majority stake, though each individual venture capital investor almost always has a minority share. Control may shift in the course of the very first investment in the firm, or it may come later. In some cases, individual owners retain their control until an IPO or even in some exceptional cases afterwards. This question is addressed in the next section.

A second issue concerns the firms that are still owned by 51 percent individuals but would be deemed ineligible under the 500 employee limit as interpreted by the SBA, whereby an investor’s portfolio companies can be included under the ‘informal’ aspects of control used by SBA to determine affiliation. There appears to be no useful way to develop a proxy that could differentiate between VC funds that breach this component of the SBA interpretation and those that do not.5

3.2
ELIMINATION I: EFFECTIVE CONTROL

The issue of control in majority venture-funded firms is exceptionally complex. There are both formal and informal aspects to control, and the question of control is often the subject of very carefully defined and tightly worded legal contracts.6 The difficulties in identifying controlling interests are of course compounded because privately-held companies in many cases do not publicly reveal their share owning structure. As a result, it is not possible to determine directly which firms are now ineligible under the 51 percent rule. Yet at the same time, any analysis of the impact of the SBA ruling must develop a good estimate for that number.

If direct access to relevant information is not available, it becomes necessary to turn to the identification of proxy indicators that we have determined to be closely associated with “control.” Upon deliberation, the Committee determined that it was reasonable to assume that firms that meet either of the following criteria are in fact venture-controlled for purposes of analyzing the impact of the SBA ruling7:

  1. They received more than one round of venture funding; or

  2. They received at least $5 million in venture funding.

This approach is captured in the Venn Diagram shown in Figure 3-1.

5

Discussions with venture firms indicate that most successful VC firms believe that they would be in breach of this requirement.

6

See Gordon Smith, “Control and Exit in Venture Capital Relationships,” University of California, Berkeley, Law and Economics Workshop 2005, Paper 9, pp. 18-21.

7

Committee members with extensive knowledge and experience of venture capital investment include Pete Linsert (Columbia Biosciences Corporation), Michael Borrus (X/Seed Capital), Linda Powers (Toucan Capital Corporation), and Clark McFadden (Dewey & LeBoeuf, LLP).



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