Financing entrepreneurship – and a missed opportunity

Yesterday, the Kauffman Foundation held an event to unveil its 2013 State of Entrepreneurship Address. The theme of the address and the accompying report was Financing Entrepreneurial Growth. The report discusses the issues entrepreneurs face in obtaining funding and contains a number of useful steps to increase access to capital in the equity financing, public markets and banking:
Equity Financing Recommendations
• Extend the requirements for crowdfunding investors to Regulation D accredited investors
• Create non-financial criteria for sophisticated investors with fewer assets
• Balance the SEC’s concern for investor protection with a greater focus on innovation
• In the venture capital industry:
   — Restructure investment models
   –Improve performance measures
   –Standardize data reporting
   –Reconsider FAS 157 on “fair market value”
Public Market Recommendations
• Move to an auction model for IPOs
• Offer shareholder choice on Sarbanes-Oxley (SOX
Debt Financing Recommendations
• Reduce the regulatory burden on banks
• Collect better data on small business lending
   1. The Federal Reserve should reinstate–and ideally annualize–the Survey of Small Business Finances
   2. The Federal Reserve and the Consumer Financial Protection Bureau must improve data collection
   3. The Federal Deposit and Insurance Corporation should require more information on lending activities in its Call Reports
• Conduct further research
• Focus SBA programs on research and evaluation
   1. Collect more information and data on SBA-backed loans
   2. Conduct program evaluations
I agree with most of these recommendations. But I think the Task Force that wrote the report missed a major opportunity to unlock more debt financing. Specifically they missed the grow role that intangibles, including intellectual property (IP), can play as collateral for loans. As I’ve noted many times before, many bank loans already put liens on companies’ intangibles as part of the loan process. But intangibles are sweep up in an “all asset lien.” These intangibles are not specifically counted as collateral and banks rarely even know what is included. Thus, companies do not receive the full funding level for which they could otherwise qualify.
As we point out in our reports Intangible Asset Monetization: The Promise and the Reality and Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance, there are many other action to be taken to make intangibles a regular part of the financial system.
A first step in rectifying this situation fits with the Kauffman theme of better data and more research. The Federal Reserve could start requiring more data on the use of intangibles as collateral. This would lead to greater transparency. Banks don’t necessarily have an inventory of the IP and other intangibles that end up as collateral in their loan portfolios as part of those “all asset liens.” In some other case, there may actually be a “negative pledge agreement” — where the borrower is explicitly forbidden from using their IP as collateral (a condition a Venture Capital (VC) investor might put on a company in order to protect their investment). Likewise, the IP might be already somehow encumbered by previous liens or licensing agreements. Thus, a requirement for disclosure of the IP included as collateral would be important for the market to understand the risk/reward calculation of any insurance product.
The second step would be further development of the market in IP. Lenders, including the entity underwriting the insurance, need to have a place where they can dispose of the asset (the IP) at a fair price and with reasonable transaction costs. Currently, the IP market place is still evolving. One of the evolutions that needs to continue is the creation of valuation standards. Some work is being done in this area, but this is an area where the regulators could help spur faster action. For example, the SEC, in conjunction with FASB, could establish a task force on valuation to report back guidelines. And/or companies could create an intangibles reporting and valuation guideline association/group, similar to the International Private Equity and Venture Capital Valuation Group and the International Integrated Reporting Council. The International Standards Organization could step up efforts to set brand and patent valuation standards to ensure that relevant expertise and stakeholders are engaged.
A third step would be the establishment of a pilot program within the SBA to specifically accept IP and other intangibles as collateral on SBA loans. As I’ve argued for before, there are two actions that SBA could take:
• Develop SBA underwriting standards for IP. SBA should work with commercial lenders to develop standards for the use of intangible assets as collateral, similar to existing SBA underwriting standards. Allowing IP to be used as collateral will increase the amount of funds a company, such as one in the high-tech sector, would qualify for.
• Create an IP-backed loan fund. Other nations have developed special programs to encourage IP-based finance. The U.S. should set up similar programs on a pilot basis, ideally run by the SBA to take advantage of its lending expertise. Technical support could be provided by the U.S. Commerce Department’s National Institute of Standards and Technology (NIST). Such a direct lending program would be a step beyond SBA’s current loan guarantee programs–direct lending is needed to jumpstart the process. Once the process of utilizing IP as collateral is fully established, the program could be converted to a loan guarantee structure.
Entrepreneurs are almost by definition idea heavy and cash poor. Unlocking the value of their existing intangibles as a financial asset could help overcome some of the funding issues outlined in the Kauffman report. It is at least worth a try.

Replace the Jobs Council with a Competitiveness Council

Yesterday, President Obama let the authorization for the Jobs Council expire, and he immediately took flack about it. Critics complained that this showed a lack of interest in the unemployment problem.
I’m not that upset about the end of the Jobs Council. If we want to simply create jobs, that’s easy: hire a bunch of people to dig ditches and then hire a bunch more to fill those ditches in. If we want to create good jobs (well paying jobs) that are economically sustainable, well that is a more difficult. Creating good jobs requires a focus on improving American competitiveness.
Yes, I know that the full title of the organization was the “President’s Council on Jobs and Competitiveness.” And I know that the end-of-year 2011 report of the Council covered a number of competitiveness topics (see also Steve Case’s recent report card on implementing some of the Council’s recommendations). But that report, as Erza Klein points out, was generally ignored by the media and politicians.
In that regard, the name of the Council worked against it. It was known as the Jobs Council. The “Competitiveness” part was ignored. Even the Council referred to itself as the “Jobs Council.”
So, goodbye to the Jobs Council; now let’s form a Competitiveness Council.
There are a couple of ways this could happen. Congress could restore funding for the Competitiveness Policy Council (CPC) they killed in the mid-1990s. During its life time, the CPC published a number of good reports — but never seemed to get much political traction. [In full disclosure, I wrote the legislation for the CPC and helped get it up and operating back when I served on Senate staff — so its demise was rather painful to me].
A better solution might be the idea advanced by the Center for American Progress (A Focus on Competitiveness) to create a system of assessments, report and organizations:
  • A Quadrennial Competitiveness Assessment by an independent panel of the National Academies whose objectives are to collect input and information from many sources and perform a horizon scan that identifies long-term competitiveness challenges and opportunities
  • A Biannual Presidential Competitiveness Strategy that lays out the president’s competitiveness agenda and policy priorities, and captures the attention and buy-in of cabinet principals
  • An Interagency Competitiveness Task Force led by a new deputy at the National Economic Council that develops the biannual strategy, oversees White House coordination of competitiveness initiatives, and monitors their implementation by agencies
  • A Presidential Competitiveness Advisory Panel of business and labor leaders, academics, and other experts who assist the administration in developing policy details.
As I’ve noted a number of times before, I think this system is much preferable to proposed government reorganization plans. It is also superior to stand-alone councils like the Jobs Council.
In any event, let us not cry over the end of the Jobs Council. Let’s focus on their recommendations and on embedding the overarching issue of competitiveness into the policy debate.