Incubator Cities: Tomorrow's Economy, Yesterday's Start-Ups

Venture development funds (“VDFs”) are products of state and local government law that use public funds to invest in local start-ups, in the hope that these companies will then attract venture capital investment. Existing analysis by legal scholars largely assumes that establishing a private venture capital market is essential to encouraging entrepreneurship. This article challenges that assumption. It argues that VDFs and other policies focused on encouraging venture capital are outmoded and inconsistent with the ultimate economic development goals of state and local governments.

In many industries, entrepreneurs can now get by with less capital because the cost of developing a product is rapidly declining due to technological advances (e.g., cloud computing) and other developments (e.g., the ability to market an app through Apple’s App Store). But venture capital funds continue to seek out investments in a small number of industries that still require a great deal of capital, such as biotech firms trying to develop new drugs. This narrow focus is inconsistent with the advice of economic development experts to pursue industry-neutral policies that broadly encourage entrepreneurial activity in all of its forms. Also, policies oriented towards venture capital may undermine goals of employment diversity and stability because companies seeking venture capital pursue particularly high-risk business strategies that often fail.

This article recommends that state and local governments shift their policies to encourage, or at least not hinder, alternatives to venture capital.