Where Does Venture Capital “Fit” in the Competitive Equation of “Small” Business

How do we define “small business”? Is it by the number of employees?  The amount of revenue? Or who owns or controls the business?  Does it matter how much money it will take for a particular product to be developed and marketed?  Does the industry matter? The technology? How about all of the above?

When it comes to defining a small business, you would think that it wouldn’t be that hard.  The reality is all businesses start out as small businesses.  How they are started and where the funding comes from plays an important part in the practical definition of “small” versus the theoretical definition.  In practical terms, two businesses may look very much alike on the surface.  They may be in the same industry.  Have the same number of employees.  They may even be competing against each other.  The difference cannot be seen until you look at how the companies are funded, owned, managed and “connected” beyond the initial “small business” façade.

The Appearance of Small

There is no doubt that growth takes cash.  Cash requires investors.  Having the ability to get investors means having the connections, the know-how, the expertise, the “package” that attracts investors, every business wants that package.  The question is when a business has that ability and puts together that package – should it then get taken out of the equation for special programs that are meant as stimulus packages and resources for companies who have not yet been able to get to that point?  If programs are meant to be funding for high risk projects where small businesses are getting the opportunity to prove themselves, then what happens when the funding is opened up to companies that have already demonstrated that they are through their business systems, processes, and capabilities beyond the “proving themselves” stage.

Hedging Venture Risk or Recognizing Longer Development Cycles?

With the passage of H.R. 3567, the debate is heating up as to where the line is in what is small business and what is big business in small business clothing.  The battle has been waging for sometime and both sides have valid points.  For instance, a company with a promising drug has years of development and testing and millions of dollars in investment to fund – and they have other ideas for products.  They want to continue to get grants for the new ideas to fund proof of concept and initial product development, but if they get to much venture investment in the company they get disqualified.  On the other side, a computer software company gets grants and with funding from state matching programs and their own savings can get their product to market.  Entirely different levels of capital needs, so where is the line?  Is there one answer?

Opponents to HR 3567 say this is back door for venture and big business to get grant funds and unfairly compete against the truly small business, the inventor, scientist, who needs the funds to get started and get the technology going.  The proponents say this is encouraging investment in the infrastructure and competitiveness of business.  Yes to both.

Unfair and Necessary

Whether it is under today’s existing rules and guidelines, or the new rules like H.R. 3567 would put in place, inevitably it will be unfair to some.  Today’s rules are intended to prevent recipient companies from “making a business from grants”.  Yet there are companies who have been success stories receiving grants for the entire length of time the grant programs have existed.  IF they are successful and commercializing technology after technology, why are they still tapping into the grant program to fund their research?  Because they have found the loophole to remaining a “small business” and have reached a point where the cost of grant funds (business systems and compliance) is negligible.  Free money any one? If these companies can participate for decades, then arguably a small start-up with venture backing with large capital needs is just as entitled, so is a university backed company, and so on.

H.R. 3567 is holding a mirror up to the system and saying look at the reality of where we are.  There are loopholes.  There are practicalities for certain types of businesses with huge capital demands.  On the other side, the small business that is not venture backed or affiliated with larger organizations must be able to compete and win.  They must have access to funding that may be their only source for proof of concept and product development dollars due to the high risk of the technology and the business stage.

USB – Unaffiliated Small Business?

There are disadvantaged small businesses.  Minority small businesses.  Women-owned small businesses. Service-disabled veteran small businesses.  May be there will be an unaffiliated small business meaning the business is funded solely by individuals or is at least 51% owned by individuals.  The government can then require so much business be done with these USB’s.

Greater Opportunity

The truly small business that has no experience in business or in capital markets that is looking for funding for its high risk, early stage technology will be potentially competing against even more players for fewer dollars.   Perhaps this is capitalism and competition at its most basic form, where small businesses have to get better at the business side much earlier in the process – becoming more competitive, more commercially aware earlier.

Venture Investment Doesn’t Mean Cash Rich or Successful

Venture investment doesn’t mean automatic success and it doesn’t mean cash rich or cash flow positive.  A venture backed firm has been successful in raising funds, but it doesn’t mean it has reached commercialization by using those funds, or that those funds were used on the particular technology currently being developed, or that the company is well particularly successful at well anything.

Many companies are able to raise funds, but those funds are sufficient to get the technology to market or the company runs into other issues.

Commercialization Potential

When it comes down to defining a small business, it is about more than who invests in the business and how much money they invested. It isn’t about how many employees.  It is about how much money it will take to develop the product and get it into production and into the marketplace.  It is about how the money is used and how it is managed.  It is about the business’ infrastructure and who will get the “benefit” of the funding.  It is about whether the small business is truly innovative and has something big business and the market is interested in – a commercialization opportunity.

Opponents to the Bill

The Bush Administration has taken the position to “…strongly opposes the proposed change to the definition of a small business for the purposes of venture capital investment. This definition strips the elements of independent ownership and control that identify small business ownership under current law. Not only would this change be inequitable for actual small businesses, but it would be a step backward from our recent progress in addressing the misidentification of large firms as small businesses for Federal procurement purposes.”

Jere Glover, Executive Director of the Small Business Technology Council, who has been lobbying against the bill says “It is important for everyone to contact their Senators and their Representatives to let them know how they feel about this bill.  It may be next month or next year or years from now that the Senate votes, but they need to know how it will impact the small businesses.”

The Other Side

For those businesses that are “pro-venture”, they have a voice too.  Some companies who “feel like the post child” for the venture vs. small  business issue are anxiously awaiting the outcome.  “We are a small business with all the small business issues.  We were able to raise venture funding, but it didn’t change us from being a small business.  We have less than 30 employees.  We are still in development stage with our technology and we still need funding.  We aren’t a front for big business.  We just happen to be a technology that was attractive to venture firms earlier than most emerging technologies would be and we had SBIR funds.  Now we have venture capital, no longer qualify for SBIR programs, and we are scrambling to find new sources of early stage capital.” says one RTP tech CFO whose firm was disqualified due to venture capital ownership.  “Getting the ability to participate in SBIR programs again would make a huge difference in everything we are doing.”

Lea Strickland, MBA CMA CFM CBM, President/CEO of F.O.C.U.S. Resources, is an international business consultant, author, speaker, and commentator on business issues and trends.  Her clients include emerging technology companies, not-for-profits, and government grant recipients and contractors for whom she designs funding strategies, management systems, and compliance programs to leverage grant funding into the financing equation.  She is the author of SBIR Basics: The Numbers and Out of the Cubicle and Into Business,  One Great Idea! and Marketing Strategies. She will be speaking at the National Small Business Innovation Conference in Richardson Texas on October 31, 2007 on “The Requirements – Creating a Business that Is Business Capable” and at the Business to Business Showcase for Tazewell County Virginia on October 16, 2007 on “Small Business, Big Opportunity”. She can be reached at 919.234.3960 or Lea@focusresourcesinc.com or visit the website focusrebuild.wpengine.com.

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