Introduced in 1994, the Herman Miller Aeron chair, with its comfortable and sleek ergonomic design, was popular among many startups during the Dot Com Boom. But at a cost of upwards of $1000, the chairs eventually became a symbol of the bubble that was forming.
Flush with oodles of cash investors were pumping into their businesses, however uncertain the chances of success, the startups felt that they could indulge on these luxurious chairs. Computer programmer, entrepreneur, and venture capitalist, Paul Graham, in an essay entitled “How to Start a Startup”, wrote that “When you get a couple million dollars from a VC firm, you tend to feel rich. It’s important to realize you’re not. A rich company is one with large revenues. This money isn’t revenue. Its money investors have given you in the hope you’ll be able to generate revenues. So despite those millions in the bank, you’re still poor.” Being in possession of so much cash, despite being unearned (through actual sales), the startups were lulled into a false sense of security, thinking that because they have so much money right now they could relax their standards on expenditures.
The net psychological and cultural effect on the startup was that it dampened its sense of urgency. The illusion of an abundance of money relieved that feeling of pressure that necessitated a prudent, creative, and conservative use of its meager funds, which is so utterly important in a startup business. And it was that feeling that permitted the startup to purchase something as frivolous and unnecessary as the Aeron chair. Venture capitalist and blogger, Guy Kawasaki, concluded on the Aeron in his book The Art of the Start, “It was a terrific chair, but I don’t know if it was $700 terrific. The function of a chair, after all, is to support one’s butt.”
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While it was the Dot Com Boom where the Aeron Chair Problem directly came to the fore, there is a new yet remarkably similar problem that has been emerging during what I call the Green Political Bubble. The Green Political Bubble is in essence just like any other bubble. Political leaders in the past few years have placed great hope, and subsequently much money, in the belief that green technology will spur the revitalization of the American economy and boost employment. Indeed, the term “green recovery” was invented and touted by many people throughout the country. So with $87 billion in the American Recovery and Reinvestment Act of 2009 (aka the “Stimulus Package”) as well as a billions of dollars from the Department of Energy’s $29.5 billion budget dedicated to green investment in one form or another, there has been an enormous amount of money available for startup businesses that focus on alternative energy technology.
One such firm that received government funding, in the form of the Department of Energy’s $35.9B loan guarantee program, where “the Federal Government will cover the borrower’s debt obligation in the event that the borrower defaults”, was the now infamous Solyndra.
Producing a new innovative type of solar panel, Solyndra Inc., according to a September 16th Wall Street Journal article “was supposed to be a marquee example of how private and public capital, brought together, could vault innovative companies to commercial success.” However, “the $535 million government loan guarantee so prized by the solar-panel maker may have ultimately contributed to the company’s undoing, say investors with knowledge of the company’s operations.”
While the loan from the Department of Energy wasn’t exactly like cash from a venture capital firm, the differences of which will be discussed below, it did have similar perverse effects on Solyndra’s decision-making that often stem from receiving large sums of such money.
Several months after it received the loan on March 20, 2009, Solyndra began building a new $733 million factory, which was to employ 3,000 people in its construction and 1,000 people to operate it, according to Energy.gov. Spanning “300,000 square feet, the equivalent of five football fields… it had robots that whistled Disney tunes, spa-like showers with liquid-crystal displays of the water temperature, and glass-walled conference rooms”, according to a report on Bloomberg. One facility manager, per the same source, said it was “like the Taj Mahal.”
Unfortunately for the company, demand for its product began to change. Prices for polysilicon, a material used in competitor solar panels, began to plummet, and thus made Solyndra’s panels less competitive. As the aforementioned Wall Street Journal article explained, “The new factory… foisted fixed costs on a company already struggling through an industry shake-out… The debt paradoxically made raising more money difficult. Once the government demanded priority in the event of failure, private investors were less likely to prop up the company.” As one Solyndra investor quoted in the article concluded in hindsight, “the worst thing that happened to Solyndra was the loan.”
The loan from the Department of Energy, coupled with hundreds of millions of dollars from many big-name private investors, shifted the mindset at Solyndra. The hype surrounding the firm, with enthusiastic praises and endorsements from California Governor Schwarzenegger and President Obama, had to have created a feeling of invulnerability. When you have the federal government and the largest state in the country with the eighth largest economy in the world backing your success, who wouldn’t feel a little cocky? Indeed, as one former Solyndra engineer, quoted in the Washington Post said “After we got the loan guarantee, they were just spending money left and right… Because we were doing well, nobody cared. Because of that infusion of money, it made people sloppy.” While a $733 million factory certainly isn’t an Aeron chair, it is however a gross sign of imprudent decision-making and unwise spending that came about from inflated expectations of success through the receipt of a large pool of (unearned) capital.
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The purpose of this essay is not to discourage investing in startup ventures – whether from private or public funds – but to highlight some of the perverse effects such funding could have on the culture of the startup itself. Guy Kawasaki, as a venture capitalist, in fact lists six reasons, in an aptly entitled article, “Why Too Much Money is Worse than Too Little”. The effects on the startup are the same regardless of the particular source of funding, whether private or public, venture capital firm or Department of Energy. The Aeron Chair Problem can happen in any startup business that is flush with unearned cash.
Despite similar effects from public and private funding, there are, however, major differences that must be recognized. The first and most obvious is that private funding comes from individuals, firms, or corporations that have invested their own money in the startup. They have skin in the game, so to speak. And venture capital firms usually place one or more of their partners on the startup’s board of directors, giving them influence over the startup’s direction and thereby hopefully preventing the Aeron Chair Problem. Private investors risk their own money in feckless startups at their own peril.
Public sources, such as the Department of Energy, however, have a shifted risk paradigm; meaning, it’s not their money that they’re risking. The executive director of the Department’s Loans Program Office, which oversaw the Solyndra loan, was not investing his own money – he was investing the taxpayer’s money. So once Solyndra went bankrupt he didn’t lose any of his personal money; he lost the taxpayer’s money. Aside from the risk of looking bad to his superiors and a possible tarnished reputation, the executive director has assumed no other risks. And whereas a private investor has incentive to create a profitable business – to get a return on his money – a public investor has no such incentive. Public investors have, instead, political incentives, such as pressure to invest in startups that are political favorable. These political incentives are additional considerations that go into the investment decision-making process. This process is changed, when investing instead from a public standpoint, because the investor’s goal now isn’t solely to create a profitable company, but one that is politically expedient. And politically expedient certainly doesn’t not necessarily mean profitable or even possible.
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As I concluded in my essay last week, it is a no-brainer that America’s greatness is largely predicated upon our ability lead the world in the development of technological innovations. We must continue such a role if we are to have another American Century. But when devising policy to spur innovation, we must be cognizant of the startup process and the effects of throwing tons of money at a startup, especially when it’s not our own that we’re investing. A patient respect for the spontaneity of innovation in a free society, comprised of discerning private citizens, will greatly serve our interests in the long-run.
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