A Senate bill introduced Thursday takes an intriguing approach to supporting new businesses threatened by the current economic crisis: helping them attract venture capital.

The New Business Preservation Act, sponsored by Senator Amy Klobuchar (D-MN), would provide a one-to-one government match for investments in high-potential, scalable startups outside the traditional VC belts that get a disproportionate amount of funding. The bill, co-sponsored by Senators Chris Coons (D-DE), Angus King (I-ME) and Tim Kaine (D-VA), also was submitted separately to the Appropriations Committee for consideration as part of the upcoming stimulus measure.

An equity-support program for new businesses represents the next stage of commercializing technology and encouraging innovation. Similar to opportunity zones, it is an effort to pump capital into underserved parts of the country. The bill was conceived late last year but the coronavirus, with its potential to destroy fragile young companies and dry up investment, moved it to the front burner. 

The $2 billion the legislation allocates is divided into two parts. The larger amount--$1.5 billion--goes to the first group of investments. Another $500 million is for follow-on investments for companies doing well after their first rounds. Eighty percent of funding would be directed to the Midwest, Southeast, and Southwest. Returns from exits would be reinvested in the next generation of new businesses, creating a sustainable funding resource.

Funds would be allocated to states based on population, with the numbers for California, New York, and Massachusetts reduced to adjust for the concentration of VC money already there. Investments would be made through the private investors. "So this is not Solyndra," says John Dearie, founder and president of the Center for American Entrepreneurship, an advocacy organization for startups and a supporter of the bill. "This is not the federal government picking winners and losers."

The Israeli model

A decade ago 62 percent of venture capital was concentrated in the greater metro areas of Silicon Valley, Boston-Cambridge, and New York City, according to data from Pitchbook. "Rise of the rest" rhetoric notwithstanding, that number has actually increased to 80 percent. In 2012 Reid Hoffman and Peter Thiel told Forbes that tech startups locating anywhere other than Silicon Valley is a "red flag" in terms of chances they will fulfill their potential.

Consequently many promising heartland businesses can't find capital to scale. Or they attract funding but only on condition that they move closer to the funder, which robs their hometowns of jobs and tax receipts.

The New Business Preservation Act is modeled on the Yozma program, which was developed by Israel in the late '90s after the collapse of the Soviet Union produced a tidal wave of immigration of Russian Jews--including many scientists and engineers who started businesses. At that time about 98 percent of venture capital was raised and invested in the United States. "Israel wanted to lure American venture capitalists to get on planes and come see for themselves what was going on, then incentivize them to provide the capital these startups needed," Dearie says.

The country achieved that by offering a one-to-one match of Israeli government dollars for private VC dollars. "It was a deal American VCs couldn't refuse," Dearie says. "They saw these companies were investable and created the Israeli VC market, which is now incredibly vigorous."

By providing matching government funds only when private funds went first, the Yozma program retained the virtues of private initiative and capital but boosted in through government support, says Robert Litan, a non-resident senior fellow at the Brookings Institution. "In this country, the states where venture funding is lacking--namely most 'flyover states' between the coasts--could benefit hugely by replicating Yozma's business model," says Litan. "The proposed bill would do precisely this."

Magnets in the middle

Attracting investment to the country's middle could set off a virtuous cycle as some of those bets pay off. Companies that scale fast--particularly those with big exits--become high-wattage beacons for other investors and founders. "The academic research shows the importance of a local winner to creating and spawning a local innovation and entrepreneurship ecosystem," Dearie says. "This is how Silicon Valley and other innovation centers like Boulder or Austin or Boston developed. The Baltic states became a hotbed of entrepreneurship because of Skype."

Syzygy Plasmonics, which makes a chemical reactor powered by light rather than heat, is just the kind of startup the bill is designed to help. CEO Trevor Best co-founded the company in Houston in 2017, raising $6.3 million from local investors, as well as ones based in Boston and Canada. But because he wanted to keep the company close to Rice University, where the technology had been invented, it was hard going. "If this bill was in place it would have been a tremendous amount of non-diluted capital coming along with their investment that would help de-risk it for them," he says. "That would have been huge."

The big check barrier

A bill like The New Business Preservation Act may help narrow the investment gap but won't eliminate it. That's because Silicon Valley "is driven by the needs of large capital, which are different from the needs of entrepreneurs," says Randy Komisar, a partner at Kleiner Perkins and co-founder of Claris Corp. VCs in tech hubs look for opportunities to write very large checks--likely larger than many heartland startups will need--that may generate very large returns. Komisar suggests the government sweeten the pot by, for example, capping its own returns so participating VCs reap a larger share. "It is about allowing investors to make much higher multiple returns off smaller sums in markets that can't absorb the scale of capital a place like Silicon Valley can," he says.

Komisar hopes if the terms are right then coastal investors will eventually see the value. And even if firms don't, individual VCs "may want to go back to Iowa or to Kansas City and may wind up bringing their practice with them," he says. 

"From an innovation standpoint, from an economic development standpoint, [the bill] makes perfect sense," Komisar says. "We have got to begin to serve entrepreneurs where they are."