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n January 2013, the government implemented changes to the Small Business Innovation Research (SBIR) program authorized by the fiscal year 2012 National Defense Authorization Act.1 These changes were designed to spur more participation in a program that offers critical funding to start-up companies and is one of the primary sources for small business innovation in the federal government. At a time when research and development (R&D) in the United States is declining relative to China2, the SBIR program has the potential to help U.S. businesses close that gap and support start-up companies in the so-called “valley of death” when they are doing promising research but not generating revenue. Unfortunately, the jury is still out on whether the changes to the SBIR program go far enough and if the government is sufficiently committed to maximizing the potential of the program. Several witnesses at U.S. House of Representatives hearings on the SBIR program in May and July 2014 said government agencies charged with backing the program are not doing enough and that the new rules encouraging broader participation—particularly by companies whose ownership includes venture capital, hedge funds or private equity companies—may not go far enough. Under the SBIR law, created as part of the Small Business Innovation Development Act of 1982 and the Small Business Technology Transfer Act of 1992,3 federal agencies with extramural R&D budgets that exceed $100 million per year are required to allocate 2.8 percent of their R&D budget to their SBIR programs, with that growing to 3.2 percent in 2017. Currently, 11 federal agencies participate in the program, including Agriculture, Commerce, Defense, Education, Energy, Health and Human Services, Homeland Security, Transportation, Environmental Protection Agency, National Aeronautics and Space Administration, and National
Science Foundation. The SBIR program awards up to $150,000 in the first phase to explore the feasibility of an idea and up to $1 million in a second phase for R&D. Agencies are permitted to exceed the amounts by up to 50 percent, provided they provide notice to the Small Business Administration (SBA) along with justification for exceeding the award amount.
Do Changes Go Far Enough?
While there have been success stories—Symantec and Qualcomm received early-stage funding from the program— in recent years, the tight eligibility rules have shut out many other small businesses and potentially other success stories.
...the tight eligibility rules have shut out many other small businesses and potentially other success stories. One of the biggest restraints has been a requirement that SBIR companies must be majority owned and controlled by “U.S. citizens”. Over a decade ago, the SBA interpreted this to mean real people, and therefore effectively excluded venture capital, private equity and hedge fund-backed small businesses from participation in the program. The intent of the rule was to limit SBIR companies to actual small, independent businesses, rather than the subsidiaries or affiliates of major companies. It also had the effect of not taking into
account funding mechanisms that were less prevalent when the eligibility requirements were initially promulgated in 1982. SBIR applicants are also limited to a total of 500 employees across all business units. This size requirement was another impediment to private equity ownership because if the private equity firm was determined to be affiliated with the SBIR applicant, than the SBIR applicant would have to count all of the private equity firm’s portfolio company’s employees in its employee count. As you might expect, many startups and R&D focused small businesses depend on venture capital or private equity funding as a source of funding as they develop. In addition, often the companies with the most promising technologies or concepts are the companies that receive third-party investment. Even with the outside investment, the SBIR program remains an important R&D funding source and, for several years, venture capital (VC)-backed small businesses have been asking Congress to loosen the eligibility requirements on ownership. In the 2012 reauthorization bill, Congress opened the door, a crack, to permit some private equity, hedge fund, and VC-backed small businesses back into the program. Under the new rule, effective January 28, 2013, VC, private equity and hedge funds can be majority owners of SBIR applicants, provided that no single such firm owns a majority or controlling interest.4 The rule also relieves the SBIR applicant of counting all of the employees of the private equity or VC firm’s affiliates5 and softens the requirement for U.S. citizenship or resident alien status, saying instead that the private equity or VC firm must have a place of business in the United States or have been created or organized in the U.S.6 This concession, however, came with several barriers to VC-backed firms. First, the 11 participating agencies are limited in the amount of SBIR funds that they can continued on page 23
National Defense Authorization Act for Fiscal Year 2012, Pub. L. No. 112-81, 125 Stat, 1298 § 5107; Small Business Size Regulation, Small Business Innovation Research (SBIR) Program and Small Business.Technology Transfer (STTR) Program, 77 Fed. Reg. 28520 (May 15, 2012) (proposed rule); 77 Fed. Reg. 76215 (Dec. 27, 2012) (final rule). 2 “The coming R&D crash” (B. Plumer), The Washington Post, February 26, 2013. 3 Pub. L. No. 102564, as codified at 15 U.S.C. § 638 (1992). 4 13 C.F.R. § 121.702(a). 5 13 C.F.R. § 121.702(c)(9). 6 13 C.F.R. § 121.701(b). 1
Professional Services Council
Service Contractor / October 2014 / 21