Academic Angle. State as provider of capital & more

The lack of sources of funds for enterprises is often identified as the principal impediment to the growth and development of entrepreneurship in many countries. That conclusion is not without its merits. There is an increasing view among economists that well developed financial systems lead to flourishing industrial sectors.

But then this is another area where entrepreneurship differs from the more traditional well-established industrial sector. Entrepreneurship needs a lot more than just funding for it to develop. That, in turn, impacts the public policy approach to entrepreneurship development.

Unlike the typical institutional investor in a venture fund, which mainly seeks financial returns, the State assumes the role of an investor in pursuit of larger policy objectives such as promoting start-ups or enabling enterprises to grow more rapidly. In his book Boulevard of Broken Dreams , Joshua Lerner argues that the State has to think of measures to encourage the creation of enterprises if funding initiatives have to realise their objectives.

Such support to entrepreneurship could be through encouraging the creation of enterprises by having a conducive legal framework; providing access to ideas and technologies; making it attractive for investors to fund enterprises; and augmenting the availability of capital itself. We will examine each of these in some detail.

Entrepreneurs will be encouraged to start up when the legal framework is conducive. This means that the legal compliance to start an enterprise, scale it up or down or, in unfortunate circumstances of poor business performance, to close an enterprise should not be cumbersome. The term legal framework refers to all statutes and regulations that impact the functioning of a start-up enterprise.

Entrepreneurs need access to ideas around which they can start enterprises. In a well developed innovation economy those who develop ideas or invent products are not always the best equipped to commercialise them. This is where entrepreneurs step in.

For this division of labour to work well, there needs to be a legal framework that will enable cutting edge technologies that are developed by universities and research centres to be transferred easily and smoothly. The Bayh-Dole Act in the US is held up as an example of such a law.

In an evolved entrepreneurial ecosystem, both experienced executives and freshers from colleges start new ventures. But the opportunity cost of being an entrepreneur is high for well-paid executives. A tax regime that sets off losses from start-ups against wealth and income from other sources can potentially encourage well-paid executives to give up their jobs to turn to entrepreneurship.

The task of providing venture capital is often managed through investment funds. The structuring of funds is an intricate discipline. As noted in an earlier part of this series, it is seen as a factor that has contributed to the success of the venture capital industry. The regulatory regime should provide for fund structures that will be tax efficient and will enable both investors in the funds and the fund managers to protect their respective interests.

Governments could consider augmenting the supply of risk capital through a variety of institutional mechanisms. But for the Government’s role as a source of funds to be effective it has to address the first two aspects above of encouraging entrepreneurship. Capital helps enterprises invest in manufacturing capacity, service delivery capabilities and technology. It is just as important for them to conduct business without hassles.

While there are no theoretical frameworks on how to design a policy for the State to effectively play its part as an LP, there are lessons that can be learned from experience elsewhere in the world. In the next part of this series, we will examine related some lessons of experience from across the world.

(The writer is Chairperson NS Raghavan Centre for Entrepreneurial Learning at IIM Bangalore. Views expressed are his own.)

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