Consider the recent deals creating the mini capital markets boom we’ve seen over the past several weeks. On the surface, the news has been good: August 2010 saw more deal volume than any previous August since 1999 with $262 billion in worldwide M&A activity. But many of the largest of these deals – such as HP’s acquisition of data storage company 3Par, BHP Billiton’s bid for Potash Corp, Sanofi-Aventis’ offer for Genzyme and Intel’s offer for McAfee – have many features of “savings” deals that will create complimentary economies of scale, not new jobs or breakthrough new technologies.
It’s hard to blame companies for pursuing cautious, strategic acquisitions. Beyond the emotional scars left by the recession, the current U.S. regulatory environment is making it more difficult for businesses to pursue higher risk innovation than to maintain the status quo. Proposed tax increases on offshore income, higher income and capital gains taxes and unnecessarily rigid and slow-moving federal approval process on everything from patent applications to FDA approvals are skewing the risk/return ratio against aggressive innovation.
Consider the plight of the life sciences and technology sectors, which currently have the greatest potential for innovation-driven growth and perhaps the least institutional incentive to pursue it. I have seen troubling trends developing first-hand in my firm’s work with international technology and life sciences companies who are increasingly avoiding the U.S. regulatory environment.
In one recent example, a rapidly-growing medical technology company based in Asia began their search for expansion capital with one simple request: we do not want to be in the U.S. market. Noting that the number of new molecular entities approved by the FDA over the last five years was 92, lower than any other five-year period since the 1970s, and that similar backlogs have grown in the medical devices space, the company’s senior management is concluding that it would be too costly to bring products to market here. In another example, a private equity investor declared a formal moratorium on all U.S. deals after selling a portfolio company to a U.S. acquirer and incurring taxes on contingent payments in the future.
It has been echoed again and again in meetings around the world: U.S. policy and growing corporate risk aversion is making it difficult to do business here. Data published by the National Venture Capital Association supports the sentiment, showing that U.S. fundraising in the second quarter of 2010 was the lowest since 2003. Though these levels increased slightly in the third quarter of 2010, most of that increase was attributable to a single $750 million fund closing in the quarter. Further, U.S. VCs have said they expect their market to contract while emerging markets including China, India and Brazil will grow over the next five years.
Contrast the U.S. market environment with those in the BRIC countries or in high tech hotbeds like Israel, where initiatives to incentivize risk-taking have been driving sustained growth. In China, which in total GDP just became the second largest economy in the world, high risk innovation has become a political rally cry. Chinese premier Wen Jiabao at World Economic Forum (WEF) Annual Meeting of the New Champions 2010 stressed that innovation is the clear path to economic growth, the essential ingredient in the shift away from "made in China" towards "created in China.” By incentivizing R&D with tax cuts and reengineering its long-criticized intellectual property laws, China has become the third largest patent office in the world, with an average annual patent growth rate of 28 percent, according to data from Thomson Reuters IP Solutions.
In Israel, which has been undergoing a staggering technology boom for the last decade, innovation risk has become a cultural mandate. Among the 29 economies surveyed by the Organization for Economic Cooperation and Development (OECD), Israel’s venture capital sector is by far the largest in relation to its overall economy. In 2008, venture investment in the region came to just under $1.4 billion, or 0.69 percent of GDP, compared with 0.2 percent to 0.3 percent for the next highest-ranking countries (Denmark, Finland and the UK) and 0.12 percent for the United States. Accordingly, Israel was the last of the OECD countries to enter into a recession (fourth quarter 2008) and the first to exit (second quarter 2009).
U.S. business – and the government regulators that set the rules of the game – must remember that risk is not the enemy. “Cost savings” are not the best course when they are nothing more than euphemism for layoffs. The U.S. needs a surge in employment - not a stalemate - and investing in innovation is key to spurring growth of new companies that historically have been responsible for most job growth. Managing risk in this kind of environment demands that we abandon the notion of risk-free and focus on allocating capital to the innovation that has been our competitive advantage.
Market psychology needs to change and the government can help by adopting a systemic approach to more innovation-friendly policies. If U.S. companies want to remain relevant players in this century’s global knowledge economy, they need to feel they can walk down the aisle and take a leap of faith.
Bruce E. Roberts, is a managing director at Roberts Mitani, LLC, a global investment banking and strategic advisory firm based in New York and Tokyo.
