Venture funding is not in and of itself disqualifying for firms seeking SBIR funding. In order for a firm to be eligible for SBIR funding under the SBA’s revised eligibility tests, a firm must be effectively controlled by U.S. individuals, or be controlled by another firm or firms that are themselves majority-owned by U.S. individuals. It has been argued—by venture capitalists and other experts—that most firms receiving venture funding cannot meet these criteria.4
A first issue concerns control of the SBIR firm. Given the high risks involved in funding early-stage companies, and the low existing capitalization relative to the investment being made in the firm, venture capitalists often make substantial investments in a firm, but do not always acquire control of the firm at an early stage. It is often the case that there are multiple venture capital investors who invest in a single small biotechnology firm that in combination make up a
Is majority ownership of a firm synonymous with control of a firm? Some economics theorists, including Oliver Williamson and William Baumol have argued that differences in motivation are likely to arise between owner and management groups and that management insulated from effective owner control may purse polices at variance with the owner’s interests. However, Public Choice scholars, including Henry Manne and Gordon Tullock, point out that a variety of incentive mechanisms in the real world, including for example the threat of takeover, help to align the motivations of managers and owners. Some economists have also questioned whether the commonly used standard of 50 percent plus ownership benchmark actually provides an effective indicator of control of a corporation. Adolph Berle and Gardiner Means, in an early empirical study, demonstrated that effective control can be exercised with as little as 20 or even 10 percent ownership. Conversely, nominal ownership of greater than 50 percent of a firm need not necessarily imply effective control of firm. For small biotechnology companies, this case occurs when “majority ownership” is in fact divided among a syndicate of investors who each hold a small ownership share. For a review of the classic economics literature concerning the tension between ownership and control, see Robert Sorensen, “The Separation of Ownership and Control and Firm Performance: An Empirical Analysis,” Southern EconomicJournal, 41(1):145-148, July 1974.
See Thomas Hellman and Manju Puri, “Venture Capital and the Professionalization of Start-Up Firms: Empirical Evidence,” in The Journal of Finance, 57(1):169-197, February 2002; See also Steven N. Kaplan and Per Strömberg, “Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts,” Review of Economic Studies, 70(2):281-315, April 2003.