The New Small Business Innovation Research Grant Program Reauthorization Bill: H.R. 5819 “Modernizing” Grant Programs

It is a long-awaited and still much-contended piece of legislation, but the SBIR/STTR Reauthorization Act (H.R. 5819) is one step closer to reality. Those involved with the grant program are no doubt pleased the program is one step closer to continuing. For those readers unfamiliar with these terms, the New Small Business Innovation Research (SBIR) program and the Small Business Technology Transfer Program (STTR) provide federal assistance in the form of grants to small businesses to fund innovations and technology that are usually deemed “high risk” in the proof of concept and product development stages. These grant programs are important funding sources to small businesses for concepts that otherwise might not get funded by private sector sources for a variety of reasons, from degree of risk to a market that isn’t “attractive” to the capital investor markets.

So the bill reauthorizes the program; what is the big deal? The bill does extend the program through fiscal year 2010, but it does more. H.R. 5819 changes some of the fundamentals of how the SBIR program has been doing business. These changes are key elements and will undoubtedly have significant impacts on who gets the money, how money is spent, and the fundamentals of how business is done under the program rules.

From the Beginning: Eligibility

One of the most significant aspects of the legislation is a change regarding which companies can be categorized as small businesses. Under the current SBIR program rules, small businesses must be at least 51% owned (and controlled) by individuals. This requirement has translated into an ownership/size determination—or limitation—with regard to the capital structure (funding) of companies. What this means is that as technology-oriented companies pursued investors and succeeded in raising capital, the composition of the sources of funding (individuals versus groups like venture capital funds) became a determinant as to whether or not they were small businesses.

Companies that raised millions of dollars in funding from certain venture sources and became owned or substantially controlled through the board composition (more than 50%) would no longer be eligible to participate in the SBIR/STTR programs. This posed a significant dilemma for many early-stage small businesses that strategically wanted to participate in the SBIR program, but needed venture level funding to get a product to market (e.g., pharmaceutical industries, other high-investment industries). Without the early stage proof of concept and product development funding of grant programs, they weren’t moving ahead to gain credibility to raise venture funding. Once they began venture funding, the ability to participate in the grant programs was potentially truncated and required a shift in funding strategy. Other SBIR recipients with products and industries that were less capital intensive could (with grant funds and using investor sources from individuals and lower levels of venture funds) get a product to market and remain eligible much longer. Some companies could, strategically and through business models, leverage the SBIR and STTR programs, seemingly without a time limit—never outgrowing the small business definition.

The Modern SBIR legislation now is opening the door to venture-backed firms to continue to participate in the grant programs. The relevant section of the bill as it applies to venture capital investment is “Title II – Venture Capital Investment Standards”, Section 201. This section can be summarized as follows:

–          The definition of a small business is amended only for the SBIR and STTR programs and not for any other government program.

–          A business concern that has more than 500 employees shall not qualify as a small business concern.

–          The SBA shall not consider whether a business concern is affiliated with a venture operating company in determining whether a small business concern is independently owned and operated IF the venture capital operating company does not own 50% or more of the business concern and employees of the venture capital operating company do not constitute a majority of the board of directors of the business concern.

–          A business concern shall be deemed to be independently owned and operated, if:

  • it is owned in majority part by one or more natural persons or venture capital operating companies;
  • there is no single venture capital operating company that owns 50% or more of the business concern; and
  • there is no single venture capital operating company the employees of which constitute a majority of the board of directors of the business concern.

–          To be eligible to receive an award under the SBIR or STTR program, a small business concern may not have an ownership interest by more than one venture capital operating company controlled by a business with more than 500 employees and that venture capital operating company may not own more than 10% of that small business concern.

Of course, the legislation contains pages substantially more details including the definitions of venture capital operating companies and terminology such as “under large business control.” These details will have to be translated, interpreted, and passed down and through the Small Business Association, SBIR agencies, auditors, and so on. So, even when things change, implementation of the changes will be, shall we say, “interesting” and subject to interpretation and much oversight.

Speaking of Oversight: Advisory Boards

Personally, one of my favorite sections is the addition of Advisory Boards for each agency, composed of employees of the agency (at least two), representatives of the private sector technology firms (at least two), a veteran who owns a small business concern (owned and controlled by veterans—at least one), and “such other individuals as an agency considers appropriate.” Each board must meet at least two times per year and is required to:

–          Review quarterly reports;

–          Make recommendations for potential modifications of the SBIR program (agency level);

–          Encourage applications from small business concerns controlled by:

  • Women
  • Minorities
  • Service disabled veterans
  • Areas that historically haven’t received many SBIR awards;

–          Support commercialization of the funded research; and

–          Submit to Congressional committees an annual report on the SBIR program conducted by the agency.

Of course, the legislation contains much more detail on the contents of the reports to Congress and the quarterly reports.

Technically Speaking: More Funding

Agencies will be allowed to spend more funding on the programs they provide to support the recipients receiving the SBIRs. As a result, each agency will be able to provide more advisory services to each recipient on “technical” matters related to successfully executing the SBIR program. The technical and commercial assistance programs currently underway will benefit from this increased funding.

More Opportunities: Topics, Solicitations, and Dollars

Essentially, there will be more of everything and faster cycles for decisions being made on proposals. More solicitation periods will be provided, and more dollars made available in each solicitation and awards. The guidelines for awards are being increased from $100,000 and $750,000 to $300,000 and $2,200,000 respectively.

First Contact: Not Getting to Phase II

Each agency will be required to “engage” SBIR Phase I recipients who have received multiple Phase I awards but never received a Phase II award. Agencies will assist these recipients in developing performance metrics for the company to measure progression in the SBIR program. The bottom line for this requirement is that performance counts; if you can’t make progress and ultimately create technology that is ultimately worthy of a Phase II award, then you may not be receiving Phase I awards much longer. Performance will be not only encouraged, supported, and measured, but also REQUIRED.

You Won’t Believe These Changes: No Phase I, No “Minimum Level of Effort”

Imagine having a Phase I in one agency and getting the Phase II from a different agency. Under the new program you may just be able to do it. Other revolutionary changes include being able to apply for Phase II funding without having had a Phase I,  if you can demonstrate that proof of concept has already been achieved without Federal funding or SBIR/STTR Phase I, or if you DID HAVE a cooperative R&D agreement.

Small businesses are innovative in many ways, including their business models. What happens if the small business concern or research institution can demonstrate that the objectives in the research proposal can best be achieved (including funding) by the government waiving the “minimum level of effort” requirements for the amount of work to be performed by each entity or both entities? Well, full steam ahead! Under the new legislation, the agency will be able to waive those requirements.

Wondering Why You Didn’t Get The Award?

Wonder no more about what went wrong with your proposal; the new rules will include providing an explanation to unsuccessful applicants when they don’t receive an award. If you ask, the agency will be required to provide an explanation. In other words, if you apply and they deny, then you ask, they answer, and you learn. You can in some instances revise and resubmit at a later date.

More, More, and More

Like Congress, I could go on and on about the details, the language, and the other changes. But, undoubtedly as the Senate reviews this legislation, it will change. The very definition of small businesses appears to be changing. Currently this is only for SBIR and STTR programs, but it is changing. Is this good or bad? Yes. It will be positive for some companies with intense capital needs. Others will undoubtedly meet new contenders for funding that may only resemble small businesses. Such is the nature of legislation, lobbying, and Congress. Whatever the final rules, everyone will be living with them, as well as their consequences and benefits.

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