As part of the blog series summarizing the Fraser Institute’s Demographics and Entrepreneurship essays, this post examines government policies that can spur entrepreneurship and entrepreneurial finance.

Since the global financial crisis of 2008 and 2009, markets for entrepreneurial finance have been in a state of flux in two respects.

First, there have been massive innovations in financial technology or “fintech.”

Second, there have been evolving regulations pertinent to fintech and other more traditional areas of entrepreneurial finance.

In our chapter in the Fraser Institute essay set, we provide an overview of theory and evidence to assess what we know about these developments at the intersection of financial markets, laws and entrepreneurial finance. We evaluate prior research trends from 2000 to 2017, highlight the state of knowledge of key drivers in promoting entrepreneurial finance markets, and offer policy recommendations based on the state of knowledge. Also, we identify gaps in our understanding, which enables some suggestions for future research.

Policy interventions to spur entrepreneurship and entrepreneurial finance should be put in place to correct market failures. More successful policy interventions are ones that incentivize performance—not merely existence. We offer a number of policy suggestions based on our review of the literature, and suggest avenues for future research based on gaps in the literature. Our review of prior research shows some key policy recommendations to create a vibrant long-term entrepreneurship environment to encourage startups and facilitate access to entrepreneurial finance.

First, tax policy, particularly low capital gains taxation, is the most efficient way to incentivize high-growth entrepreneurship and access to entrepreneurial finance.

Second, special small business tax rates do not incentivize scale-up. At best, they encourage entrepreneurial starts, but subsequently lead to reduced incentives to grow or incentives to move to different jurisdictions after reaching a certain scale.

Third, tax programs that incentivize retail investors to invest in venture capital funds structured like mutual funds, such as the Labour Sponsored Venture Capital Corporation (LSVCC) and the Venture Capital Trust (VCT), do not work and are potentially extremely harmful.

Fourth, entrepreneur-friendly bankruptcy laws, low labour frictions, healthy securities laws that promote IPOs and enable intermediaries such as VCs, PEs and hedge funds, encourage entrepreneurial activity and enable scale-up investment.

Fifth, equity crowdfunding rules in the United States with the JOBS Act have had negative externalities on the U.S. IPO market. As discussed above, the JOBS Act has given rise to fewer IPOs and greater underpricing of IPOs, contrary to the objectives of the JOBS Act.

Sixth, equity crowdfunding rules in Canada are too stringent, and no entrepreneur has made use of this new form of finance. By contrast, equity crowdfunding has been successful in other countries including Australia and the United Kingdom.

Seventh, some government subsidy and direct expenditure programs have been successful, including programs where governments act as limited partners in venture capital funds. But the success is highly dependent on the way the program is implemented, which poses risks for both entrepreneurs and the broader entrepreneurial finance marketplace in the region.

Eighth, policy programs to stimulate entrepreneurship and entrepreneurial finance should not be evaluated in isolation, but should be assessed with consideration for their possible spillovers and unintended consequences. For example, a tax subsidy to LSVCCs can have negative consequences for private VCs. As another example, regulation changes pertaining to crowdfunding can affect other forms of entrepreneurial finance such as angel investment, venture capital and IPOs (see also the fifth point above). The extent of our knowledge on spillovers to date is quite limited; further empirical work is warranted.