INSME's Interviews

INSME: Mr. Cardullo, you are counsellor for technology and entrepreneurship within the US Department of Commerce. Can you tell us what the main activity of this office is?

Mr. Cardullo: It is to bolster the development of entrepreneurial companies and capital formation worldwide. The associated question is “why does the US Government want to foster this?” Because the more companies exist, the greater will be the potential for trade and the greater will be the growth of democracy. So it is really related to increasing trade and increasing democracy. The more companies are started, the more people have control on their life. That’s why it is so important.

INSME: Talking about the U.S. economic system, it has had a dramatic growth over the last decade and no economic system of comparable development has performed as brilliantly as the U.S.
So what is peculiar in the US economic system that makes it so successful? Legal framework? Capital accessibility? What are the differences with respects to other areas of comparable economic development, for instance Europe?

Mr. Cardullo: It is culture. The culture is that “it is ok to fail”. So if I start a company and it goes under, I can start another company and I learn from my failure. And that, tied to the ability to get it financed, if it’s a good idea, is the key.

You also have to remember that the United States is a country of immigrants. So we come from many different cultures, but we are capable of working together. Even though we are from very different cultures, we have learnt to share. When you have a company, the culture of sharing it is very important. So you don’t just say “this is my country and company and you are working for me” but “this is our company and we are working together to build a shared vision”. A shared vision is very important.

INSME: What about the legal framework of capital accessibility?

Mr. Cardullo: Well, in the US it is very easy to set up a company. You can set up a company legally in a matter of minutes, even with the Internet today. There are not real barriers. You have responsibilities, however, to get a tax number, to be able to file any local papers. But there is no impediment.

Secondly, there is a system made up of venture capitalists and business angels for companies with a great deal of potential to grow. But is not so easy. You have to get to know them, so it is a matter of relationship building. You have to be in the network, you have to see people, so they know who you are.

INSME: However, compared to other countries, even European countries, in the US if you have a good idea and the entrepreneurial drive, it is easier to get financed, don’t you think?

Mr. Cardullo: The point is that people in a country have to have a feeling that setting up a company, being an entrepreneur is a good thing. In most of the countries in Europe this doesn’t work because governments are “socialistic” and take care of people. And the tax structure is such that it is very hard to be an entrepreneur. If there is a heavy tax structure, why should I set up a company? I’d rather go work for somebody and make a living.

So tax structure is very important. We have a good tax structure in the States to foster entrepreneurship. It is not a simple system. As I showed in my presentation at the INSME Barcelona Conference, it is complicated but all the pieces have to be there and as far as I can see very few economies in the world have those pieces.

INSME: Talking about the innovation system, what is the role and importance of R&D?

Mr. Cardullo: We foster innovation in an interesting way. Some of our R&D developments come out of military, including Internet, and health. So what happens is that an idea is developed for military reasons or health reasons and then somebody says: “I took this and changed it this way and maybe I can make some money!”

Universities are also important in this process. I belong to Virginia Polytechnic Institute. It is a State University - that means that it gets money from the State of Virginia - and they have an agreement that if I am a professor and I invent something, it is not just that the university owns it. I also own a piece of it.

Moreover, if I am a professor and I have a good idea but I’m not a good manager, I share the idea with people who are managers. In the US, entrepreneurs who were successful are willing to step back and bring in professional managers. In Europe and in a lot of other countries the entrepreneur says: “this is my idea, this is my company. I am not sharing anything with you”. Well then. Good luck!

INSME: Are you saying that in Europe there is nothing comparable?

Mr. Cardullo: Actually in the UK, around Cambridge and Oxford, you have university clusters that work this way. I haven’t seen any clusters like that in Italy. A little bit in Germany. In France they are working forward, because they have something called “Tremplin Enterprises” where they bring all the entrepreneurs and they expose them. They are moving forward but it is not easy, it is not happening as fast as it probably should.

INSME: Let’s now focus on the role of venture capital in the US innovation system. What is its specific role? How does it work?

Mr. Cardullo: It basically doesn’t work in the US. I have written a number of papers on this. Very few venture capitalists are successful.

The venture capital industry in the United States is made up of small and medium-sized enterprises. The average size of a venture capital firm in terms of people working in it is 14 people. You may think that they are managing hundreds millions of dollars, but it is not true. It is only a 2 million dollar a year business. And then because 60% are managers and 40% are staff, it is an inverted pyramid, it is a guild structure. And they also take a lot of the money from themselves, they won’t live off the fees.

0nly 10 to 15% of the 657 companies that manage venture capital in the US are really successful! There are only 74 of them that are over a billion dollars, it is only 10%, and those are the ones that have some degrees of success. I can be even more specific and tell you what the numbers are as we have recent audited numbers.

In a 12 years period, the US invested 270 billions dollars on new companies….11.600 plus.
8% went public, 49,5 billion dollars was lost. The average rate of return to the industry in that period is somewhere between -1.8% to +3%.

Recently Calpers (California Public Employees' Retirement System), the California Public Retirement Fund, that is the largest institutional investors in the US, was required to report all their investments and alternative investments…which include venture capital, buy out, etc. They have committed 19 billions+ dollars over that period of time, invested 12 billions +, got back 8 billions+ and said that the residual was another 8 billions. If you put those numbers together, the return on investment based on the weighted average size of the fund is 2.44%, less than what you will get investing in a bank.

So the industry is not an efficient industry and there are only a few companies, like Crescendo, that have been very successful. Crescendo manages 1.1 billions dollars and they may have returns of 25%. They are structured as a corporation not as a guild.

INSME: So why is the US venture capital system considered like the best in class worldwide?

Mr. Cardullo: I don’t know if you remember the story “the emperor has no clothes”. It is an old medieval story about this emperor and two men that came to him and say “Oh, we have this magical suit to wear and if you wear it everybody will love you” and it was nothing. So he took his clothes off and the men made him believe they were putting the suit on. He walked out and everybody “the emperor!”, clapping. But as he was naked a little boy pointed to him and says: “he is naked, the emperor has no clothes”. That is what that industry is. The industry itself has blown itself up because it is not a regulated industry so they can say what they want and use the numbers as they want.

Let me put it more precisely. Of 300 to 500 business plans that are written, only 1 gets financed and out of every 10 companies that get financed only 1 survives and makes money, 2 die and the rest we call “walking dead, walking wounded“, they try to sell, maybe they’ll get 50% of their funds.

So 1 out of 3000 to 5000 business plans is a hit. Is that efficient? No, it isn’t. How many real innovative ideas are lost? Many of them.

And as far as Europe is concerned, the French have lost a fortune, the British have lost a fortune, the Danes have lost a fortune because they have tried to follow our model. I have written a paper on this, and unless people start really thinking of venture capital as a business and companies as a product, everybody will continue to lose money.

INSME: In this situation, how can innovative SMEs overcome financial barriers?

Mr. Cardullo: That is the big problem. The gap that I pointed out here is due to the fact that the venture capital firms are so small.

For example, if I have 100 millions dollars under management, I am getting 2 millions dollars a year. On average the whole firm has 5-6 people in it including the secretaries. The average investment on a start up is 1 million dollar and it remains almost constant for 10 years (on constant dollars). So based on that, could you invest in 100 companies managed by 5 people? Who can? So what you do is you move upscale where the average investment is 10 mil $ or 5 mil $. 5 mil $ dollars is 20 big companies. 20 companies, 5 people: you have four companies per person. Maybe you can do it.

So you tend to move upscale to be more successful, you pass by.

INSME: You mean you move from early stage to later stage…

Mr. Cardullo: Exactly! And very few later stages are venture capitalists. Crescendo is one but they are big.

INSME: In this chart you design flows to foster the creation of venture and private equity funds. There are different players and they act in different times. What’s the role of the public sector in fuelling the system?

Mr. Cardullo: In the first place governments shouldn’t directly invest in companies. Two, governments if they want to invest they have to be institutional investors and invest in a large fund of funds and then hire a professional or build a corporate structure that can provide services throughout the cycle so that once a company enters the cycle you can ensure an exit.

So you have to look at the company as a product if you want to do venture capital and then be able to move it through that cycle instead of saying “I am investing, maybe she is going to make a lot of money for me and maybe you can make a lot of money for me and I stand back and say “I turned the roulette wheel”. That’s gambling!

INSME: What kind of synergy can be found between private and public in this scenario?

Mr. Cardullo: What we proposed to the Chinese government is to invest in a fund of funds that covers different stages and different types of sectors. Some people say that I am speaking heresy, but I’m not! There are people that are starting to do it and those are the people who will be the future of the industry.