Access to Capital: The Great Income Inequality Accelerator

Access to capital has been one of the great income inequality structures in the United States. The legal compliance cost of getting public money through a public offering (an initial public offering or IPO) or even a private offering, to do it properly, is prohibitive for those not already rich. Access to low interest bank loans and commercial paper is available only to the biggest of the big. Trading companies with commercial banking affiliates, thus access to Federal Reserve lending rates, have huge advantages, particularly when you add supercomputers, with short-length fiber links directly to stock exchange servers, and self-actualized programmed trading capacity (AI). And if you are a small, minority-owned business, no one seems to care when you are on the ropes. 

The problem is compounded by a legal system in which the only stakeholders in corporations are the shareholders. Left out of this statutory equation is any fiduciary responsibility to the community, society and national priorities, the employees or the environment. Other countries have added statutory stakeholders beyond shareholders, a 21st century necessity. Not us. 

If you’re big enough, especially if designated an essential industry (the automakers) or “too big to fail” financial institutions (commercial and investment banks in the last Great Recession), the government will step in with bailout money. But as the recent “too little, too late” COVID-19 stimulus checks, the ill-constructed renters’ “benefits” (everyone still owes the money, just deferred; eviction still looms) generated in many states, suggest, if you just happen to fit into the wrong category, or when those benefits stop, you lose. 

How about those angles investors or venture capitalists, those legendary early-stage investors that have defined the Silicon Valley? Great if you have sufficient expertise or credibility to access them – an Ivy League or equivalent network – but good luck. Most applicants will not even get to the front door. 

Further compounding and further distorting the capital markets is the withdrawal of government research money from the nation. Thus, privately-supplied risk R&D capital is only following exit strategies, generally an IPO, within 3 to 5 years. Niche segments get ignored. You will note that loan sharks do not exist for the rich, only for those at the bottom of the economic ladder. Take away quality public education and upward mobility and what do you get? The United States of America! 

Whatever else is said and done, recovery from this pandemic – when it gets under control which will hopefully happen no later than 2021 – is going to need a ground-up reworking of our economic structure. We’ve already learned that when companies are left to being self-regulated, they talk a good game, but they really will not spend money for that social good. That “duty to shareholders” thang. We now know that massive tax cuts for the rich generate little more than massive useless increases to the federal deficit. The money did not go where Congress thought it would. For most of entrepreneurs (particularly small businesses) who are not sufficiently self-funded (almost everyone), the starting place is angel investors and venture capitalists. 

Elizabeth McBride, a freelance journalist and founder of the Times of Entrepreneurship, writes for the June 17th MIT Technology Review: “Venture capitalists sell themselves as the top of the heap in Silicon Valley. They are the talent spotters, the cowboys, the risk takers; they support people willing to buck the system and, they say, deserve to be richly rewarded and lightly taxed for doing so. 

“The image, however, doesn’t strictly match the history of the Valley, because it was ‘the system’ that got everything started. After Sputnik launched the space race [the first satellite launch by the Soviets in 1957], the federal government poured money into silicon chip companies. Historian Margaret O’Mara documents this well in her book The Code: In the early 1960s, the US government spent more on R&D than the rest of the world combined. While that fire hose of cash flowed, the first venture capitalists found many winners to bankroll. 

“The link to government is still very much there in today’s technology companies. Google’s early work came out of the Clinton-era Digital Libraries project at Stanford, and the CIA was Palantir’s first customer in 2003—and its only one until 2008. 

“O’Mara says there isn’t anything wrong with tech companies’ being built through US research dollars. In fact, she argues, the most important decision of that era was for the government to pour money in without exerting too much control. But, she adds, a mythology has grown up that focuses on lone heroes and rule breakers rather than the underlying reasons for a company’s or technology’s success… 

“Susan Choe, the founder of Katalyst Ventures, is an investor in Zipline, whose drones deliver medical supplies in poor countries where infrastructure is lacking. It’s valued at more than $1 billion. She also pointed me to All Raise, an organization that promotes women in venture capital. It reported in 2019 that a record 54 women became VC partners, though 65% of venture capital firms still have no female partners. 

“‘Change is being driven by the fear of being left behind,’ says Choe, who says that limited partners—investors—in her funds include executives from outside the US. Millennials tend to be drawn toward more diverse teams, too, she says… She is among those who make the case that venture capital firms overlook products and services that cater to ignored communities or create new markets. ‘Investors are leaving money on the table, and they are missing innovation because the people that are running these VCs cannot relate to the preferences of people that are living outside their experiences,’ says Lisa Green Hall, a fellow at Georgetown’s Beeck Center for Social Impact & Innovation and former CEO of Calvert Impact Capital. ‘In the white male culture ... those cultures are extremely narrow. For women and people of color, those cultures are much more expansive.’… 

“People who really study innovation systems ‘realize that venture capital may not be a perfect model’ for all of them, says Carol Dahl, executive director of the Lemelson Foundation, which supports inventors and entrepreneurs building physical products… In the United States, she says, 75% of venture capital goes to software. Some 5 to 10% goes to biotech: a tiny handful of venture capitalists have mastered the longer art of building a biotech company. The other sliver goes to everything else — ‘transportation, sanitation, health care.’ To fund a complete system of innovation, we need to think about ‘not only the downstream invention itself, but what preceded it,’ Dahl says. ‘Not only inspiring people who want to invent, but thinking about the way products reach us through companies.’… 

“So how can that change? The government could turn on the fire hose again, restoring that huge spray of investment that got Silicon Valley started in the first place. In his book Jump-Starting America, MIT professor Jonathan Gruber found that although total US spending on R&D remains at 2.5% of GDP, the share coming from the private sector has increased to 70%, up from less than half in the early 1950s through the 1970s. Federal funding for R&D as a share of GDP is now below where it was in 1957, according to the Information Technology and Innovation Foundation (ITIF), a think tank. In government funding for university research as a share of GDP, the US is 28th of 39 nations, and 12 of those nations invest more than twice the proportion the US does. 

“In other words, the private sector, with its focus on fast profits and familiar patterns, now dominates America’s innovation spending. That, Dahl and others argue, means the biggest innovations cannot find their long paths to widespread adoption. We’ve ‘replaced breakthrough innovation with incremental innovation,’ says Rob Atkinson, founder of the ITIF. And thanks to Silicon Valley’s excellent marketing, we mistake increments for breakthroughs. 

“In his book, Gruber lists three innovations that the US has given away because it didn’t have the infrastructure to bring them to market: synthetic biology, hydrogen power, and ocean exploration. In most cases, companies in other countries commercialized the research because America’s way of investing in ideas hadn’t worked… The loss is incalculable. It is potentially enough to have started entire industries like Silicon Valley, perhaps in areas that never recovered after the 2008 recession, or communities that are being hardest hit by the coronavirus. 

“World Bank economists determined that in 1900, Argentina, Chile, Denmark, Sweden, and the southern United States had similar levels of income but vastly differing capacities to innovate. This gap helped predict future income: the US and the Nordic countries sped ahead while Latin America lost ground. It’s been easy to dismiss people who say America is now more like a developing country than a developed one. But if the ability to solve society’s problems through innovation disappears, that may be the path it is on.” 

There is a reason there’s such an emphasis on software. Not only are we dealing in a data-driven world plus a universe where artificial intelligence offers analytics and control, but the earliest stages of writing code and developing conceptually functional structures are less capital intensive than biotech experiments or constructing complex automated machinery. We really need a lot more hard-science applications, as the uncontrolled outbreak of COVID-19 has clearly evidenced. 

Our woeful unpreparedness for the current pandemic is our metric for a failing capital allocation system based on a 19th century laissez faire “self-directed capitalism is king” assumption. There was no global climate change then. Polluted toxins being released into our ecosystem were not even on the radar. And the recent political proclivity to reduce or eliminate government spending on education, infrastructure and research has deeply, and possibly permanently, undermined our nation’s once-preeminent role as the world’s most technologically innovative nation on earth. 

I’m Peter Dekom, and a nation predicated on limited innovation into software or military hardware cannot expect to maintain any semblance of global greatness.