Funding woes threaten next tech revolution Is the US system for financing technology innovation broken? It's certainly damaged, according to one of the most successful US tech investors of recent years. If he's right, both entrepreneurs and investors could be living with outsized expectations that were set in a different era and have little bearing on what is to come. Bill Janeway made his name at Warburg Pincus with companies such as BEA Systems, a business software company that was sold to Oracle in 2007, and Nuance Communications, whose speech-recognition technology is included in the iPhone. He has set out his ideas in a book that marries his own investment experience with a passion for economic history.* As Mr Janeway sees it, Silicon Valley has thrived thanks to two very different forms of capital, neither of which was supplied with any real expectation of making a normal market investment return. One was the money put up by government to back long-term scientific research. Much as Silicon Valley likes to burnish its preferred image as a haven for self-made pioneers, there's no getting away from the central role that government largesse has played through agencies such as the Department of Defense and the National Institutes of Health. The other source of "inefficient" capital allocation has been the public equity market, particularly during periodic tech bubbles. Whether consciously or not, most investors at such times invest on the "greater fool" theory that they will be able to find a buyer at a higher price, rather than on any rational analysis of the likely cash flows from their investments. US venture capitalists have had a field day, taking ideas shaped in government-funded labs and pushing them out to hungry backers of initial public offerings. The VC industry's periods of outsized returns coincided with the long bull market that began in 1982 and, in particular, with periods of great IPO activity, says Mr Janeway. The bubbles may look highly inefficient, but they are a necessary part of the process that turns hard-to-evaluate (and finance) ideas into real businesses If this "waste is good" mantra for tech innovation sounds a little self-serving, that's probably because it is. As an investor, Mr Janeway himself says he has always followed a highly disciplined approach: to push a start-up to become cash flow positive as soon as it can. Asked about this paradox, he tries to draw a distinction between the need for investment discipline at the micro level and waste at a system-wide level. Yet the best investors, while paying lip service to the need for experimentation, are the ones who know how to indulge in it at someone else's expense. Since 1998, however, the VC industry as a whole has been misfiring badly, taking in more cash from investors than it has paid out. There may be huge, unrealised profits just waiting to be released. But the longer the wait for a cathartic IPO boom goes on, the less likely it seems - and the more the world of scarce IPOs feels like the new normal. The stumbling US "cleantech" industry is an object lesson in what happens when the virtuous cycle ceases to function. Rather than being funded by government, much of the science research was paid for by a shortlived venture capital bubble from the middle of the last decade. President Obama's invocation of a "Sputnik moment" early in his presidency did not build support for public investment in a new low-carbon economy. Government also failed to show up for what Mr Janeway calls its other main role in supporting technology innovation: acting as initial customer, setting performance targets and dispensing money to the companies that meet them first. Instead, it stepped in with loan guarantees that floated a handful of US cleantech "champions," helping them soar above the normal start-up funding challenges - and even pushing some as far as an IPO - but without turning them into sustainable businesses. A123 Systems, an advanced battery maker that filed for bankruptcy last month after raising roughly $250m each from venture capitalists and government grants, followed by $370m from an IPO, is the poster child for this failure. Mr Janeway's call for a new wave of government-funded Big Research sounds anachronistic in this day and age. And, as he says, there are still plenty of fortunes to be made and lost in the current cloud-and-mobile phase of the IT revolution. Sooner or later, though, the next tech revolution will demand to be born. Whether it happens in the US is another question. "Doing Capitalism in the Innovation Economy," William H Janeway (Cambridge University Press) Richard Waters is the FT's West Coast managing editor