Prasad Thammineni, my occasional co-blogger, responded to my post yesterday with a question on the SBA and venture capital. His question centered around the efforts of the NVCA (the VC’s public policy organization) to get the US’s SBA (Small Business Administration) to allow VC backed businesses to access SBIRs (Small Business Innovation Research grant-things.) Man, lots of abbreviations when talking about government groups!! And yes, the inclusion of my name in the title of this post is a blatant SEO-effort; I don’t want some other Healy Jones to win the SEO battle with these new Google profiles. Thanks, Healy Jones. (Ok, enough with the SEO.)
Prasad’s question:
Healy, I have a related question about VCs and funding start ups. I read an article this morning in WSJ about how VC firms would like the SBA to expand their investments beyond small businesses to venture backed firms. Do you think that VCs are going after the SBA because they are not able to raise enough funds from limited partners or because they some strategic advantage to getting the Govt to back investments? Do you think VC backed firms should be able to tap into the SBA pot?
Basically, VC’s want their companies to be able to access the same types of government funding that other small businesses can get. Since 2003 VC backed companies have not had access to certain government grants controlled by the SBA. The argument appears to be that VC backed companies would crowd out mom and pop businesses seeking this funding. VCs counter argument includes the ideas that the awards are designed to promote 1) innovation, something that VC backed companies do pretty darn well; and 2) commercialization of technology, something else that VC backed companies are known for.
Yes, VC backed companies would probably be better than mom and pop startups at writing the SBA applications. I can see funds running effective seminars or hiring application experts to help their portfolio companies. The mom and pop companies have a legitimate fear here. However, I do also think that VC’s usually expect a certain level of capital and time efficiency from their portfolio companies and the SBA may be well served to trust professional investors with (some of) their capital.
As to Prasad’s question as to why VC’s want access to this money, the answer is pretty simple. VCs like money and want as much of it as they can get. Regardless of how much capital VCs can or can’t get from limited partners, a good venture capitalist will want more free money for his/her portfolio companies.
Finally, yes I think that venture backed companies should have access to this capital. As a tax-payer I would hope that the government would use its capital as efficiently as possible, and I’m pretty sure some deserving VC backed companies would be among the best users of the SBA’s money.
I am obviously not an expert on the SBA; most VCs aren’t because it can’t really help our companies. I may have messed up some terminology here and welcome any corrections/clarifications on my understanding of the program.
Thanks,
Healy Jones
April 22nd, 2009 at 5:55 pm
Healy,
Having gone through the SBIR application process last year for Pixily, I know a little bit about the process and the award criteria.
I see your point on how VCs could be better users of tax payer money than a small business. But I feel the reason the SBIR was created was to help individuals and small businesses innovate, whereas VCs are more about commercialization.
The SBIR's main objective is in promoting fundamental discoveries that have a broad impact on the community. It is more about innovation (at least in Phase I of SBIR) and less about commercialization. Only in Phase II, one needs to commercialize.
The other criteria is that the applicant should not have been already funded externally. But once they receive the grant, they can raise external money and in fact SBIR matches the external funds up to a point. This is true with both the phases (Phase 1: $100K and Phase 2: $500K and matching of I think $50K in phase 1 and $500K in phase 2). That means a VC can invest in a SBIR funded company.
Being an entrepreneur, I feel that VCs should not have access to Phase I of SBIR – for the following reasons:
1. If VCs are allowed, the playing field will be tilted heavily towards VC-backed companies. VCs and their portfolio teams have access to great talent and will put together very winning applications thereby putting a non-VC backed small business at a great disadvantage.
2. There are at least 5M small businesses in the US and a number of them come up with innovations that have a great impact on the society. All they need is time and some capital to build prototypes and test them out without the pressures of a professional investor. SBIR gives $100K and 6 months in Phase 1 and if you achieve defined milestones, you can apply for Phase II. As the inventors of the light bulb would say, it takes a lot of passion, perseverance and many tries before you perfect an invention for large scale commercialization. I am not sure VCs would give the innovator the same amount of time, capital and resources.
3. My last point is even more important. $100K goes a long way for a small business as opposed to a VC backed company. If the VC truly believes in the idea, then finding $100K is a non-issue. For a small business on the other hand, especially in this economic climate, that $100K could make or break the idea.
April 22nd, 2009 at 6:20 pm
Prasad,
Thanks for the response. It's good to compare the opinion of an entrepreneur and a VC on this question. I would like to respond on the topic of commercialization – I do think this is an important aspect of the SBIR funding. Otherwise, these grants could be done through research grants to universities. The SBA and SBIR are trying to get technology that can be eventually SOLD into the marketplace. I wish there were some statistics on what % of SBIR funded companies ever commercialize their research; I’d like to compare it to the % of companies backed by VCs that do and the % of SBIR+VC funded companies (pre 2003) that commercialized the research. I’d guess that the VC funded companies get their research into product more often, although this is mainly probably due to the additional funding resources that these companies have. But still, I think that’s a good thing – again, as a tax payer I want my government to make good use of my taxes!
Point 1 – I totally agree with your point that VC backed companies will win a serious % of the SBIR grants if allowed to compete for them. This is probably totally true. Should we be really upset that the private marketplace would crowd out government backed spending? I think it usually goes the other way.
For point 2 – In my mind this may be the strongest point. This program definitely gives the entrepreneur a run or two before they try to seek professional investors’ capital (assuming they want/need to get VC’s capital.) Proof of technology can really help someone get funding, and if this program does that then it has a strong case for preferring to back non-VC backed companies.
Point 3 – Also true. A good point.
I don’t think you’ve convinced me that VC backed companies should be excluded from the program. But I definitely understand why they currently are. I’m sure someone out there has statistics on the success of the program; I’d love to hear about it. If it is really really successful then I could be convinced that the VC exclusion is very appropriate.
Healy
April 22nd, 2009 at 6:27 pm
Healy,
VCs are not actually excluded from the program completely. They are excluded from the Phase I of the program. A SBIR firm can get VC funding and still continue to qualify for further SBIR grants. On the other hand, VC backed companies cannot apply for any of the phases.
Prasad
April 22nd, 2009 at 4:21 pm
[...] headed as well. What Canada needs more than anything is more capital to work with. We’re Healy Jones responds to Prasad on the SBA and VC – startable.com 04/22/2009 Prasad Thammineni, my occasional co-blogger, responded to my post [...]
April 24th, 2009 at 10:04 pm
I'm no specialist of the US SBIR but I assume it's a government innovation funding agency. There is something similar in France, called OSEO. It's open to all SMEs including VC backed start-ups but also including SMEs with hundreds of employees. So competition is fierce to get this money whether or not VC backed start-ups are included. There is also a difference with SBIR: OSEO gives a financing only if there is already private investors in place. It seems to me SBIR is doing the opposite which I sort of find weird. Having private investors in place is a sanity check for the government institution that the project has at least a bit of "financial" market traction.
April 24th, 2009 at 11:42 pm
Julien, that is an interesting comment; thanks. I guess Prasad is making the point that some startups could get to the \\"VC fundable\\" stage if they only had a bit of government help. So, if VC backed companies crowd out the unfunded startups then it will keep some from actually making it to the getting funding stage. It sounds like in France the government uses the private financing as a way to sort the companies commercial viability.