SmoothSpan Blog

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:

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.

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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.