IP and its crucial role in start-ups

Virgil Cojocaru is a JD candidate at Osgoode Hall Law School.

These days governments are funding private sector enterprises. The public purse is increasingly used to aid businesses. However, many questions remain about the effectiveness of such a strategy. Josh Lerner, in his book, Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed — and What to Do About It tries to address the issues surrounding this topic. In an interview posted on the Freakonomics – New York Times Blog, Lerner comments on the complexities decision makers face in today’s environment. It is not merely a question of ‘to fund or not to fund’, but rather who, how, and when.

Central to Lerner’s ideas is creating the right environment for business. Handing out money is just the beginning of a very long process, and without the right environment leads to failure. What is the right environment? This can be illustrated through the development of Silicon Valley in the first half of the 20th century. In those days, the US government ensured the right environment for entrepreneurship through subtle policy decisions. For instance, Stanford University was a source of technology. However, local financiers were the source of capital. What bridged the gap between these two worlds? Generally speaking, it was taxes and contracts. Taxes are meant to stimulate entrepreneurs to start new business. Contracts reinforce the relationship between a source of technology, such as a university and an entrepreneur.

Contracts require consideration. What is consideration in this case? Surely, not just the prototype, but rather the rights associated with it. This is what the entrepreneur buys and markets from a source of technology, such as a university, and what will ultimately be used to gather private funds from financiers. Intellectual property and the effectiveness of patents become crucial. Perhaps in hard times, we should not just think about government money and funding, but rather consider intellectual property law reform. The law and intellectual property play a critical role in the business cycle, and hence are a vital component of creating a fertile environment for public funds.

This is just part of the story. Lerner points out that government funds played an important role. They accelerated the development of the area in the early 20th century through contracts for specific projects. If a project would fail or develop too slow the funding was cut—this is the nature of contract work. This is part of the understanding that programs that promote entrepreneurship need flexibility; sometimes they need to be terminated. It is important to also note that the government only provided funding once these firms were already in place largely as a result of existing policy, law, and initial private funding. The critical role of intellectual property law, such as patents, cannot be overstated.

The public purse is only meant as a catalyst. It is not a substitute for start-up. This explains why Lerner values venture capitalists. They serve the role of early financiers—funding young or restructuring firms and “providing a layer of insulation” between entrepreneurs and government. This helps tackle two thorny issues: inappropriate/inefficient allocation of funds and agency problems. Venture capitalists provide an indication of what the market thinks is a good investment; government should follow those signs. This assures that funding is not distributed ineffectively and top down, but rather according to the market’s judgment. Venture capitalists can also reduce the agency problem because as investors their judgment is based on performance. This makes it a lot harder to set up an entity that will misuse public funds.