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How Government Can Stop Killing Innovation and Start Encouraging It

Posted by Bob Warfield on February 16, 2009

The US prides itself on being the world’s innovator, but the US government has been working overtime in recent years to kill innovation.   Consider things like Sarbanes Oxley or the way our patent system works.  Both are set up to work against innovation.

Sarbanes Oxley was created in the wake of the Enron disaster to protect investors from similar kinds of problems involving malfeasance by company management.  It’s called the Public Company Accounting and Protection Act of 2002.  There’s just one little problem with SOX: it makes it dramatically harder for companies to go public.  The average newly public or about-to-be public company spends $6 million getting itself in shape for SOX and another $3 to $4 million each year thereafter.  For a company that’s barely making a profit, that’s a lot of money.  It delays profitability until substantially later, forcing companies to grow much larger before they can go public.  How does this impact innovation?  Going public is a liquidity event, one of the driving reasons investors put up venture capital for new ideas.  Without the possibility of IPO, many companies have to look to already public companies to acquire them.  As a result, VC James Patricof recently moved from a $30B fund to a $75M fund.  He’s accepted that the landscape has changed, and that startups need to plan for $20-$100M exits instead of IPO’s.  If this is the future of venture capital, as Patricof believes, there’s going to be a lot less capital to go around, and a lot less innovation as a result.  Note that all this is part of the Law of Unintended Consequences for a bill that was designed to protect the public from companies like Enron.  Just before it went down, Enron was booking revenue of over $100 billion dollars.  That’s billion with a “B”.  Yet the government in its infinite wisdom is penalizing all comers of all sizes with the same treatment.  The end result is that small companies are penalized much more severely than large companies.

Another area that works against small companies is the current patent system.  VC Fred Wilson says Patent Trolls are a tax on innovation, and he’s right.  But wait, the patent proponents say.  Patents are there to protect the little guy.  Without them, big companies could steal their ideas blind.  There’s just one problem: the big companies can defend themselves and the small ones can’t.  The patent code favors big in two ways.  First, Patent Trolls are gaining access to what are essentially bogus patents.  These are not patents associated with any going concern business that’s creating jobs.  They can’t be, because the best patents for the Trolls are overly broad patents that never should have been granted anyway.  A typical example would be a patent on any system that applies rules to databases.  If SQL statements aren’t rules, I don’t know what are, yet such a patent exists and it was filed after SQL was well established.  Evidently the USPTO is incapable of distinguishing good patents from bad.  Trolls love these broad patents because they can go after anyone and everyone with them.  The second half of the Patent Troll business is the asymmetry of coverage provided by the system.  Put simply, it tremendously favors the plaintifs over defendants.  This in a country with a constitution that states we are innocent until proven guilty.  I’ve been involved with patent trolls before, and attorneys advised my company that it would cost us $1 million just to get to trial.  The cheapest route at that point would be to prove we did not infringe the patent.  If we have to try to get the patent thrown out, that will cost millions more.  The cost to a Patent Troll to bring a case to court?  A couple of hundred thousand dollars.  When the Troll wants $500K to go away, guess what the answer is?  There is no point fighting it as it will cost twice that to get to trial, much more to finish, and the outcome is uncertain.  Trolls like to bring suit in the backwaters of Texas were a jury of your peers has no clue what’s being discussed or how obvious the Troll’s “invention” may be.  Trolls also like to attack small companies.  It helps them to establish precedent and build their war chests to go after bigger prey.  But the reality is that Big Companies can defend themsevles while Small Companies are at the mercy of these characters.  Fred Wilson says one of his portfolio firms recently spent 10% of their round of financing fighting off a Troll.  How does that help innovation in any way?

But there is a new sheriff in town in the form of Barack Obama.  Various parties are crowing about how the stimulus package is finally geared towards High Tech and Innovation.  The NY Times writes:

    What oil was to President Bush, some say, clean energy and technology are to the Obama White House. “We have a president who gets it,” said Dean Garfield, the president of the Information Technology Industry Council.

We’re giving $7B for broadband, $19B to automate healthcare record keeping, and billions more to create a “smart grid” for energy distribution.  What does it all mean?  Is this innovation?  In a word, “No!” 

Start with the broadband.  It’s largely about delivering broadband to rural areas, so the Department of Agriculture (a real hotbed of innovation) is getting almost half the money right up front.  There are no speed requirements at all, leaving the Federal Government free to declare victory however it likes.  This is pork.  You may as well consider it the Internet to Nowhere and put it up alongside Alaska’s Bridge to Nowhere.  Sure we’d love to make Internet access ubiquitious.  Will this package actually do that?  I won’t hold my breath.  And meanwhile, what does it do for non-rural areas?  Absolutely nothing. 

Contrast that with a plan by South Korea to spend $24.6B dollars, create 120K jobs, and deliver 1 Gigabit per second internet connectivity to the entire country.  Which one sounds more innovative, and more likely to spur innovation to you? 

Smart Grids?  Automated Online Health Records?  These don’t sound like innovation either.  I debated whether to even start in on the Stimulus Package until I read a series of exchanges by the Enterprise Irregulars.  They snapped me out of feeling like a curmudgeon and into seeing pork for what it is. 

Sam Diaz says Silicon Valley is finally getting some respect from the White House, but that isn’t it at all.  The companies that are going to benefit from this package are not Silicon Valley companies, they’re big tech companies.  IBM, Fujitsu (not even a US company), and similar large companies are the ones commonly talked about.  We’ve replaced the Bush administration’s pets like Halliburton with a few slightly more techie names that are still giant corporations.  This is not helping the little guy or innovation.

Why all the emphasis on the Small Companies, BTW?  Because that’s who creates the jobs.  That’s who innovates.  Isn’t that what we need right now?  More jobs?  More Innovation?  Look to Small Companies, not big ones to do that.  Take a look at this chart, for example:

jobcreationsmall

That gigantic spike in job creation all the way on the left is courtesy of Small Business, and represents the vast majority of jobs created from 1987 – 2005.  President Obama, if you can’t get the Small Sector fired up, how do you expect to replace all the jobs the economy has lost so far (not to mention those yet to come as more shoes drop)?

Tim O’Reilly has it right when he agrees with this Twitter quote about the origins of success and failure:

    “privatize success (by chalking it up to individuals) & socialize failure (by blaming it on large systemic problems).”

Obama and the Rest of Government, take note of what you’re doing to Innovation and give us back a system that favors the Individual Innovators in Small Businesses and quits forcing Failure.  Do what you want with the stimulus package, it’s pork already promised, but reform the patent system and get rid of Sarbanes Oxley except for companies with at least $1B in revenues.  You’ll be amazed at what it’ll do by way of turning things around.  And it doesn’t cost anything at all compared to what the stimulus package itself costs.

Related Articles

Suddenly, startups and the stimulus package are an exciting topic.   LinkedIn’s Reid Hoffman on Techcrunch asks Obama Claus to give us Small Business Loans, No limit on H1B visas, and Matching Funds for VC’s and Angels.  But Reid misses the bigger point: availability of capital is a non-issue if liquidity is available.  Which brings me back to the point of this post.  Eliminate SOX for small companies and make liquidity easier and you’ll have private capital moving to the sector in droves.  You don’t have to pay for all this from the taxpayer’s pocketbook.  Fix the incentive side and the capital side fixes itself.  That’s how capitalism works.

Awesome post by Todd Dagres pointing out the linkage between SOX, the lack of IPOs since SOX, and the impact on innovation.

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8 Responses to “How Government Can Stop Killing Innovation and Start Encouraging It”

  1. sinclairschuller said

    Bob,

    Great post. This summarizes so many issues. One thing I would add is the notion of establishment of precedent. I see where you were going with the “Contrast that with a plan by South Korea to spend $24.6B dollars, create 120K jobs…” example, and although it’s “better” and allows for “innovation”, the deal breaker for me is that it sets precedent and that’s a deal breaker. It’s essentially the benevolent dictator problem. A dictator is not so bad if the dictator is benevolent and immortal. Unfortunately, a dictator fills a post. A government based on a dictatorship has established precendent for this style of government. Once the benevolent dictator leaves that post, who replaces them? What if its a bad dictator? You now have centralized massive failure.

    In the case of South Korea, injection of capital may be good in this one case, but now that the precedent of massive resource allocation has been set, what happens when the next architected allocation is poorly implemented? You get centralized massive failure affecting everyone. The beauty in your small business chart is the isolated failure mechanics. Imagine it was inverted and that spike was with a single huge company. What happens when it fails? Everyone is affected. I fear any sort of broad stroke centralization. It’s centralized mainframe vs a shared-nothing architecture. We should take some lessons from distributed computing!

  2. smoothspan said

    Sinclair I hear you. As I said, I’m not trying to change the pork barrel package at all. I’m just trying to change the system so it favors innovators more.

    With that said, that pork barrel is huge, and it is going to happen whether we like it or not. Whether it is setting the precedent you fear and making a benevolent dictator, it’s a done deal. It’s a pity it wasn’t done a little better.

    Cheers,

    BW

  3. darrellross said

    Ah, don’t get me started on the stimulus and the misguided notion that EHR (Electronic Health Records) is the cure-all to the inefficiency in our health-care delivery system.

    In conversations with Healthcare IT execs, EHR is small potatoes when you look at the overall value chain. There are other factors that we should address, such as impact of the payor organizations like BC/BS, Aetna, etc. and how they reimburse providers and hospitals. New predictive analytics to detect fraudulent medical claims are showing huge ROIs, moreso than the claimed ROIs for EHR.

    I urge your readers to actually read (or skim) the entire stimulus legislation. When I read the 768-page version that exited the Senate the first time, it had over 150 pages devoted to healthcare IT – thats over 20%. It was very detailed, even specifying how hospitals would be reimbursed (by us taxpayers) $200 per discharge if they use the gov’t-specified EHR format.

    Nay…..EHR isn’t to improve the economics of the healthcare delivery system. Nope…..its to set a foundational piece for nationalized healthcare. But that is a different conversation.

    Good post Bob. Thanks!

    Darrell Ross
    http://www.enablus.com

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  5. logicshop said

    You raise some very good point here. I agree that the U.S. economy has been drifting away from innovation and new business for quite awhile now, and that nothing in the economic stimulus package fixes the U.S. economic machine. I’m glad that you’re talking about South Korea, because they are cornering the market on successful capitalism.

    I do not agree that IPO is the answer for all new business, but it’s true that the less appealing it is for investors to put money into start-up companies the fewer start-up companies will ever get a chance to succeed. Eventually investors will simply stop looking at new companies as options (which has *almost* happened) and we will be left with an entirely M&A based economy, liquid capital will dry up, the middle class will shrink down to a tiny merchant class, and we’ll be left with the feudal system of old.

    There are two truly frightening things about that possibility: First, that it is already so close to being a reality; Second, that other countries, such as South Korea, are doing well with alternate systems of capitalism and will have no need to join us in a regression to feudalism, should we continue our slide. What I’m saying is: if we don’t want to end up sliding way down the wealth and influence ladder on the world stage then we need to get our investor + entrepreneur = innovation system working again, and quickly!

    requisite plug:http://logic-shop.blogspot.com

  6. [...] extremely quickly and with relatively little capital.    Liquidity ain’t what it used to be post-SOX, but it just hasn’t been that long since Google and it’s peers were created to declare [...]

  7. [...] him?  SOX and all the other regulatory changes meant to curb a few excesses like Enron (which BTW, was WAY larger than any tech startup when they caused their problems) have slammed the lowest common denominator.  And, unless I am sadly confused, Wall Street just [...]

  8. [...] him?  SOX and all the other regulatory changes meant to curb a few excesses like Enron (which BTW, was WAY larger than any tech startup when they caused their problems) have slammed the lowest common denominator.  And, unless I am sadly confused, Wall Street just [...]

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