We’re not building widgets here. Bribery, cajolery and punishment do little to spark the creative spirit (except perhaps in unintended ways). You get the best out of creative people by having them reach into themselves and pull out their own best. This applies as well to how we fund our work. How do we place that investment dollar so as to best elicit creative solutions from investors and researchers? Unfortunately creative people sometimes get a little too creative.

Below we discuss what can go wrong, based on a review of past wrongs in firms with missions similar to ours. We list specific dangers and describe precautions we have taken to protect against them. These are a sampling but are among the most important for our understanding.

Systemic Failures

Systemic failures can bankrupt an entire enterprise. Each investment within the funding agency⁺ may be doing fine, but management over-extends credit lines and places the entire enterprise at risk. Or, agency management⁺ picks a fight with the U.S. Department of Justice, and loses. Systemic risks are often precipitated in financial, contractual or regulatory failings. They are often due to agency management: from what they have done or what they have failed to do. They are often found as perfect storms. Systemic failures occupy a very special niche in the history of corporate failures. They are often spectacular and their memories are enduring.

We protect against systemic risks as best we can. Precipitating events are minimized by following the teachings of expect the unexpected⁺. Occasionally a persistent individual (i.e., a dissenter⁺) can keep pulling on a thread until the garment starts to unravel. We engage third parties and interest groups, providing them with incentives to be on the alert for the next storm. But in the end our best protection against these types of risk is a tall firewall⁺ between separately managed perpetual funds. Systemic risks, perfect storms, are perfectly unpredictable.

 

 

Mortgaging the Future+

Mortgaging the future refers to decisions taken (or not taken) that make wealth creation more difficult in the future. Examples include decisions to shortchange programs in community-building or investor retention⁺. Included are actions that limit or shut off access to future credit lines. The best protection for the future comes from a robust, vibrant, ever-growing community. We must protect against over-extending finances, operations or reputation.

The mandate for an accelerating blockbuster growth rate⁺ is perhaps our best protection against mortgaging the future. It forces officials in the funding agency to grow the investment base, and therefore to increase funding from investors. Over the long term, investing into future capacity in the agency is the only way this can succeed. Fall short in capacity and you fall short in either investees or investors, and you fall short on the measured growth rate.

The judiciary protects against short term thinking. There will always be a temptation to shortchange today’s programs with the intention of back-filling them tomorrow. This temptation must pass muster with the judiciary. They will view with suspicion each attempt to sell short the future. It’s in their mandate.

Hostage Taking

The funding agency cannot be held hostage⁺ by investors, investees or agency managers. We are never forced into substandard choices. We are never forced to stay with substandard choices. We always maintain a waiting list of highly-attractive candidates for investors, investees, third party partners and agency managers.1 Everyone is expendable and we must, at times, make very painful choices to drive home this understanding.2

The agency’s Rolodex is the only Rolodex. Investors, investees and agency managers come and go but the Rolodex stays. The success of middlemen, agency management, is often found in their ability to leverage contacts within the Rolodex. We know who knows the right people, and they willingly share those names with us. We seek, maintain and expand a vast network of promising researchers, investors and agency managers. The Rolodex is a fund asset never to be expropriated by any one or few players.

Agency managers are a precious commodity and require special attention. How do you replace a Steven Jobs at Apple Computer? How can Apple Computer’s owners not help but feel hostage to the demands of Sr. Jobs? Our challenge is to take good leaders and make them great. We do this repeatedly. But how can we do this within a single funding agency? The answer, most likely, is to build several funds.

Complacency

We can’t become complacent. We do our best and hopefully this turns out to be wildly successful. But that doesn’t mean 1) we will continue to be successful and 2) we couldn’t have been more successful. ‘What have you done for me lately’ is embroidered on our agency flag. We avoid complacency by the following actions:

• We build multiple funds with multiple management teams in friendly competition. This allows us to stress test the next generation of leaders.
• We mandate an accelerating blockbuster growth rate. You can’t rest on your laurels when there is a constant need for new investors and investees.
• We promote special interest groups. These groups invigorate their members and make them more active in agency affairs, pushing management to higher levels of investor responsiveness.

Sometimes the spark in an individual dims or takes an extended leave. Having a robust management team is helpful, with individual members waxing and waning in enthusiasm over time, but always with a few highly engaged leaders. The most important action for avoiding complacency over the long term is a deliberate grooming of the next set of leaders and enthusiasts – passing the baton from one generation to the next.

Conclusion

Rule number one is protecting the economy. Let the economy tank and no amount of hand waving will protect you from the wrath of the citizens. We’re still learning how to fund unpredictable R&D⁺. There will be tough times. Investors have a right to expect competency even in times of economic distress. Having our stock price drop less than the general market is no great consolation. Don’t spend too much time worrying about the above cautions to the neglect of doing the hard work needed to make the funding agency financially successful.

An informed citizenry is the best protection we have against all dangers. We invest heavily into their education. An important part of this education is helping them understand the many dangers facing the funding agency. Investors are asked to reflect on how they would design a funding agency to protect against these dangers. Management does this for a living and will most often provide the best insights. But familiarity can lead to blind spots. Our citizenry, educated, participative and empowered, can provide verification for management’s thinking and actions.

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Home Page September 2011

• 1. With investees we maintain flexibility of choice across investment categories⁺.
• 2. One major strategy consulting firm needed to sever a quarter of its partners (and a fifth of its revenues) in order to make this simple rule stick.

Further Reading

What Can Possibly Go Right?