kinds of activities.
Chairman Kerry. So, you would see it as secondary or
ancillary issues, not necessarily primary, in terms of the
business development, itself.
For example, I was talking with Dean Schmalensee a moment
ago and we were talking about what they are teaching here at
Sloan now. He said that one of the things he tells his students
is that there is no such thing as an unregulated business.
Every business has a relationship with the Government, like it
or not, one way or the other. Some of those relationships are
environmental regulations, others are export administration
laws. I mean you can run through the gamut.
Mr. Gnatovich. Yes.
Chairman Kerry. The question that I am trying to get at is
here in Massachusetts, we had--one of our witnesses is a long-
term veteran of the Mass. Technology Development Corporation.
When I was Lieutenant Governor, I briefly served on that in an
ex officio capacity. We made business decisions about start-up
companies that had trouble getting credit, but which we thought
had a viable concept. They simply were on the lower end of the
food chain of what was most attractive for a fixed capital
pool. So, they came to the State, and the State, in fact,
invested in them, and there are a number of stories of
companies that went on to become stock exchange members, highly
successful, creating an enormous number of jobs; at which
point, as they grew, the State would sell out its portion and
not take any kind of management role or any sort of stockholder
role as a group. So, it was really a--it was seed capital, I
guess is what you would call it.
Mr. Gnatovich. Yes.
Chairman Kerry. Is there a larger role for the Government
in doing that without crossing the line of how we view our
marketplace?
Mr. Gnatovich. You know, I may be making a bad assumption
here, but I think that is commendable, but it is very
selective. It needs to be a broader kind of initiative, and as
a broader initiative, again, I would look at creating an
environment which funded research can be more easily
accessible, and again, where costs can really be avoided by
companies that really cannot afford to have that kind of
infrastructure in place in their early stages of development.
Chairman Kerry. How would you do that? Particularly with
respect to employees when you talk about immigration as a
critical component, what is the role that you foresee?
Mr. Gnatovich. I have to say that what we have to go
through in terms of just being able to move people back and
forth within our own company, it has to do with complexity. It
has to do with the complexity of the tax codes and the
complexity and problems associated with immigration.
I look at, to some extent, maybe the European community is
somewhat of an example here, that within the European community
now, things are flowing somewhat better. I am not sure that I
would hold it as a model yet, but between the boundaries of the
various countries within Western Europe, there is a lot more
free-flowing commerce and activity.
Chairman Kerry. So, what you are saying is if you are a
multi-national growing corporate entity like yours, where you
are not yet turning a profit, but you see it in your business
plan--
Mr. Gnatovich. Yes.
Chairman Kerry. But, you have people in one country who may
be essential to something you do in this country, there should
be a more seamless movement between them without the long-term
problems we face in terms of immigration.
Mr. Gnatovich. I think it goes to your distinction between
small business and entrepreneurial type ventures. Small
businesses maybe to some extent tend to be local activities and
are managed more by local government. Very few of the
entrepreneurial ventures that I have been involved in have ever
looked at anything less than the world as their marketplace.
Chairman Kerry. At what point, properly, do we sort of say,
``OK, we did our piece and now you are out there on your own?''
I mean, it is absolutely appropriate for us, I think, in terms
of the playing field, to work as hard as possible to eliminate
all encumbrances. That means, obviously, we have to be diligent
on market access. It means we have to enforce the trade laws,
we have to avoid dumping practices. We have to do all those
things where we are trying to leverage our ability to make the
playing field as fair and as successful as possible.
But, in terms of small business, itself, at the moment that
they are really small businesses, start-up status, et cetera,
what is the role that we should be playing or the SBA should be
playing, for instance? I mean, like Ms. Card mentioned, her
experience in terms of Springboard.
Now, I want to get you involved in this discussion, Ms.
Card. You talked about the pinpointing of quality professionals
and the need for exposure to VC's. Now, to some degree, the
Women's Business Centers and the entrepreneurial efforts of the
SBA have moved towards helping people do that. It occurred to
me immediately that if there is that kind of need, maybe there
is a nitch, I mean, maybe that is a service that small business
entities should grow and fill.
Ms. Card. Right.
Chairman Kerry. That there is a capacity for people to
provide that kind of pinpointing. To a certain degree,
obviously, there are entities that do that already.
Ms. Card. There are and they are up and coming, and
unfortunately, what is happening is that you have--
Chairman Kerry. Do you want to use the mike, maybe, so that
everybody can hear you?
Ms. Card. We have very limited resources, and basically,
everyone is asking for a share of the stock. Now, that is the
world, but generally, we do not have enough stock to be giving
it away to all of the incubators at the rates at which it is
being asked. I mean, that is why, you know, we are talking all
the time and on the phone all the time with the hope that
serendipitously, that we are connected to the appropriate
support services. If you have no time, you have no money, and
you basically are not paying your people that are working for
you because they really like the idea.
Chairman Kerry. Would a purist sit here and say to you,
``Well, if your product were viable enough, people would be
tripping over themselves to give you X amount more for whatever
the portion of stock is'' or they would finance you in other
ways?
Ms. Card. I think you are right, and I believe that we are
not asking for any assistance beyond the very difficult job and
working hard that we are expected to do. We are running in
right now at this moment into a situation that is really beyond
our capacity. We are out of money, we knew we would be out of
money. We expected that we would go into a second round because
our product is, proof of concept is there. We have a very good
relationship with our customers.
You know, what do you do at this point when you have no
money and you have great relationships and, you know,
Springboard has assisted us greatly. We are making alliances
now among other little companies with high tech innovative
products. So that, we as a little consortium can offer
something extraordinary that maybe is a good competitor for a
larger company. What we would be looking for, some assistance
there in innovating that approach. It is international. As Rock
has said, I mean, we are dealing with German companies and
French companies. We are 10 people, but it is recognized that
we have a high quality product.
You know, we are learning as fast as we can, and yes, the--
Chairman Kerry. So, it is a facilitation as much as
anything, that you believe is necessary.
Ms. Card. Right. I think that it is important for there to
be some thresholding and understanding that this is worth
investing in.
You know, my only comment about Springboard, as
extraordinary an opportunity as it was, only maybe a hundred
companies nationwide, women entrepreneurial companies, are
really benefitting by being selected to give that presentation
before the 400 VC's. Many more are being coached, but
nonetheless, it is a real culling out of the best.
Chairman Kerry. How would you then describe the role that
you think something like the SBA could do? For instance, could
the SBA, perhaps, have its own pool of qualified start-ups that
it feels are overlooked and it somehow convenes VC's?
Ms. Card. I do not have a problem with the idea of the SBA
doing a thresholding with good cause for investing in this
particular opportunity. For example, just this immediate one
which is sort of an economy crisis in the semiconductor market.
This is a good opportunity to say, ``Yes, this is a very
worthwhile activity.'' This company may not make it 12 months
on their stocks. They really need capital right now. Make that
decision and then go forward with it in just enough--with just
enough incentive to allow us to survive. That is what I am
really looking for.
Chairman Kerry. How did Springboard, very specifically,
make a difference to you?
Ms. Card. What was great was that they were bringing
together investment banking, VC's, legal professionals,
business consultants, to help coach a group of women to make a
pitch. For somebody like myself, I said I can do technical
presentations, that is no problem, but I did not know how to do
a business presentation.
Chairman Kerry. Really do a pitch, yes.
Ms. Card. During the coaching, Battery Ventures said, ``May
I talk to her now?'' I signed the terms sheet 5 minutes before
I walked out on stage in the Harvard Business School, and then
an hour later, we had a bridge loan from Imperial Bank. So, it
helped me tremendously in connecting me with the right
professionals here in town. Our key lawyers, in particular. We
have, you know, a lot of patents. We want good representation.
Chairman Kerry. So, we can do a better job, in your
judgment, of helping to marry entities and different skills.
Ms. Card. Right, and I would say that the effort that was
spent by the Springboard Committee and CWE here in getting
those people to come and share their time and their expertise
and finding the woman was extraordinary, and that is what made
it work. So, in fact, yes, they were doing a tremendous amount
of work.
Chairman Kerry. Interesting.
Mr. Gnatovich, do you want to add anything to that?
Mr. Gnatovich. Well, the other area that I wanted to
mention is the areas where we have sort of the infrastructure
working together and the role that the Government can play in
that. Silicon Valley is obviously one that is remarkable, I
think that the area right here around MIT is remarkable, as
well as RTP in North Carolina. To the extent that you can
create an environment that has a whole suite of inter-
connections between academic institutions, government
institutions, business institutions, that create an environment
in which small businesses can survive and thrive, is an area in
which the Government can play a more pro-active role.
One of our biggest challenges in going from basically 17
people to 180 people in a little over 3 years, you know, is
simply the recruiting of talented people in still a very tight
and difficult job market. The fact that the infrastructure is
here and the reason why we are here as opposed to anywhere else
has a lot to do with what surrounds the business. We could look
outside of our window and basically see many of our customers.
We certainly have the academic support from the institutions
here in Massachusetts, but then we look at that on an
international scale, as well.
Chairman Kerry. Sure.
Mr. Gnatovich. You look to find those centers of
infrastructure so your business will thrive.
Chairman Kerry. Well, as you all know, last year we passed
the visa program, H1B visa program, that allowed us to bring in
195,000 skilled workers from other countries. Now, apart from
the clear condemnation of our own education system that that
particular action sets out for all of us, I mean, it is a
damning statement when you figure that we really do not have a
worker shortage in America, we have a skill shortage in
America. The fact that we have to turn to some other countries
with educated people is a disgrace.
With that said, it reflects some awareness by the Federal
Government that we have got to find these folks in order to
make them available to people. Now, we could probably do a
better job. It seems to me that one of the things that comes
out of this is getting the Commerce Department, particularly,
to focus on sectors of our economy more specifically and do a
better job of analyzing current needs and perspective needs and
stay ahead of that curve a little bit, and we probably could
have better interaction between those conclusions and the
academic community. I mean, it tends to be pretty ad hoc, and
we go in these great swings. So, that might be something that
the Committee might look at a little bit.
What also leaps out at me, and I want to move to the second
panel because of the time constraints here, I think you both
laid out a good picture of two different entities and how you
have approached it; but the other thing that leaps out at me is
we probably also could do a better job of really putting
together a map, if you will, a road map of all the different
entities, all the different sectors, that have an impact. You
talked about sort of getting rid of the burdens and lifting the
side bars, for example, immigration, the tax base, et cetera,
and again, that tends to be pretty ad hoc. But, if we could
have a better sense of each step of the way that kind of blocks
the barricades that you run into, I think it would be helpful
for us in thinking about how we can facilitate as we go
forward, and I think we could try to do that with a little more
specificity.
Let me thank you both for putting these two examples on the
table and for doing what you are doing, and I would like to ask
the second panel if you would come up now, and we can sort of
pick up on this in a more general form.
So, if I could have Mr. Patrick Von Bargen who is the
executive director of the National Commission on
Entrepreneurship, whose study I have cited; George Gendron, the
editor-in-chief of Inc Magazine; and Mr. John Hodgman,
president of the Mass. Technology Development Corporation.
Folks, thank you very much for being here.
Patrick, do you want to lead off, and we will just run
across the table?
STATEMENT OF PATRICK VON BARGEN, EXECUTIVE DIRECTOR, NATIONAL
COMMISSION ON ENTREPRENEURSHIP
Mr. Von Bargen. Sure. Thank you, Mr. Chairman.
Before I begin on my substantive remarks, I would like to
take the procedural time to note that I have submitted
testimony for the record.
Chairman Kerry. Without objection, everybody's full
testimony will be placed in the record as if read in full. I
thank you for your summaries.
Mr. Von Bargen. First, I want to commend you as your first
act as Chairman of the Committee was to include the word
entrepreneurship in the new title of the Committee. I think
that sometimes the significance of that act is sometimes hard
to understand outside the beltway. But, it is, in fact, a
significant change. If you think about it for a moment--the
mental map of policymakers in Washington about the economy and
how business is structured--I think most policymakers know
there are the Fortune 500 big companies, there are medium size
companies that generally populate and fund trade associations
in every industry you can possibly imagine, and of course,
there is the very well organized traditional small business
constituency headed by groups like NFIB and the Chamber of
Commerce.
It turns out, though, that by putting entrepreneurship in
the title of the Committee, you have identified the most
important component on that economic map, and that is
entrepreneurial growth companies. They have not been on that
map because they are not a very organized constituency. They do
not spend much time--they do not have much time, as they are
busy building companies--getting involved with politics,
moreover, their timeframes are such that the company is either
going to succeed or fail within 3 or 4 years, which means major
public policy shifts probably cannot help their particular
company. So that is why they fly a little bit below the radar
of public policymakers.
But, notwithstanding the fact that they are not organized,
they are critically important. At the National Commission, we
use the fraction two-thirds a lot. If you look at all the data
out there about what these companies do, they create roughly
about two-thirds of all the new jobs in the economy. They
create well over two-thirds of the innovation in the economy.
Other studies have shown that when you look at differential
growth rates among countries around the world, two-thirds of
that difference is accounted for by entrepreneurial activities.
So this is a very high-leverage part of the economy that is not
on the Washington map. But you are helping put them on that
map, and you know better than I what a critical role these
companies play in the Massachusetts economy.
One of our most recent reports ``High Growth Companies''
pointed out that Boston is actually the No. 1 area among all
large metropolitan areas in terms of entrepreneurial growth
companies as a percentage of all business activities. So we are
here at one of the capitals of the country in that respect.
Now, I want to talk a little bit about the differences
between the entrepreneurial growth company ecosystem, if you
will, and small business, traditional small business, just to
highlight some of these policy areas that we began to uncover
with the first panel. First and foremost, let me talk about the
financial capital needs of these companies. There is a set of
growth stages that these companies go through, and capital
plays in each one of them. Start-up capital comes in the form
of personal savings, it comes from investment from friends and
family, it comes from signing up for every credit card you can
get your hands on, it comes from second mortgages you put on
your home, and that gets the company maybe up to $200 to
$300,000. Then you move into an early-stage phase, and that
early stage phase has to be filled typically now with
individual investors, sometimes called ``angel'' investors, or
sometimes seed capital funds very much like the Massachusetts
Technology Development Corporation would provide. Then the next
stage would be going to institutional venture capital, and then
finally to exit strategies for that institutional capital in
the form of IPO's and acquisitions.
But the key point here is that almost at every stage, these
companies are seeking equity and not debt, which is the
difference with small business. Where small businesses
celebrate the success of guaranteed loan programs which are
admittedly critical, entrepreneurs more celebrate the success
of SBICs. They celebrate the fact that the reason we have a
huge venture capital industry in the United States is that in
1978, the Congress changed a ERISA to allow public pension
funds to invest a small portion of their assets in venture
capital. They celebrate the creation of NASDAQ. Without NASDAQ,
we would not have the IPO market for entrepreneurial growth
companies. The challenge today in capital is this early-stage
area. There is a lot of venture capital out there. True, right
now, it is very slow on the pickup, but the urgent need is this
early-stage capital gap between $300,000 and $3 million,
roughly.
Let us talk a little bit about human capital needs. What
entrepreneurial companies need are incentives for managers,
technical staff, and even entry level employees to join their
companies as opposed to more established companies. The focus
is on attracting skilled employees, not controlling labor
costs. Whereas traditional small business might lament every
increase in the minimum wage, entrepreneurs talk instead about
tax-favored stock options and stock-ownership programs. They
talk about the national defense education programs of the
1960's and 1970's that created math and science graduates
throughout the country, and they talk about the H1B visa
program, for example.
The challenge today in the human capital area from an
entrepreneurial company standpoint is reform of the K-to-12
education system, re-instituting incentives to produce more
graduates in science and technology, and in a very specific
case, undoing some of the damage done by the alternative
minimum tax to incentive stock options.
Let us talk about other business assets, like equipment.
For small businesses, tax-expensing of new equipment purchases
is critical, but for entrepreneurial growth companies, the key
business asset, other than money and human capital, is the
creation and protection of new intellectual property--
intangible assets as opposed to tangible assets. Entrepreneurs
celebrate public investment in R&D, balanced patent and
copyright laws, and successful SBIR and STTR programs.
The fourth area is creating new markets, and expanding
existing markets. Those are absolutely critical to
entrepreneurs because they create entirely new business
opportunities. Whereas traditional businesses may fight for
better Federal procurement set-sides, entrepreneurs instead
celebrate the deregulation of the telecommunications market,
information-technology market, transportation industry, and
also insist on the expansion of U.S. exports around the world.
The challenge today for entrepreneurial companies is how will
entrepreneurial companies do in the shake-out in continuing
changes to telecommunications regulations and legislation, and
will there be trade assistance for smaller entrepreneurial
growth companies so that they can truly realize their potential
in global markets.
The final area is infrastructure needs. Entrepreneurial
growth companies depend on physical, legal, and social
infrastructure that creates an environment in which they can
thrive. Small businesses and entrepreneurial companies alike
lament complex Federal regulation, but entrepreneurial
companies also are concerned about continuing Federal
investments in the transportation system that connects them
with the global economy. Same with the communication system.
Also entrepreneurs urge the Government to do everything it can
do to support some of these local entrepreneurial networks that
we talked about a little bit in the first panel--those local
and regional networks that connect entrepreneurs with other
entrepreneurs, with investors, with suppliers, with potential
employees and with customers. Those are just absolutely
critical to successful entrepreneurial regions. Next month, we
at NCOE are going to be publishing a report on the importance
of networks and how networks can be started and maintained.
Interestingly, entrepreneurs also are generally favorable
towards sound environmental legislation because it creates the
clean air, clean water, and recreational opportunities that
they like to find in regions where they tend to congregate and
grow. Finally, laws that increase tolerance in diversity in
communities are quite important because entrepreneurial
companies want to draw upon all skilled people, no matter what
ethnic background they have, what nationality background they
have, their lifestyles or whatever, and they seek out
communities in which tolerance and diversity are strong.
So, in conclusion, by renaming the Committee, I think you
have done a great service to the Nation. Nothing I have said
here, I think, diminishes the importance of traditional small
businesses concerns. They are very important to the economy,
and you know that, and your record evidences that quite
adequately. But, by adding entrepreneurship, you really added
to the role of the Committee. I think the potential role of the
Committee here could be as a steward of the entrepreneurial
ecosystem in the country; that stwardship means examining every
Federal policy action, with one question in mind, ``Does it
help to maintain or enhance or expand entrepreneurship in the
United States?'' If the Committee looked at its mission as
playing that stewardship role, I think the value to the Nation
would be enormous.
[The prepared statement of Mr. Von Bargen follows:]
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Chairman Kerry. Thank you, Mr. Von Bargen. I appreciate
your comments very much, and I also thank you for your personal
stewardship of the commission, which I think has made a
significant contribution. Thank you.
Mr. Gendron.
STATEMENT OF GEORGE GENDRON, EDITOR-IN-CHIEF,
INC MAGAZINE
Mr. Gendron. Good morning, Mr. Chairman. Thank you for the
opportunity to appear in front of this Committee. For the past
few years, I have been editor-in-chief of Inc magazine, the
preeminent publication for founders and top managers of
America's premiere growth companies. Last summer, as we
discussed earlier, I made the decision to sell the magazine,
and as of last August, it had become part of the $17 billion
German media empire. But, despite that ownership change, the
magazine continues its mission of helping people create
professional and economic independence for themselves by
starting and growing their own enterprises.
I will do one thing that is most difficult for an editor
this morning, I will be very brief. I just want to make really
three points to you. The first is at the risk of sounding as if
I am disagreeing with some of the earlier panelists, I start
with the observation that the greatest misconception about
entrepreneurship today in the culture at large is the belief
that it is synonymous with technology. It is not. As important
as the technology may be to our national interest, it is only
one part of a vast mainstream entrepreneurial economy.
A corollary of this misconception is the belief that all or
most of our significant new businesses are venture backed. They
are not. For 20 years now, we have published Inc 500, an annual
ranking of America's fastest growing private companies. This
year's list, the 2001, is about to be released in a few weeks.
Of this year's Inc 500, half of them were started with $20,000
or less, 88 percent were initially funded with the founder's
personal assets, or what Patrick earlier referred to as friends
and family money. Only 3 percent of this year's Inc 500 were
venture backed at launch. We call this bootstrapping, and it is
this process that transforms human capital into financial
capital. It transforms hard work, ingenuity, innovation, and
risk taking in every part of the economy into the true wealth
of the community. I point this out because it is crucial for
this Committee to understand that the challenges and
opportunities of building a self-financed growth company bear
almost no resemblance to the challenges of growing a venture
backed firm.
Just to cite one crucial difference, in the interest of
time, the overwhelming majority of young virgin companies in
this country are completed unaffected by events and
developments in institutional venture capital or the IPO
markets. On the other hand, they depend utterly on access to
credit, both long and short term. I would urge this Committee
to include these objectives in examination of current
conditions in credit markets where even the most credit worthy
entrepreneurial borrowers are experiencing chronic
difficulties.
The second thing I would like to discuss briefly this
morning is the single most important development in the
mainstream economy in the past two decades, and Patrick
referred to it just moments ago. It is the growth of what we at
Inc refer to as the entrepreneurial social networks that have
been developing in this country. During the past 20 years, we
have created in the United States unprecedented levels of
knowledge about every facet, large and small, of how to grow a
business. The conventional wisdom is that this knowledge
resides primarily in the form of books, magazines, case studies
in universities, courses in entrepreneurship on our Nation's
campuses. This simply is not the case. The real know-how is
imbedded in the community, itself, in the knowledge possessed
by service providers, lawyers and accountants, bankers and
investment bankers, and principally experienced entrepreneurs
who have done it all before, often more than once.
For first time entrepreneurs--in fact, I think Judy
addressed this earlier this morning--increasingly, the
challenge at start-up is less a question of whether you
personally have the necessary skills and knowledge to launch a
new venture, but rather whether you can identify the people who
had that knowledge and experience and how to enlist them in
your cause. This meeting is taking place at the epicenter of
one such entrepreneurial network, MIT, in a city that is
blessed with one of the most fully developed networks anywhere
on the face of the earth.
One thing that is not well understood about the networks is
that they are self-replicating. Experienced founders, mentors,
young entrepreneurs, in formal and informal relationships, they
invest as angel investors in the next generation of start-ups.
Entrepreneurial cultures develop an entrepreneurial mindset
among their employees leading to spinoffs. Increasingly,
entrepreneurial companies developing managing practices and
training programs desire to build upon their employees not only
an entrepreneurial spirit, but the actual skills and talents to
go off and start their own ventures and approach the culture
building we at Inc refer to as open book management.
What this means for communities that have developed a
certain critical mass of entrepreneurial activity is that
entrepreneurship breeds entrepreneurship. Entrepreneurial
success leads the next generation of entrepreneurial success.
My final point is to talk just very briefly about the rise
of a new generation of what recently has come to be called
social entrepreneurs. It strikes me that the best and brightest
of every generation gravitate to that part of a culture where
they feel they can have the most impact, government in the
1960's, journalism in the 1970's, entrepreneurship and Wall
Street in the 1980's. But, recently, the best and brightest
have taken a new direction all together and have become what is
known as social entrepreneurs, creating new, young, nonprofit
organizations designed not to maximize profit, but to create
new innovative solutions to chronic social and cultural
problems.
Ten years ago here in Boston, two young graduates of the
Harvard Law School, Michael Brown, and Alan Khazei, decided to
forgo lucrative careers on Wall Street and instead launched an
organization many of us in town know well called City Year, a
domestic urban peace corps which transforms thousands of young
men and women into community leaders with the equivalent of an
MBA, and creating and leading community service projects
throughout the country.
In recent years, the number of young entrepreneurial
nonprofits operating in the United States has grown
dramatically, as has employment in the nonprofit sector. Yet,
for all of their innovation and for all of their passion, this
sector is plagued with an absence of resources and
infrastructure that we in the for-profit sector take for
granted. The result is that many new ideas and innovations
languish at the local level. Consider this: Every year, we see
thousands of young promising companies go to scale; in other
words, take an idea that has worked locally and bring it to the
national or international level. In recent memory, in our
lifetime, only one nonprofit has gone to scale, Habitat for
Humanity, and most observers agree that it would never have
been possible without the support of our former president,
President Carter.
It is time we as a nation understood that entrepreneurship
today is about more than the creation of financial wealth. It
is about getting important new things done. It is time we
focused on the need to create an infrastructure that will
support and sustain the entrepreneurial efforts of our
counterparts in the nonprofit sector, as well.
Thank you very much.
[The prepared statement of Mr. Gendron follows:]
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Chairman Kerry. Thank you very much, Mr. Gendron.
Mr. Hodgman.
STATEMENT OF JOHN F. HODGMAN, PRESIDENT, MASSACHUSETTS
TECHNOLOGY DEVELOPMENT CORPORATION
Mr. Hodgman. Senator Kerry, I would like to thank you and
your Committee for holding this hearing in the Boston area
regarding the needs of entrepreneurial companies. My testimony
will address the issue of risk capital needed by these
companies.
My name is John Hodgman. I have been the president of the
Massachusetts Technology Development Corporation since 1984.
MTDC is a state-chartered venture capital firm which focuses on
very early-stage technology companies located in Massachusetts.
Since its inception in 1978, the corporation has invested about
$47 million in 111 companies, leveraging $14 of private capital
for every MTDC dollar, and the internal rate of return over
these 23 years is about 18.2 percent.
MTDC concentrates on companies that fall into a chronic gap
in the venture capital marketplace. These firms usually have
the following characteristics: They are raising relatively
small amounts of capital, they are founded by technologists who
are first-time entrepreneurs, and they are initially pursuing
small market segments.
There are two factors that cause this gap. The first is how
long it will take for companies to reach an exit that will give
investors a return. If the harvest period exceeds 5 to 7 years,
the rate of return may not be attractive enough for typical
venture capital firms. The second is the amount of money the
company is raising. As funds that venture capital firms manage
have grown to hundreds of millions of dollars, these firms have
set high thresholds for minimum investments. Start-up companies
seeking less than these threshold amounts fall into the capital
gap.
Let me illustrate. Since 1995, the capital gap has widened.
One way to measure this is to look at the size of the average
venture capital investment per deal. Between 1986 and 1994, the
average deal size each year consistently ranged from $1.8 to
$2.9 million. Then between 1995 and 1997, the average deal size
grew from $3.9 million to $4.3 million. Finally, in 1998, 1999,
and 2000, the average deal size ballooned to $7.3, $11.1, and
$16.7 million, respectively.
At MTDC, we generally consider the upper end of the capital
gap to range between 30 to 50 percent of the average deal size.
From 1986 to 1994, companies raising less than $1 million fell
into the capital gap. However, during the last 3 years, we
found the upper end of the gap had risen to $4 million.
The more venture capital dollars that become available, the
more difficult it has been for early-stage companies to raise
smaller amounts of money. Between 1995 and 1999, this problem
was addressed to a large degree by individual investors.
However, since the stock market meltdown, individual investors
have abandoned early-stage investing.
In the next few years, it appears that the venture capital
industry is evolving as follows: There will be stable firms
managing $300 million to $1 billion each. There will also be a
large number of newer firms managing $50 to $300 million, of
which a significant number appear to be unstable. There will
also be a relatively small number of experienced firms managing
$25 to $50 million and a much larger number of newer firms
managing $5 to $25 million.
This environment presents several challenges for all of the
smaller venture firms that focus on early-stage investment. I
would like to use MTDC's experience and perspective regarding
one of these challenges which is efficient fund raising by the
venture capital firms, themselves.
Our mission is to help companies get started and grow. We
have a policy of co-investing with private investors.
Therefore, we are very concerned about the health of the early-
stage venture capital industry. The major challenge all the
early-stage funds face is how to raise appropriate size venture
capital pools in the most cost effective way. These funds or
pools range from $20 to $50 million and they need to be secured
every 3 to 4 years. Historically, senior venture capital
partners in smaller firms have to effectively shut down
investing every few years and spend up to 2 years raising $1 to
$5 million from smaller institutional investors and individuals
to put these funds together.
As a matter of public policy, it would benefit all
stakeholders if there were mechanisms to encourage the
consistent placement of smaller size investment funds within
the nationwide network of venture capital firms that focus on
start-up and early stage companies. This would help the
professionals to focus on company building, not fund raising.
It would also help to supply a steady stream of growing
companies that might at some point attract the interest of
larger venture capital firms. These new companies would
continue to provide new job opportunities for both new entrants
to the labor force and experienced people who are dislocated by
virtue of the downsizing of larger companies.
Whether the mechanisms are created using tax policy, risk
mitigation strategies, or ``jaw boning'' by public officials,
is really in the domain of you and your colleagues. However, I
believe that addressing this chronic capital gap is a priority
you should carefully evaluate.
Thank you for listening to my testimony, and I would be
happy to answer any questions.
[The prepared statement of Mr. Hodgman follows:]
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Chairman Kerry. Thank you, Mr. Hodgman. Thank you. I want
to take a moment just to say thank you for your tremendous
contribution to the Commonwealth and to the economy through
your years of service. I think it has been a great success
story and I was pleased to be there at the beginning of it.
Mr. Hodgman. Indeed. As I said earlier, this is a bookend
because I retire in 2 weeks. I am actually going to be teaching
entrepreneurship, both for profit entrepreneurs and social
entrepreneurs at Tufts University.
Chairman Kerry. Terrific. They will be lucky to have you
doing that.
Mr. Hodgman. Thank you.
Chairman Kerry. Come back to those, the whethers, whether
it is this or that that we might engage in. What are you
suggesting that we do specifically to address that gap in
capital?
Mr. Hodgman. Let us look at the goal. The goal is to get
smaller size funds raised consistently. To some degree, the
SBIC program has offered this opportunity, and interestingly
enough, there are incentives that will cause, for example,
banks, to invest in SBIC's because they receive CRA credit,
where they might not like to or that might not be a priority
for them. So, I think if you took the SBIC mechanism and
started to look more closely at what size funds you would like
to see generated around the country, what the network ought to
be, how predictable the fund managers might look at this source
of capital. I think some engineering here might help.
Chairman Kerry. What kind of incentives, other than the
CRA, SBIC might you envision?
Mr. Hodgman. There may be some tax incentives that could be
offered to investors who put money into these particular funds,
so that they can tolerate the lower rate of return that is
driven by the time of the investment, or some risk pool
strategies. The SBIC does this to some degree with their
approach.
Chairman Kerry. Is it a function, is the gap a function of
just the time and slow return and cycle, and therefore, it is
more attractive to people to manage a larger amount and get in
in second stage or third stage?
Mr. Hodgman. It is a lot easier to raise larger funds.
Plus, your management fees are much higher if you raise larger
funds.
Chairman Kerry. But, are not the larger funds also paying
out those funds at a rate that is determined by the
availability of deals that they find attractive?
Mr. Hodgman. It is, and frankly, in the last 3 years, we
had much too much money going into venture capital pools. $151
billion nationwide over the past 3 years, $15 billion in
Massachusetts, alone. Those numbers, incidentally, in 3 years,
were almost three times more than what went out over the
previous 12 years nationwide and in Massachusetts.
What is wonderful about capital markets is that they self-
correct. We are self-correcting with a vengeance right now, but
the whole system has been distorted at this point.
Chairman Kerry. What is the role of the Government in terms
of that? I mean, is not that the marketplace that is subject to
those distortions?
Mr. Hodgman. Absolutely, and I would not suggest that the
market should be altered, except to take some lessons learned
from that experience and look at what is needed to make the
availability of funds at the seed and early-stage level,
consistent, not fluctuating up and down. Just keep it
consistent, no matter what goes on with the larger fund
raising.
Chairman Kerry. Given the success of the MTDC, should there
be some kind of small business program, that was to some
degree, the new markets venture initiative that we started, I
guess, a few years ago, or have been pushing for. Is that an
appropriate role?
Mr. Hodgman. I do not know enough about the new markets
initiative to be able to use that as a model. MTDC actually got
its initial funding through the U.S. Department of Commerce
Economic Development Administration setting up a revolving loan
fund. That was about $3 million, and then the State provided
another $5 million, and we have grown that to over $30 million
in assets.
So, there are some programs that could be used to try to
seed some of these funds, but I think that the bigger challenge
is once you have got these funds up and running and they have
been successful and they have a track record, raising that next
$20 to $50 million that you need every couple of years becomes
the real challenge.
Chairman Kerry. Mr. Gendron and Mr. Von Bargen, what do you
think in terms of the Federal role here, particularly the SBA's
small business focus?
Mr. Von Bargen. I think the idea just discussed is a very
good one. In fact, to some extent, that was the conceptual
notion with the new market venture funds. That bill, of course,
was targeting even tougher areas in which to get
entrepreneurship going, but using the risk mitigation
capabilities of SBIC's and community development fund structure
to pull that off. I generally endorse those ideas, and if that
could be paired with tax incentives to move more capital into
this seed gap area through the kind of mechanisms that we just
discussed, I think that that might make a lot of sense.
Chairman Kerry. Do you draw a line, any of you, that it is
perhaps appropriate for us to create a framework which may draw
the capital, but we should not be making decisions with respect
to the capital? Now, that is different from MTDC. You made
decisions.
Mr. Hodgman. Yes, but I think setting the framework makes a
lot more sense because, you know, MTDC represents a very small
amount of money. What we are trying to do is leverage private
investors. So, if you can create a framework that could get
private investors more interested in this segment, it is going
to help across the board.
Chairman Kerry. What do you think, Mr. Gendron? You have
written about this for a long time and observed it.
Mr. Gendron. I was thinking about the program created by
Governor Blanchard in Michigan in the late 1980's in which, not
unlike the MTDC, but with a very specific goal of building in
the State of Michigan a long term private sector venture
capital presence that simply never existed before, particularly
to fund young technology conduits that were servicing the
automotive sector. That was a really intelligent, highly
leveraged use of public funds, and it went beyond trying to
pick winners in this particular case and achieved a relatively
extraordinary degree of success in adding a component to the
infrastructure that simply did not exist before his tenure.
Chairman Kerry. Well, we should take a look at that. We
will go back and sort of pull it out and see how it might be
applied here.
Are there any other steps we should take with respect to
the bootstrapping versus equity?
Mr. Hodgman. Well, one point I want to make is that MTDC is
a venture capital firm in terms of its operation, but we do
something that most other venture capital firms do not do, and
that is meet with entrepreneurs at very, very early stages,
when they have a draft business plan. We will critique the
plan, will arrange for them to make presentations in the
technology capital network. We do a lot of the behind the
scenes support, introducing them to consultants and advisers. I
think this was stated earlier and it is extremely important in
company building for people who have never started businesses
before. They need this network of coaching and assistance and
capital at critical stages.
Chairman Kerry. Do you think--yes, you wanted to comment?
Mr. Von Bargen. On the bootstrapping question, I think
there are a number of companies that have actually begun to
sell product and actually make some profit, but have the
potential to grow substantially, and they may not fit the
venture capital investment profile because their candidates for
initial public offering is not the case or acquisition path is
not obvious to see, but they would like to continue to grow in
funds. There are proposals in draft legislation right now that
would allow companies at that stage, that are profitable, to
defer Federal income tax paid for some period of time up to
some amount, so that they could use their earnings to re-
invest and the company to grow. That is a proposal we might
take a look at.
Chairman Kerry. Well, I think that is valuable. I think
what comes out of this this morning is the notion that there
are obviously different missions, different roles, at different
stages here which we could look at without violating, I think,
sort of the arm's length notion again about not picking winners
and losers, but just adjusting the framework, tweaking the
framework in ways, for instance, there is certainly a response
to what Ms. Card said about that early networking and
availability, clearly SBA's role, it seems to me. Under its
umbrella, technical assistance that already exists is to
broaden the technical assistance component to be doing a much
better, job maybe to even have a division targeted towards
start-up entrepreneurial efforts versus the traditional mom and
pop smaller entity that may not have growth aspirations. Those
really are two different kinds of companies, they are two
different kinds of approaches and two very different kinds of
prospects.
Then, of course, there is the credit/bootstrapping issue. I
mean, how effective is CRA? How well are people implementing
it? How much are some of these banks that have consolidated
maintaining small business portfolios and access in their
lending? There has been the same instinct in banks, we notice,
to start dealing with the larger portfolios because it is
easier. Same amount of time for the loan officer, same amount
of paperwork, better return on investment, so people turn off
helping the small business person.
I think we can do a lot to help energize people's focus on
the start-up case. I have talked to a lot of friends in the
community, and the numbers of deals crossing their tables, you
know, for their decisionmaking versus the numbers they actually
get engaged in are just staggering when you think about it. I
mean, literally.
Mr. Hodgman. Usually, it is about 3 to 5 percent of the
total.
Chairman Kerry. So, obviously, there are a lot of ideas out
there, but again, that is the nature of the marketplace, too. I
mean, people are going to grab good ideas.
I have to, unfortunately, truncate this discussion, and I
apologize for that, but schedule demands that I have to be
somewhere else in the city. We are going to leave the record
open for 10 days, and any of you here in the audience who feel
that you have a comment that is relevant or an observation that
could add to this discussion, there is a form outside at the
desk when you leave, and that will instruct you as to how you
can, in fact, contribute to the public record with respect to
this. So, if you pick that up on the way out and submit that
within the 10-day period, we can review and include your
comments in the record of this hearing.
It is an interesting issue. In the last 10 or 15 years, Mr.
Gendron sort of talked about the cycles, have put an enormous
focus on
entrepreneurship, and I think the public imagination has been
excited by it. I mean, it is sort of a new era, as the
Commission report points out, it is a new era of respect for,
and even, sort of admiration and envy for the most successful
of the entrepreneurial efforts of the last decade or so, not
just for the wealth created, but for the impact on people's
lives and concepts. One could argue that there is really a new
age of acceptance of that kind of entrepreneurial activity.
There are many ways that I think we could harness its energy
more effectively, and that is the purpose of this effort, to
figure out how we can perhaps leave it less to lady luck or to
just the few who are successful to expand the market, to expand
the job base and the tax base, and ultimately, the upside of
the technological productivity increases that come with it for
all of us. So, it is a worthy quest, I think, and we are going
to continue to travel down this road and see how it comes
together.
So, I thank all of you for your testimony this morning. It
has been helpful and instructive, and it has begun to set some
guidelines for how we might proceed as we go down that road. I
really would welcome very specific notions from anybody about
how the Committee might either begin something new within the
framework of the SBA or other entities, the Commerce
Department, Export Administration, other places which touch on
these efforts, or how we might augment current efforts that are
already underway.
The SBA, I might add, has moved on its own to sort of begin
to cope with a lot of these issues, and I think it is doing a
much better job than it did previously in helping to provide
some of the networking that Ms. Card talked about.
So, we will leave the record open for 10 days. I thank
everybody for being here today, and the hearing is adjourned.
[Whereupon, at 10:55 a.m., the Committee was adjourned.]
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