Should VCs Hold the Key to Access Government Money?

There is a controversy brewing in the world of government grant money to start-ups that is trickling into the VC community.  The Small Business Association (SBA) of the US government administers Small Business Innovation  Research (SBIR) and Small Business Technology Transfer (STTR) provides grants to small businesses (defined as fewer than 500 employees) to the tune of $2 billion per year.  This compares to $20-30 billion per year in VC money that flows to start-ups, so a meaningful figure in the entrepreneurial economy.

But the two worlds of VC-backed start-ups and SBIR grants have mixed like oil and water historically due to a key restriction in grant eligibility:  start-ups that are 51% or more owned by VCs do not qualify for SBIR or SBTR grants.  Thus, a young start-up in a field relevant to the government grant world has a conundrum when it considers taking VC money - it no longer will be eligible to receive non-dilutive government grants.

Many VCs argue this is a ridiculous exclusion that is fostering an adverse selection problem.  The economy is awash in VC money and so only the less promising start-ups aren't getting it.  Instead, they get taxpayer-funded government money.  The most promising start-ups who can get VC money are not eligible for government money.  Hence, the government is serving as a funder of last resort to companies who the invisible hand of the market has rejected.
 
That may sound like an overly harsh view, but it is one that the NVCA (National Venture Capital Association) is arguing as they try to get the Senate and House to agree to loosen the restriction. Mark Hessen of the NVCA points out that "Venture capitalists have funded well over 90% of all the biotech firms in the United States".  It is an interesting debate and the House and Senate are in the midst of it. 

I confess to being sympathetic to both views.  My father was an entrepreneur in the 1960s and 1970s who received government grant money to foster his innovations in the defense electronics community.  At the time, though, the VC community was miniscule compared to today.  In 1980, the VC industry comprised of under 100 firms with a mere $4 billion under management.  Today, there are 700 firms with over $250 billion under management.  It's hard to argue that just because a firm is successful in attracting VC money, it is unworthy of government support.  The fact that SBIR applications have been dropping sharply in recent years (down 12%, 15% and 21% in FY'05, FY'06, FY'07) is a clear signal that something in the system needs to change.

Comments

[Xavier de lecaros-Aquise]

Some money sure, and in many seed stage funds that is the case (at least in the UK).

Should VCs represent a significant part of Govt Money...I doubt it. The more VCs feel they have clients the better - Govt secured money can be a big disadvantage to the industry's development.

[raj]

Govt secured money will be surely a deterrent for development of industry.
http://www.decisioncare.org

[Kirstin]

Jeff,

This was one of the most informative, valuable blog posts I have read in a long while and especially pertinent as I am working with an entrepreneur that has a transportation algorithm that is perfect for SBIR funding but also for an angel investor. You have helped me think about this bigger picture and adjust my strategy. Thank you and count me in as a new fan!

[Mike Dee]

Bad idea for private investors, angel and VCs, to be involved in SBIR/STTR.

See: http://mdichi.wordpress.com/2008/09/04/keep-sbir-funding-opportunties-pure/

[Grant]

I agree with Mike Dee - this is jut a bad idea to get involved here as a VC.

[Jarrod]

Excellent post! I found this post at just the right time and am very thankful for it. I do have to agree with you though Xavier on gov secured monies.

[Nursing gowns]

The economy is awash in VC money and so only the less promising start-ups aren't getting it.

[scoremore]

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