Venture Capital: Innovation, or Big Business in Disguise?

Is venture capital new, innovative small business, or just big business disguised?
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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.

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