In December, Jeff Bezos, the visionary behind Amazon, Blue Origin, and The Washington Post, was interviewed at The New York Times DealBook Summit. He provided valuable insights into the unique role of risk capital in the United States, a system that has driven much of the country's entrepreneurial success.
Bezos stated that the United States has the “best risk capital system in the world, by far.” He went on to explain why the United States has become such a hub for innovation:
“Why does the United States have so much venture success, so much entrepreneurial success? Why are the big tech companies here and not somewhere else? What's really going on with all this dynamism in this country compared to what we see elsewhere in the world?”
“You can raise $50 million of seed capital to do something that only has a 10% chance of working. That's crazy! But the people giving you that seed capital know that their expected value is still positive in many cases, or they are at least gambling that it is. That risk capital system that we have in this country is turning out to be very hard for other countries to duplicate.”
We seek to explore the catalysts for the risk capital system that has emerged in the United States relative to the rest of the globe. Venture funding to United States companies totaled $178 billion — around 57% of total global funding, up from 48% in 2023. This scale stems from a deep pool of institutional and private capital, tax incentives, and a culture that encourages founders to take risks. Is this a result of the venture capital system fueling innovation, or has the country’s history of innovation attracted more venture capital? Much like the classic “chicken or the egg” dilemma, the United States has built a self-reinforcing cycle where access to risk capital and a thriving startup culture continually strengthen each other. These factors create an environment where investors are willing to back high-risk, high-reward ideas, fueling innovation and solidifying the United States as the world’s most attractive hub for venture capital.
Tax Incentives and Innovation
The United States leads the world in venture capital and entrepreneurial success, largely due to its favorable tax policies, especially those related to capital gains and incentives for high-risk investments. The capital gains tax, especially on long-term profits, is lower than ordinary income tax rates, providing a significant financial incentive for investors to back risky start-ups. This tax structure, combined with incentives like the Qualified Small Business Stock (QSBS) deduction, allows venture capitalists to retain more of their profits from successful investments, which fuels further risk-taking and innovation. By offering tax breaks such as the ability to exclude up to $10 million in capital gains from qualified investments, the United States creates an environment that encourages risk-taking and supports the growth of high-potential start-ups.
In contrast, higher tax rates in other regions, such as Europe, hinder entrepreneurial activity and innovation. While European countries have strong investment bases, their higher tax burdens and less favorable capital gains tax structures make it less attractive to start and scale businesses. The United States tax system incentivizes investment in high-risk, high-reward ventures, enabling a thriving ecosystem of innovation and entrepreneurship. This is why major tech companies and successful start-ups predominantly emerge from the United States. Higher capital gains taxes lead VC firms to demand larger profit shares and consolidate their portfolios, ultimately reducing resources for start-ups and limiting innovation potential. These dynamics underscore the crucial role of tax policies in shaping the effectiveness of the United States risk capital system.
Employment Laws Driving VC
United States employment laws, such as at-will employment and the lack of mandatory paid vacation, create a more flexible and cost-effective environment for startups. Without extensive legal requirements like Europe’s mandated vacation or complex termination procedures, United States startups can scale quickly and adjust their workforce as needed. This reduces operational costs and encourages innovation, making the United States an attractive environment for investors willing to take on higher risks. Additionally, stock options are widely distributed to employees, aligning their interests with company growth and further driving venture capital investment.
The absence of enforceable non-compete agreements in many United States states, particularly California, promotes talent mobility, allowing employees to freely move between companies and share ideas. This contrasts with Europe, where job security laws and non-compete agreements limit talent movement, creating a less dynamic environment for startups. The widespread use of stock options in the United States, compared to Europe’s focus on executive-only allocation, fosters greater employee ownership and risk-taking. Stock options are especially a strong retention tool for startups. It reduces the amount of cash salary given to employees, which allows for venture capital money to finance more startups or to provide them with more capital. These factors combined make the United States a more appealing destination for venture capital, fueling innovation and growth.
The Self-Reinforcing Cycle of Venture Capital in the United States
Silicon Valley, which represents the United States’ VC success, has long been the global hub for tech innovation, fostering a reinforcing cycle of successful exits, experienced investors, and a culture that celebrates entrepreneurship. Did the VC funding culture lead to Silicon Valley’s success, or did Silicon Valley’s success foster more VC investment? In either case, the cycle continues. The rest of the world, while making progress, is still catching up. Venture capital (VC) has become a dominant force in funding United States companies, especially in numerous sectors such as technology, communications, and biomedical industries.
This growth was driven by the Prudent Man Rule in 1979, which allowed pension funds to invest in VC, leading to a tenfold increase in funding. From 1982 to 1987, VC funds raised $4.5 billion annually, compared to just $0.1 billion a decade earlier. Over time, this rule has been relaxed, and states have adapted their regulations to maintain the flow of capital into VC.
United States investors are willing to take risks because they know that a few successful investments can lead to massive returns. Failure in the United States is often seen as a stepping stone to success, whereas in many European countries, failure carries a stigma, making entrepreneurs and investors more risk-averse. Cultural attitudes toward risk vary significantly between countries based on the development of formal institutions and informal cultural behavior. Well-developed political, economic, and contractual rules provide proper incentives to VCs to offer risk capital. For example, the Employment Retirement Income Security Act under the United States Department of Labor allows pension fund managers to invest in VC funds. This rule has helped increase the level of VC funding in the United States In high uncertainty avoidance cultures like Germany, Japan, and Italy, people tend to avoid risky ventures whose outcomes are uncertain, leading to less VC activity. The United States, with its more moderate uncertainty avoidance, is more accepting of risk, fostering greater openness to venture capital.
Additionally, in collectivist societies like many European countries, relationship-based transactions can introduce transaction costs that hinder VC growth. In contrast, the individualism of the United States encourages risk-taking and innovation. Another factor is market fragmentation. The United States operates as a large, unified market with common language and regulations across states. Europe’s fragmented market, with its diverse languages and regulations, makes it harder for startups to scale quickly, which can limit their appeal to VC investors.
Conclusion
The question of why venture capital thrives in the United States does not have a single answer. As Bezos points out, these systems often become "self-fulfilling prophecies." While overestimating opportunity and underestimating risk may not be natural, the United States has built a system that encourages high-risk, high-reward investments. Key factors such as favorable tax incentives, flexible employment laws, and a culture that embraces risk and failure have created an environment where innovation thrives. This system has made the United States a hub for venture capital, driving entrepreneurial success and attracting global investment. As Bezos notes, the risk capital model is difficult for other countries to replicate, and this self-reinforcing cycle of success continues to strengthen the United States economy. The United States has established itself as the world's top destination for venture capital, and its culture of risk-taking will continue to fuel innovation for years to come.
*The views expressed in this article do not represent the views of Santa Clara University.
Comments