Do Venture Capitalists Really Deserve Half a Billion Dollars in Taxpayer Money?

Two government programs designed to help fund critical, long-shot technology have recently been opened to venture firms. But is this the sort of development venture capitalists do best?

According to the National Venture Capital Association, 169 venture capital firms raised $18.7 billion in 2011. Do taxpayers really need to subsidize VCs with another half a billion dollars – especially when that half a billion moves at a snail’s pace?

The Small Business Innovation Research (SBIR) and the Small Business Technology Transfer (STTR) programs have been renewed for six more years, much to the relief of the small businesses who feared those programs were on the brink of extinction. The two programs are supposed to give small companies the funding to engage in long-term development of technology that is crucial to government agencies.

Renewing the program is one thing. But this time around, there’s a major change in who can get that money. Until now, venture-backed companies, as well as those backed by private equity and hedge funds, haven’t been eligible for either program. The logic has been that companies with institutional funding don’t need government help –institutional investors have already evaluated their portfolio companies, have decided they’re worth the risk, and are willing to invest in them. The SBIR and STTR programs were for companies that didn’t have institutional backing. Not because they weren’t good companies, but maybe because their technology development was on a very long time horizon, or because they were in industries that VCs don’t tend to favor.

No longer. Now, venture-capital backed companies, as well as those backed by private equity and hedge funds, can qualify for SBIR and STTR funding.

But there are important aspects of both the SBIR program and STTR program that seem all but incompatible with institutionally-backed startups. I can see a few possible advantages to this change, but I’m not sure this is how the folks in Washington intended the programs to work.

Here’s the paradox as I see it:

1) Clock rate. Venture-backed start-ups run at a much higher clock rate than government-funded small businesses. Even non-VC backed, competitive small businesses run at a much faster clock rate than government agencies that make funding decisions. In the time it takes to get a ‘yes’ or ‘no’ on SBIR or STTR funding, a VC-backed start-up has typically had six to 12 board meetings.

2) Risk profile. A successful SBIR or STTR grant doesn’t start with an entrepreneur. It begins when a government agency, such as the National Institutes of Health, solicits applications to develop a particular technology. Some technology requests are more specific than others, but they are generally very, very early stage and high risk. Meanwhile, VCs have moved to later and later stages of investment, leaving a vacuum at the seed stage. (Angel investors have filled some of this.) In addition, VCs are looking to reduce their risk. They’d rather come in after the early stage innovation has been funded and the highest technical risks have been removed. There seems to be a fundamental mismatch here.

3) Timeframe. SBIR and STTR programs fund innovation, and in the cases I’ve seen, they fund innovation that takes time. I saw one request for new materials development to enable new telecom technologies. Is that high-value? Yes. Is that high value before a VC needs an exit? Probably not. In fact, it’s virtually impossible to schedule at all.

4) Critical technologies. SBIR and STTR programs may result in successful innovation that addresses mission-critical needs for the government or military, but that same technology may have limited appeal to the outside commercial world. In other cases, it may be impossible to know what spin-off applications will later be. It is sad to think that some of these programs may not get funded because a VC is not interested at the outset. I’ve seen critical laser technology, developed for use on submarines, that later became useful for inspecting the highest-performing microprocessors. But at least ten years passed between the government funding and the commercial application. VCs can’t wait that long.

There would surely be some benefits to allowing VC-backed companies to participate in the SBIR and STTR programs.

1) Rejuvenating interest in unpopular sectors. Perhaps access to that funding would stoke VC interest in sectors that have become less palatable over the years, such as equipment for manufacturing or other hardware. The SBIR/STTR programs are a source of equity-free financing that could boost these companies’ returns. The question is whether there is really enough money in play to cause a shift in investment behavior.

2) Expertise in commercialization. VCs could certainly help at the later stages, when it is time to commercialize technology that a company has already developed. That’s something that has been a challenge for the SBIR/STTR program.

3) Outside verification. Getting VCs involved in these programs could be a good way to make sure taxpayers don’t fund lifestyle businesses or so-called “SBIR shops,” that many find offensive.

I’m not confident that the current framework will enable the benefits of VC involvement to be realized. If their participation isn’t well thought-out, VCs may see the SBIR/STTR program as merely another government distraction they need to avoid.

Last updated: Jan 18, 2012

LAURA SMOLIAR | CEO, Peppertree Engineering

Technology expert. Global entrepreneur. Mentor. Laura Smoliar, with over 15 years professional experience and a Ph.D. in physical chemistry, specializes in the commercialization of technology.

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