How to Really Spur Innovation (Or Why You Shouldn't Listen to Venture Capitalists)

While a comprehensive national plan to spur innovation sounds good, the devil is all in the details. Any such plan must be based on a comprehensive understanding of the innovation ecosystem, and its multiple inputs, in order for it to have the impact that is desired.

Posted by Teryn Norris on December 15, 2008 at 6:05 PM

By Victor W. Hwang
Managing Director, T2 Venture Capital

There is much talk today about the need to invest in innovation. Saying this will not make me many friends, but I'll say it anyway: you really shouldn't listen to venture capitalists. Asking a typical venture capitalist to tell you how to enhance innovation is like asking a football player how to manufacture modern athletic footwear. The truth is that most venture capitalists don't really know why the American innovation system works the way it does; they just think they're really smart.

Smart government policy generally tries to smooth out inefficiencies, but venture capitalists like inefficient markets. Inefficiency means there is imbalance in a system, which means someone can make a profit by "arbitraging" that inefficiency (in simple terms, "buying low and selling high"). Thus, when you hear most venture capitalists opining about how to stimulate innovation, their ideas generally emphasize subsidies for existing market leaders: tax credits for R&D or infrastructure development or investing, government as a major customer, government risk-sharing for private capital, etc. What is not being discussed, however, is more important: what policies will create a level playing field for all innovators, not just help the large players win bigger? The stereotype of innovation in America, after all, is about the little "garage startup" that competes with and ultimately brings down the entrenched old boys.

It is in vogue now to assume that simply spending more on scientific research into renewable resources -- a so-called "Manhattan Project" for energy -- should lead to increased innovation that will accelerate our nation towards energy independence. Such an assumption, however, would not be entirely correct.

In a unique way, innovation derives from an ecosystem of multiple inputs. This is a well-documented phenomenon, including famously by academics such as Annalee Saxenian and Michael Porter. Innovation is not just about the quality and amount of science. Innovation depends on the existence of risk-seeking capital, fearless entrepreneurs, skilled supporting professionals, and a strong social network that links all of them together in a "frictionless" ecosystem. On top of that, innovation requires a culture that supports risk-taking, a willingness to allow people to fail over and over again without any social stigma or loss of faith that the next time (or the next next time) might just be the home run. Government stimulus of innovation can be extraordinarily useful, but only if done in a smart way, that truly understands the nature of innovation and how to affect its multiple input processes. Policies to enhance innovation should be grounded in smart, practical solutions, not abstract theories.

So, what's "broken" in the innovation system? It is not necessarily a lack of technologies. While there are always more scientific discoveries to be made, there is already today a backlog of scientific innovation that is waiting to be "commercialized", or turned into commercial products. Therefore, while increasing funding for scientific research can be useful, such action alone does not go to the heart of the problem, which is that commercialization requires a bunch of other things to work in concert.

Here are a few of my ideas for addressing the holistic "bottlenecks" in the innovation ecosystem:

1. Capital formation. The Federal government should sponsor the creation of a "fund-of-funds," a pool of capital that invests in smaller venture capital funds addressing underserved markets, including geographical areas, sectors, and stages of development. This fund-of-funds can be evergreen, which means that it can be an independent nonprofit entity that recycles proceeds back into future investments. The market today has failed to make sufficient risk-capital available, for instance, that targets Midwestern or Southeastern research universities, despite the fact that many of the nation's top research institutions are not necessarily in California or the Northeast. Such a fund-of-funds should be managed by professional gatekeepers and use market-based incentives for managers.

2. Putting the right talent in the right places. Doctors are subsidized to practice in rural areas, presumably since there is a dearth of doctors who voluntarily move to such communities. Why not put skilled entrepreneurs in the heart of research institutions to help find new scientific breakthroughs and turn them into commercially viable products? These "entrepreneurs-in-residence" would be like a geek version of Americorps, sponsored with modest Federal funding, and fill a gaping need in research institutions where few skilled business people dare enter. A smaller version of this idea is being run successfully by the University of California.

3. Mind the gap. The Small Business Innovation Research (SBIR) program, despite its lack of notoriety in America, is the world's role model for how government can fund proof-of-concept projects to jump the commercialization gap. The $2 billion SBIR program needs to be updated for the 21st century. SBIR should be made permanent and have its budget raised from 2.5% to at least 3% of total research spending by agencies. Applications should be evaluated year-round and quickly, as innovation does not wait for government cycles. Program managers should have more discretion in setting award sizes. Technical assistance should be expanded, so that more intensive business mentoring and training programs can be provided to even more awardees to overcome the enormous cultural, social, and intellectual divides ("network failures") between science and business.

4. Go for big gambles. Innovation is a numbers game: there will be far more failures than successes. There are some risks that may be worth taking from a societal standpoint but that no single venture capital firm would take. The Federal government has one program that acts like a venture capital firm for the nation: NIST's Technology Innovation Program (TIP). TIP and its predecessor program. ATP, have been quietly doing their work since 1991, and there is no other government program with the institutional expertise to roll the dice competently on big, audacious projects. TIP should be funded generously.

5. Carrots and Sticks. The Bayh-Dole Act is what gives universities the right to commercialize intellectual property generated from Federally-sponsored research. Bayh-Dole, in theory, has a "use it or lose it" approach, so that universities are required to move forward aggressively in commercialization. In practice, however, universities usually move slowly or not at all, since university officials have nothing to gain and much to lose by moving as quickly as the market demands. Congress should add teeth to Bayh-Dole's "use it or lose it" philosophy so that universities that do not actually consummate a transaction on a particular technology within a certain timeframe will lose their right entirely.

While a comprehensive national plan to spur innovation sounds good, the devil is all in the details. Any such plan must be based on a comprehensive understanding of the innovation ecosystem, and its multiple inputs, in order for it to have the impact that is desired.

Victor W. Hwang is Managing Director of T2 Venture Capital, a venture firm that invests in spinouts from universities and government research programs. Victor is a Kauffman Fellow. Victor was formerly the President of Larta Institute, which manages commercialization programs for Federal agencies. He earned his A.B. from Harvard University with Honors and his J.D. from the University of Chicago. His email address is