Venture Capital: Innovation, or Big Business in Disguise?

Is venture capital new, innovative small business, or just big business disguised?  Steve King at Small Biz Labs this morning has a good summary of the debate about venture capital and government-funded Small Business Innovation Research (SBIR) grants.

Last year 3,600 smaller companies got about $2.2 billion in first-stage grants provided by 11 federal agencies. The basic idea is funding research, particularly from new innovative companies that aren't getting money from larger corporate development budgets.

That wouldn't seem so controversial, but venture capital was ruled out of SBIR loans in 2003 after a stink about companies funded by (oh dear) AIG, among others. Hence, what Rob Kuznia in Hispanic Business calls a wolf in sheep's clothing:

A federal grant for $750,000 from a program meant to foster innovation among small businesses went to a Utah-based biopharmaceutical firm called Cognetix that, at first blush, appeared to be a qualified small business.

But whistle blowers noted that the business was majority-owned by a pair of venture capital firms, one of which belonged to insurance behemoth AIG.

So that program is up for debate again. Steve reports:

There are two SBIR bills currently winding their way through Congress.  The House bill eliminates restrictions on VC backed companies and lets them fully compete for SBIR grants.  The Senate bill eases restrictions, but limits VC backed firms to a maximum of 8% of the grant money (except for the Department of Health and Human Services, which would be capped at 18%).

There are good arguments on both sides of this debate, but missing is a very important point:  if the House bill passes, larger VC firms will quickly start providing their portfolio companies with extensive and specialized support helping them identify, bid on and win SBIR grants.  The math associated with the grants is simply too good for them not to.

He recommends a compromise:

Allow VC backed firms to win SBIR grants, but limit the amount to a maximum of 40% of the total pie.  This will provide access to innovative VC backed firms but also keep SBIR money flowing to other deserving small businesses.

That makes sense to me. While you can trace some venture capital back to larger pools of money, like insurance, that feels like the dreaded and demonized "big business," it's also true that venture capital funded and helped to build some of the most innovative companies in US business history, in both the personal computer revolution and the Internet revolution that followed. And that venture capital decisions are almost entirely independent of the mainstream investors who wrote the original checks. 

Follow Tim Berry on Twitter: www.twitter.com/Timberry

Comments

[GardenerNorCal]

Yet another handout of American taxpayer's money to big business in the guise of promoting little entrepenuers. What a crock.

[Rubyfoo]

The primary aim of venture capital firms is not to foster innovation, but to bring their portfolio companies to a liquidity event, where they can convert their ownership to cash. I've consulted for many such firms whose products and technologies were not worth much, but could be sold to the public as hot IPO stock. Most of those stocks went way down from their initial price when everyone with money wanted to get in on the action. It's all pretty gross, with occasional standout companies formed, very rare.

[Offsite]

I have two separate but related questions.

Is an SBA loan a better option than VC money?

If so, what is the deal the the SBA and SBA loans? Since the SBA is ostensibly the most expedient way for the federal government to put cash into the hands of struggling small businesses (it is one of the tools the American Recovery and Reinvestment Act is using to offer small business owners relief) why aren't the mega banks that received federal bail out money being required to underwrite SBA loans? The only banks issuing them at the moment are small local banks.

[Tim Berry - Huffpost Blogger]

@offsite, I can answer those questions for you.

First, is an SBA loan a better option? It depends on the nature of the business plan.

1. VC money is usually much more, starting in the single-digit millions, than an SBA loan. And it's investment, not a loan. They sell ownership, so they never pay back a loan.
2. VC money is only available to a very select few of the most interesting business plans around, meaning management teams, technology, growth prospects, etc. Only about 1% of startups can get it.

Second, what's the deal with SBA loans?

1. SBA loans are loans, so they have to be paid back. They are usually only tens or hundreds of thousands, not millions. The SBA guarantees them, but banks actually process and make the loan. And they can normally only be for a maximum of 70% of what's needed to start the company; the founders have to put up at least 30%. There are some exceptions.
2. There's a lot of info on the sba.gov site.
3. I've also heard, as you suggest, that the smaller community banks are getting back into processing SBA loans quicker than big banks, after the big economic plunge, and if so, shame on them. We need this money to flow.

Tim

[Offsite]

Thanks for the info Tim.

[mikekc]

More similarities to big business:

1. Companies that get funded usually have Harvard, Stanford, or MIT graduates and several polished MBAs from the corporate set. Hippies in sandals working out of garages or corn-fed grads of Midwestern state schools out in the flyover lands tend to not get funded (if they are even considered in the first place).

2. VCs impose business practices to enforce the big business cut-costs-­first-inno­vate-later approach - such as must use offshore labor in development of the product.

I work in the industry and would never waste my time asking for VC money. These days it's not really needed to launch a great idea except for the couple of huge mega-next-big-thing types of companies that hit it big every year or so (facebook, google, twitter... it's a short list really).

[Mildmannered]

good posting

[hey0there]

I agree, they also go straight to hiring H1B's over American Technology workers, not because there is a shortage of American talent, but because H1B guest workers can be treated and paid like slaves.

[BillZBubb]

The Senate has it about right. The House bill is an invitation to a corporate raid.