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20 Responses to “JumpStart makes the NYT”

1. Valdis Says:
   July 25th, 2008 at 4:47 am

   $400M into JumpStart?

   Great idea, Ed.

   Why don’t we round it off to $500M and do it now!

2. Bill Callahan Says:
   July 25th, 2008 at 1:02 pm

   Here’s a question I’ve been meaning to ask someone…

   Do I understand correctly that JumpStart investment comes with the requirement (or strong suggestion) that the business plan include an “exit strategy”, i.e. a point at which the company will either go public or seek to be acquired by another firm?

   In other words, are JumpStart companies required by the terms of the financing to plan to eventually shed their original local ownership? And if so, what’s supposed to keep the jobs these companies create (with the help of state tax money) in the region?

3. Bill Callahan Says:
   July 25th, 2008 at 1:04 pm

   Incidentally, wrt to inventing other uses for the $400 million that won’t buy a convention center — I think I’d just like my money back, thank you.

4. J Murray Says:
   July 25th, 2008 at 1:58 pm

   Bill, it’s a standard part of a business plan to discuss the way that investors will be repaid. There are basically three choices: 1. An IPO; 2. A sale of the company; 3. A recapitalization that could either be an infusion of cash by new financial investors, or a management buyout. There are no other choices.

   The objective of JumpStart investments is to take ideas and turn them into companies that are appealing to venture capital investors. It is therefore logical for business plans to include a discussion about exit strategy. This tells potential investors that the company founders and managers have considered the interests of the investors they will be soliciting and that the interests of the parties will be aligned, i.e. the intent of an investment is to make money, not to create jobs (which is a desirable, but corollary benefit).

   The objective of company founders is to turn their ideas and sweat into cash, not to cling to ownership indefinitely. So it isn’t that JumpStart requires companies “to eventually shed their original local ownership,” as you would have it. It is that the people who start companies want to be able to sell them (or sell shares in an IPO) in exchange for cash that they can then use as they see fit–to plan for retirement, pay for children’s college tuition, donate to the endowments of their universities, donate to charity–and to forevermore be able to choose whether or not and where to work.

   Whether JumpStart existed or not, this dynamic would remain the same.

   When companies are sold, there is always a risk that some or all of the jobs in them will migrate. There are ways to mitigate this risk, but it cannot be completely prevented. Businesses have their own logic–being close to customers, suppliers, natural resources, etc.–that drive these decisions. The best way to ensure that the activities of JumpStart and others produce permanent benefits to the local economy is to make sure that the entire ecosystem is robust, producing many companies and jobs, and attracting as many companies as are relocating elsewhere.

   For instance, this region is now attracting a number of medical companies that are moving here from elsewhere. Just this week, a Portland, Oregon company announced plans to relocate here. Previously, New Jersey and Florida imaging companies have decided to relocate here Why? Because of the cluster of customers, employees, suppliers, capital, and support resources that exists in Cleveland for these activities.

   There are other reasons for companies to stay or relocate here. Prime office space in San Francisco is $300 per square foot, and $18 in Cleveland. A starter home in Silicon Valley is $1 million or more, and is $300,000 in this region. $1 million buys you a very nice house indeed here.

   We’re part of a global economy, like it or not, and this is how it works.

5. John Ettorre Says:
   July 25th, 2008 at 2:08 pm

   Jonathan is at his best when, as here, he’s explaining something he knows intimately. One small addition: I believe that the Third Frontier funds (of which Jumpstart gets some) come with some type of requirement to either keep the company HQ’ed in the state, or pay a penalty. Can Jonathan or anyone else confirm and/or amplify that?

6. J Murray Says:
   July 25th, 2008 at 2:22 pm

   John, I can’t speak to any requirements attached to funds received by JumpStart. The Third Frontier obviously has as an objective the bolstering of the state economy. The terms of individual grants tend to vary situationally. For instance, it is typical for investment firms that receive state of Ohio monies in various forms to agree to some standard, usually “best efforts” to invest that capital in Ohio. Similarly, companies that receive state monies through the Third Frontier or Ohio Department of Development typically make some type of commitment, and the terms of such agreements may contain penalties for failing to fulfill the commitments.

   The structuring of such agreements requires a delicate balance. The terms can’t be so onerous as to inhibit the functioning of the recipient, yet the use of proceeds must be generally directed to support of the state economy.

   The important thing to note, though, is that early stage companies are usually in a particular location for a specific reason–founder preference; support infrastructure; access to research institutions; access to talent; etc. Whereas the factories that the state used to funnel money to for retention can easily pick and move, early stage companies are usually rooted in a place for a reason.

7. John Ettorre Says:
   July 25th, 2008 at 2:47 pm

   Thanks for that enlightenment, J. These are the kinds of issues Jumpstart can address itself, and soon. I’m told they’ll be unveiling their own blog very shortly. I’m looking forward to reading it.

8. Bill Callahan Says:
   July 25th, 2008 at 4:24 pm

   Jonathan,

   I think your answer to my question was, basically, “Yes, that’s right.” Right?

   “The objective of company founders is to turn their ideas and sweat into cash, not to cling to ownership indefinitely.” Really? People don’t start their own businesses in order to own and run them any more, but simply to create cash-out opportunities? Do you think this is widely communicated or understood by policymakers or the public when they’re asked to appropriate big chunks of tax money to fund venture capital operations “to create Ohio jobs”?

   “… early stage companies are usually in a particular location for a specific reason – [for example] founder preference…” My point exactly. “Founder preference” as a location factor makes little long-term difference if the founder is expected to leave the decision-making seat after five or ten years.

9. Justin Balck Says:
   July 25th, 2008 at 5:32 pm

   As I understand it, limited partners in private equity funds know and understand that 2% of their money will go towards operational costs (salaries, infrastructure etc) and that 20% of profits will be kept as well.

   Is there a similar limitation for Jumpstart? My concern is that far more than 2% of our tax dollars are being used to support salaries and infrastructure.

   Even if there is no “carry” of 20% on profits, we end up in the situation discussed on the RTA thread - bureaucratic institutions not concerned about outcomes but solely focused on entrenchment of their jobs.

   Perhaps, accessing private funds to deploy our tax dollars would be more efficient.

10. Ed Morrison Says:
    July 25th, 2008 at 8:08 pm

    Justin:

    You are touching on one of the main issues I have with JS.

    JumpStart is not a new idea. The Massachusetts Technology Development Corp. is the grand daddy. It’s been around since the late 1970s. Because the MTDC is state-owned, it is not structured to earn a return for private investors.

    (The MTDC was founded in 1978 from an initial grant of $3 million from the Economic Development Administration. An additional $5 million was granted by Massachusetts.)

    JS has well over 20, as best I can figure. (There’s no single listing of staff.) Instead, there’s a Management Team (5 people), an Acceleration Team (another 6), a Development Team (2), an Exchange Team (4), an Inclusion Team (another 1), an Investments Team (another 2), an Operations Team (another 4). That’s a lot of baggage, given the size of their investment portfolio.

    The MTDC has seven staff members. MTDC is self-supporting based on returns from previous investments.

    I’m not sure how JS gets to sustainability. To me, it’s a flawed design.

    Not too many regions would put up with a gold plated VC operation like JumpStart. (Compare the Youngstown Business Incubator.)

    But as long as the foundations are willing to put their money in to support operations, JS can keep going.

    But would I rather invest public dollars in JS or a convention center? JS is at least changing the conversation about NEO. (In contrast to the convention center, my guess is that JS at least has a business plan.)

    The rub, of course, is geographical. County dollars probably need to stay in Cuyahoga County, and that may be a problem.

11. J Murray Says:
    July 25th, 2008 at 8:28 pm

    Bill, my answer to your question is “No.” No investment “comes with the requirement (or strong suggestion) that the business plan include an “exit strategy.”” It is an understood and accepted part of venture capital financing that the company is being built for sale or an IPO. Most business plans contain this section before they ever appear at JumpStart or a VC firm. People who don’t want to do it this way don’t seek venture capital investment.

    Only 1% of businesses in the U.S. are financed by venture capital. (These businesses have a disproportionately positive impact on the economy, providing most of the growth in wealth and jobs). My comments about the motivation of company founders apply mostly to businesses seeking venture capital or similar types of financing. They intend to sell them from the get-go.

    Other people may start companies to run them for life and leave them as legacies for their heirs. These are called “owner-operated” or, more colloquially, “Mom-and-Pop” businesses. There is nothing wrong with these types of companies and they are an integral part of the economy. They just aren’t suitable for investment from venture capital firms.

    You seem to imply that there is something wrong with people buildilng companies to sell them. Without this activity, there would be no growth in the economy or in jobs. There would be no Silicon Valley. Compare the U.S., which encourages entrepreneurship and economic dynamism and has created 18 million jobs and countless wealth in the last half-dozen years, with France, which discourages entrepreneurship and has a moral distaste for wealth creation, and has a stagnant economy, high unemployment, and little class mobility.

    You also seem to suggest that there is some “good” associated with founders running companies ad infinitum. Frequently the people who start companies are unsuited for running them once they grow bigger. Entrepreneurs are often quirky, creative, and intuitive. These are good talents for creating technologies, products, and companies. Larger enterprises typically require managerial excellence. Some entrepreneurs grow into being managers, some do not, and some don’t want to. There is no particular “good” to having people who start companies run them indefinitely. The transition from the founder to professional management may be much faster than five or ten years. It may be two or three. Even when a founder is no longer the CEO, however, he or she remains a significant shareholder and may take on another role in the company. Often founders become CTO’s or VPs of R&D. That may be where they belong.

    By that time, however, the company may have enough links in the region to root it in place and make it undesirable to relocate. As I said before, however, we live in a mobile, global economy. You can’t prevent companies from moving. The key isn’t to focus on each individual company, but to create lots and lots of companies and to create a vibrant region that attracts companies from others areas so that, on balance, the region is a net creator and gainer.

12. Justin Balck Says:
    July 25th, 2008 at 8:41 pm

    Ed:

    My opinion mirrors yours and was cemented when the PD publicized the bloated salaries of several economic development groups within Cleveland.

    Combining this with the region’s CONTINUED slide into irrelevance, despite nearly a decade of operation by these groups, makes me want to look for another way.

    Your focus on education may just be it. It seems just too long term. People (myself included) get excited about shiny (empty) buildings and self-promoting surveys that chart the region’s “growth.”

13. Ed Morrison Says:
    July 25th, 2008 at 9:00 pm

    Justin:

    I am also focused on applying open source models of innovation to economic and workforce development.

    Our experience so far has been promising. I think we can launch many more innovations with a lot less cost and a lot faster through these models.

    We are now applying these models to the emerging cluster of fresh water technologies in SE Wisconsin (Milwaukee) and in Indiana with an exciting Indiana Energy Systems Network.

    In sum, I think the JS model is a first generation innovation model (with roots back in the 1970’s). At places like Purdue, The University of Akron, the University of Wisconsin-Milwaukee, and Penn State University, we are defining “what’s next”.

14. J Murray Says:
    July 25th, 2008 at 9:03 pm

    Justin, JumpStart is not a venture capital fund with a carry. Their business model was developed with a lot of input from a lot of people including, as Ed points out, those who fund it. JumpStart is modeled after the very successful Innovation Works in Pittsburgh, and is now being emulated by other regions.

    The stage at which JumpStart is investing is generally earlier than private funds will invest. Without JumpStart, the great ideas and energy of regional entrepreneurs would either be untapped or would be exported to other regions that do provide support for nascent ventures.

    Whether the model will ultimately be successful remains to be seen. It’s an experiment worth conducting, however, given the alternatives.

15. Bill Callahan Says:
    July 25th, 2008 at 9:21 pm

    Jonathan, this thread started with a suggestion (not by you) that a lot of county tax money be directed to JumpStart. As it stands, JS got something like $12 million from the state Third Frontier fund last year, including over a million dollars in operating money. So we’re talking about investing public money, which would seem to make “For what public purpose?” a reasonable question.

    Saying “No, there’s no exit strategy requirement, that’s just what’s expected and it’s what entrepreneurs who seek venture capital always plan on anyway” is a little disingenuous, don’t you think? In fact, JS’s web site does currently list such an exit strategy as one of the key elements of an application for its help, and I believe it used to state it as a flat-out requirement. If that doesn’t at least amount to a “strong suggestion”, what would?

    But look: What you’re saying is that investing, building equity, selling and moving on (”serial entrepreneurship”, yes?) is the business model for which venture capital is most useful. I believe you, and I don’t have any problem with that. My question is: If you assume that companies built with JS investment are mostly going to be sold (to bigger companies, or to the public) when they’re big and successful enough, where’s the return to the state/region/county if there’s not a high probability that most, if not all, will continue to operate here under the new owners?

    I’m not saying there’s something sacred about founders running their companies forever — just that a model that discourages local founders from continuing to run the companies they create probably lowers that probability.

    Your answer is: “create lots and lots of companies and to create a vibrant region that attracts companies from others areas so that, on balance, the region is a net creator and gainer.” Sounds cool. Of course, JS could be using lots of local public and philanthropic money to help create lots of companies whose assets and operations will end up enhancing the vibrancy of Arizona or Szechuan, and whose entrepreneurs will take their newly created wealth — well, wherever they feel like going. Nothing is more mobile than cash, after all.

    Do you really think these are not legitimate questions to raise about a publicly funded business development strategy?

16. J Murray Says:
    July 25th, 2008 at 11:58 pm

    Bill, good discussion and good questions. Thanks for being inquisitive, rather than dogmatic. I’ll try to respond to your questions and concerns.

    I’ll start by saying something that would seem to be obvious, but that nobody seemed to be considering when I started saying it ten years ago. “We know what the consequences of doing nothing are. More of the same.” The strategy that was in place for three decades here was clinging to the past. The consequences were decline, foolish “investments” in failing industries,a generation of children going east or west to school and jobs and never coming back, and a loss of entrepreneurial vibrancy and the wealth it creates.

    Your fears about companies leaving are rooted in those years and in the views that developed then. Companies left because innovation in them died and they became solely focused on production. (We still cling to the magic of “manufacturing” and “manufacturing jobs” in our public and political discourse on this subject). The only way forward for those companies was to lower costs, and that meant moving.

    Innovative companies, alternatively, are created and rooted in the regions that nurture their innovativeness. Virtually every medical company here–of the very many being created or relocating–has a considerable relationship with the Cleveland Clinic. For most medical companies around the country, the Cleveland Clinic is the first or second largest customer. A company in which the Clinic has an interest–whether an ownership stake or inventors who work there–isn’t likely to relocate, because an acquiring company would be reluctant to irritate one of its largest customers, and the Clinic is clearly committed to nurturing home grown companies.

    Additionally, the Third Frontier has made massive investments in the research base of the medical institutions of the state to ensure that they continue to create technologies that can be spun off into new companies or licensed to existing ones. That type of investment attracts companies and keeps them close. That is cluster formation happening.

    Over time, this region will generate plenty of its own large companies. These will become acquirers, rather than being acquirees. Then other states will be voicing the same complaints that you are, which is that their companies are being acquired by Ohio companies and some of their operations are being moved. That’s what happens, and the way to be successful is to do just what I said, create a vibrant economy and lots of companies.

    Consider this: the very silicon chips that were the foundation of Silicon Valley are no longer manufactured there. It has been at least two decades since a major chip manufacturing plant was built there. Instead, plants are being built in Albuquerque, Boise, Phoenix, and Asia. Why? It’s too expensive to manufacture in Silicon Valley. Do you hear Silicon Valley residents complaining? No. You see them creating entire new industries in the space of a few years. They are not attached to the past, but looking to the future.

    As the questions all you like. But consider the framework from which they emanate. This is not the 1950’s Golden Age of Manufacturing when a high school graduate could land a high paying manufacturing job just by having a pulse, and despite Sherrod Brown’s eloquent elegies to that (probably fictitious) past, that age will not return. The framework for today’s discussion is how to foster entrepreneurship and a good quality of life.

    The number one determining factor of where a company is located is the preferred residence of the CEO. Build a vibrant economy with a good quality of life and a low tax rate, and plenty of CEOs will want to live here. They’ll be running the companies that grow out of this effort, and they’ll want to keep them here.

    Which leads me to my final point. Yes, entrepreneurs who cash in here do migrate, usually to Florida. That’s because the the state income tax rate here is uncompetitively high and Florida has no state income tax. That disparity, more than anything else that occurs in Ohio, drains the state of talented people and capital.

17. Ed Morrison Says:
    July 26th, 2008 at 4:35 pm

    Jonathan, Bill:

    Here is a recent commentary on the issues you have been discussing.

    http://snurl.com/35hfg

18. J Murray Says:
    July 26th, 2008 at 6:03 pm

    Ed, thanks. Interesting article, but fundamentally wrong on one point: what the author calls the bias of the U.S. tax code towards convertible preferred equity. The evidence is clear that the U.S. produces far more innovation and far more wealth creation than any other market–certainly European and Canadian markets. The argument that a tax code that favors common stock instead of convertible preferred is a better model is unsupported by the evidence. The argument being made is an argument based on the “industrial policy” view of life. I would be reluctant to follow any policy associated with innovation that originates in Europe or Canada–not absolutely resistant, but reluctant without significant evidence showing that the policy differentially supports innovation, entrepreneurship, and wealth creation better than current U.S. policy.

19. Ed Morrison Says:
    July 27th, 2008 at 3:02 pm

    Jonathan:

    This article is a bit obtuse, I agree. But I find the exploration of country differences in VC formation is still helpful in light of Bill’s concerns.

    Private returns to VCs are not the same as public returns from public investments (or subsidies) in VC formation (through such vehicles as JumpStart).

    As I take it, JS has two objectives:

    By addressing capital and management constraints, to encourage the development of new technology companies which are commercializing research and development; and

    To develop a self-sustaining early stage, technology-based venture capital industry in NEO.

    Beyond these two broad purposes, it’s not clear to me how JS measures its outcomes. These measures should be different from your measures (as a private VC firm), I assume. See for example, how Innovation Works measures its outcomes:

    http://www.innovationworks.org/About/impact.html

    You can also download a community impact brochure:
    http://www.innovationworks.org/IW-2007_AnnualReport.pdf

    The CSU study of JS economic impact (available on the JS web site) is helpful, but it does not tell a story in the same way. (Few people will even read it, I suspect.)

    The regional VC report is more helpful, but it does not focus on JS.

    The JS model needs on-going public support to fund its operating costs. The best place to find these funds is through local investment. To generate support for public investment, JS can to do a better job telling its story by following the Innovation Works Community Report.

    While the JS model is expensive to run (about $4 million in salaries is a ballpark estimate), it’s better than building and operating a convention center.

    My guess, though, is that given the choice for public support, the convention center investment ranks higher in the public’s mind. (Although neither would likely pass a referendum; most people are in Bill’s camp, I think.)

    That’s too bad. JS has some success on which to build, and the probability that a convention center will have any positive economic impact (beyond a construction blip) is very low.

20. J Murray Says:
    July 28th, 2008 at 5:26 pm

    Ed, I think the European model favors short-term measures of public returns over private returns. However, markets over time allocate capital to the place where returns are highest. That explains why, despite the bias of the European markets to measures of public returns, the U.S. out-performs Europe in public measures anyway. The invisible hand, you know.

    I don’t thik JumpStart’s objective is to create “a self-sustaining early-stage, technology-based venture capital industry in NEO.” They can be a contributor to that happening, but only one part of the ecosystem. Saying it in another way, if they were the only organization striving for that objective, it wouldn’t happen.

    There is no question that the public and the media are challenged to understand the complexity of this discussion, which is one reason it is easier to get public support for a statium or convention center.