No Such Thing as Too Much Seed Capital Availability (Reprise)

A while ago I wrote that there is “No Such Thing as Too Much Seed Capital Availability."  I have been asked a bunch of questions (offline) by folks about this idea and am speaking about it tonight.  The biggest question has been whether this is really an area for government involvement (whether city, state or federal).  I believe the answer is an emphatic yes but I want to elaborate on this a bit.

The key here is that every startup generates benefits that do not accrue to the investors.  In the last post I had mentioned the experience gained by the entrepreneurs.  But the human capital benefits don’t end there.  All the employees and even the service providers accumulate knowledge and experience that outlives the startup.  It goes even further though by having people who have worked together as a team, which means that they are much more likely and capable to work together on a new opportunity.

In fact, much has been written about how there is a significant network effect that occurs when you reach a sufficient density of startups.  For instance, AnnaLee Saxenian examined the differences between Silicon Valley and Route 128 and identified network effects resulting from density and attitudes of startups as critical.  Bijan has pointed out repeatedly how non-competes in the Northeast have been blocking some of that network effect.  Critical here is the recognition that in a network effect setting there is significant value to the network that is not captured by the individual participant.

So we have a classic situation that is a variant of the Tragedy of the Commons.  The usual textbook illustration for the Tragedy of the Commons is overgrazing of public farmlands and there is a lot of real life evidence of this happening with overfishing in the world’s oceans.  This of course happens whenever you have negative externalities, which means that there is a cost that is not born by the individuals taking the actions.  In the case of startups it is the other way round.  There are powerful benefits that are not reaped by the individual startup.  The net result of that is there is not enough startup activity if society relies on individual incentives alone.

As a society, we have agreed that there are areas where this type of "underproduction” is so severe that the government needs to intervene.  The biggest one is of course national defense, but we also see this need for basic research and education.  Given the problems that we are facing in the economy and the environment, I believe that we cannot afford to have an “underproduction” of startups.

If you believe that, then the question becomes what government should do about it.  I had a number of suggestion for New York City on this in my previous post.  Another possibility that I did not mention would be a public-private partnership to create an entity similar to YCombinator (which has just announced that it will be Silicon Valley only), Techstars or DreamIt.