Innovation needs capital

Tomorrow, a new company will begin trading in public markets, one that is well-known to millions (around nine hundred one million at last count, to be more precise).  Having now announced that its IPO price will be $38 per share, Facebook will be valued at roughly $104 billion and will raise roughly $18.4 billion of capital from the offering*.

The offering is being hailed as the "largest internet IPO in history"  (and in fact the highest valuation by any US company at time of offering, according to the Wall Street Journal) and receiving non-stop media coverage, with pundits opining on the things that Facebook will have to do in order to justify its lofty valuation.  

Facebook and those whose vision and hard work created the company achieved this milestone through innovation: the creation of something new (from Latin novo, meaning "new" or "fresh").  In order to create future growth that will enable its earnings to grow into its IPO valuation, it is clear that further innovation will be required from the team at Facebook.

This brings up a very important point, and one that should be very clearly understood by all investors: innovation needs capital.   In order for innovators to bring new value to others, they need capital.  Many of those who will see a payout tomorrow in the IPO are those who provided the young Facebook with capital back when it was still just getting off the ground.  Without that capital, Facebook could not have built the computer infrastructure needed to power its product, or hired the engineering talent needed to write the code, or paid for the many other people and services that it needed along the way.

Every other company whose products people enjoy needed capital as well in order to turn an innovative idea into a reality.  Most of the time, a very innovative company will eventually need levels of capital that are larger than any one family can provide.  This capital can be provided by banks, by angel investors, by venture capital firms, and ultimately by Wall Street in a public offering.

There are many voices today which vilify "bankers" and "Wall Street" as something evil or nefarious.  At the same time, many of those vilifying the forces of capitalism are happy to enjoy the fruits of the innovation that creative individuals and teams created over the years, which was watered by capital that was provided by the mechanisms that "marry up" innovation and capital.  This is a very unfortunate turn of events.

In the free world, these mechanisms allow capital to flow to innovation by free choice.  In systems other than capitalism, capital only flows to those firms connected to centralized rulers.  This alternative does not work very well at all (see, for example, the ugly example of Solyndra).  Thus, we should not be to quick to vilify the mechanisms which in a free economy allow decisions about capital flows to be made freely by private individuals (nobody is being forced to buy shares of Facebook tomorrow, for example -- that is everyone's free choice).

We need to do a better job of educating our children of the fact that innovation is a very good thing -- in fact, that it is essential -- and of the equally important fact that "innovation needs capital."

* At the time of publication, the principals of Taylor Frigon Capital Management did not own shares of Facebook (FB).