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VCs see federal R&D cuts ahead

The post-election stock market rally pleased venture capitalists, but a few years down the road doesn’t look so rosy.

VCs are worried a cash-strapped federal government will reduce its investment in basic research — the source of many of the innovations that venture-backed companies commercialize. If this happens, "Our pipeline becomes thinner and thinner," says Mark Heesen, president of the National Venture Capital Association.

Kent Hoover
Washington Bureau Chief

http://www.bizjournals.com/dallas/stories/2004/11/15/story6.html

Heesen believes President Bush will be "under intense pressure" to cut spending on domestic programs.

"You’re going to see an emboldened conservative majority in Congress telling the president, ‘You cannot continue to spend the way you’ve been spending the past couple of years,’ " he says.

Once the budget knives are out, basic research won’t be spared, Heesen says, despite its importance in fueling economic growth.

"We certainly will bang the drums," he says, "but we have to look at reality."

One piece of good news on the research front, venture capitalists say, is that California voters approved a $295 billion-a-year, state-funded program for stem cell research.
California factor

This initiative, Heesen says, "trumps the Bush administration" — which has been reluctant to fund research that uses human embryos — and could make California "a real locus of activity" for stem cell research.

California already is a major biotech center, but the stem cell research funding will draw even more companies and more venture capital to the state, says Andrew Dale, managing partner of Seattle venture capital firm Buerk Dale Victor.

The pharmaceutical industry also will be more attractive to venture capitalists since Bush’s re-election defuses efforts to import drugs from Canada or put price controls on drugs used by Medicare patients.

Companies that specialize in software or other services for pharmaceutical companies also will do well, says Scott Perricelli, vice president of LLR Partners in Philadelphia.

Bush’s victory also boosts the for-profit education sector because it bolsters the school accountability mandate of the No Child Left Behind Act, venture capitalists say. This will lead to investments in businesses that run charter schools and firms that help schools measure their performance or operate more efficiently.

The Bush administration also gained traction in its efforts to reduce the federal government’s exposure to losses on investments made by Small Business Investment Cos.

SBICs are private venture capital funds that make loans or equity investments in small businesses with their own money and funds guaranteed by the Small Business Administration.

The White House estimates bad investments made by SBICs will cost taxpayers nearly $2 billion. It has proposed dramatically increasing the SBA’s share of profits in SBICs’ equity investments and charging SBICs a lot more for the use of the government’s money.

The SBA’s Web site lists 16 SBICs that either are based in the Dallas-Fort Worth area or have an office here. Some SBICs are units of larger venture or investment firms and, in at least two cases, the firms have two or more SBICs.

Capital Southwest Corp., a Dallas venture firm, has had an SBIC arm since 1961. Vice president Pat Hamner says the firm’s SBIC, Capital Southwest Venture Corp., has helped generate good returns for the firm.

"It’s been a fairly reliable source of capital," he says. Capital Southwest has paid off all its debts to the SBA related to the SBIC, and hasn’t taken on any more debt, he adds.

Early-stage companies and firms in low-tech industries would be hurt the most by the demise of the SBIC program, as would companies in regions of the country underserved by conventional venture capital, VCs say.

Staff writer Jeff Bounds contributed to this report.

Hoover is Washington bureau chief for American City Business Journals, parent company of the Dallas Business Journal. He can be contacted at khoover@ bizjournals.com

© 2004 American City Business Journals Inc.

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