Venture Capitalists, Start-Ups at Odds Over Who Should Get Funds

By Kim Hart
Washington Post Staff Writer
Wednesday, July 8, 2009

Dozens of executives from small technology firms descended on the halls of Capitol Hill yesterday to protest a proposed change to a popular government program that they say is crucial to their survival during tough economic times.

The change pits against each other two groups whose interests are often more aligned: the venture capitalists who invest in start-ups to help them get off the ground and the fledgling firms who rely on outside funding to develop new products.

At issue is the federal Small Business Innovation Research Program, which funds $2.2 billion a year in research and development at small businesses and is scheduled to expire this month. The House is expected to vote as early as today on a bill to reauthorize the program. But the bill has sparked a debate over whether companies that have received venture capital financing should also be eligible for federal grants, which has so far been reserved for start-ups without large investors.

Under the current program, a company in which a venture capital investor has a majority stake is not eligible for government grants. Companies without venture capital funding say this increases their chances of receiving research grants because they won't have to compete with more mature and better-financed firms.

The House reauthorization bill, however, would allow firms with more than half of their capital coming from venture firms to participate in the program.

"In this economy, small businesses everywhere are struggling to access capital and we should be making it easier on them, not harder," said Rep. Nydia M. Velázquez (D-N.Y.), chairwoman of the House Small Business Committee.

Investors and venture-backed firms applaud the bill for treating all small businesses equally, regardless of their ownership. Because venture capital investment is harder to get in a down economy, more young firms are looking for other ways to raise money.

But start-ups without venture capital funding argue that the bill would siphon much-needed early-stage funds to companies that have other sources of financing.

"Without SBIR, we would never have gotten the angel investors, which got us to the venture capital investors," said James Prudent, chief executive of Centrose, a pharmaceutical development firm in Madison, Wis., who spent yesterday visiting members of Congress about the issue along with about 30 other company representatives. "There needs to be a spectrum of funding opportunities."

Prudent has founded three companies, all of which have taken venture capital funding when they were ready to expand. But in the beginning, he said, when the firms were not mature enough or considered too risky to get the attention of investors, SBIR grants kept them alive.

"If [venture-backed firms] take over, we're dead," said Yvonne Rosenberg, president of PlantVax, a biotech firm in Rockville.

Venture capitalists and companies backed by them say the House bill allows the firms to be evaluated the same as any other small business.

"The definition of a small business should not be determined by who may be backing them financially," said Mark Heesen, president of the National Venture Capital Association. "At the end of the day, we hope they all grow, but they're all small businesses now."

Rep. Edward J. Markey (D-Mass.) has introduced an amendment that would allow venture capital recipients to apply for 15 percent of research and development funding at the National Institutes of Health and 5 percent of funding from other agencies.

The company representatives visiting Capitol Hill yesterday urged lawmakers to vote for the amendment. But Heesen said the compromise still promotes artificial distinctions between small businesses.

Velázquez said the House bill reinstates previous program parameters. Venture-backed firms were allowed to participate in the SBIR program until a 2003 administrative change made them ineligible.

A Senate version of the bill, which has not yet been approved by committee, would let venture-backed firms be eligible for 18 percent of the NIH funding and 8 percent of funding from other agencies.

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