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November 01, 2011 (Vol. 31, No. 19)

Retooling SBIR Not That Easy

Concerns that Some Firms Will Be Squeezed Out Conflict with Confidence of Improved Success

  • The Small Business Innovation Research (SBIR) program has been surviving on the same $2 billion per year budget since its authorization ended in fiscal 2008 thanks to three years of temporary spending fixes. The program’s authorization is now set to expire on November 18, when the first continuing-resolution (CR) for the 2012 fiscal year, which started October 1, ends.

    Set up in 1982, federal agencies with extramural R&D budgets that exceed $100 million set aside 2.5% of their R&D budget to the SBIR program. Eleven federal agencies are included. Each sets its own guidelines: NIH, CDC, and FDA, for example, award phase 1 grants of up to $150,000 covering six month’s total costs and phase 2 grants of up to $1 million covering one year’s costs. The Department of Defense typically limits awards to $100,000 in phase 1 and $750,000 in phase 2.

    House and Senate leaders are reportedly working on reauthorizing SBIR, fine-tuning how much the program can spend and how. “Progress has been made, and the situation is still very fluid,” Wendy Knox, a spokeswoman for Rep. Sam Graves (R-MO), chairman of the House Committee on Small Business, said.

    While both the House and Senate profess their desire to reauthorize SBIR, they differ on key details. One major sticking point in both versions of the reauthorization is the return of majority investor-owned businesses to the SBIR program, as was the case before 2003.

    At present, VC-backed companies can access SBIR funds as long as venture firms own up to 49% of a small business; majority VC-owned businesses are not considered “small” businesses, according to the U.S. Small Business Association.

    Opponents of this measure fear the new competition. Proponents, on the other hand, applaud the possibility of additional participants in the SBIR program and believe it improves chances of success.

  • In Congress

    Rep. Renee Ellmers (R-NC), chairwoman of the House Small Business Subcommittee on Healthcare and Technology, introduced the Creating Jobs Through Small Business Innovation Act (HR 1425). The Senate’s SBIR reauthorization measure (S.493) was introduced in March by Sens. Mary Landrieu (D-LA) and Olympia Snowe (R-ME).

    The House would allow NIH, NSF, NASA, and the energy department to award up to 45% of their SBIR funds to small businesses majority-owned by venture capital firms, hedge funds, or private equity firms. All other federal agencies could set aside up to 35% of their funds to such businesses.

    Under S.493, 25% of SBIR funds from NIH, DOE, and NSF and 15% for all other agencies would be awarded to businesses majority-owned by investment companies. The Senate would not permit companies where more than half the investors are from overseas; the House has no such limit.

  • Advantages of Focusing on "Small"

    Many smaller businesses contend that investor-owned companies will squeeze out funding now going to smaller start-ups with less capital. One umbrella group, Save SBIR, includes among its members Centrose, a developer of targeted therapeutics designed to fight cancer.

    Centrose has won five SBIR awards and one STTR award toward development of its extracellular drug conjugate EDC-One, which has shown efficacy against metastatic non-small-cell lung cancer.

    “Nowadays, you either get some government support so that people say, ‘Look, the government believes in this company,’ or you go and try to build partnerships with pharmaceutical companies. The only problem with this is that no pharmaceutical company is going to give you any money until you’ve actually got some results,” James R. Prudent, Ph.D., Centrose’s president and CEO, explained.

    “The nice thing about the government is that they’ll look at what you’ve got. They’ll say your company is just getting started, it has a good team, yet it doesn’t have any money, so why don’t we put some money into this company and see what it can do?”

    Centrose spent its first year as a virtual company before receiving its first four SBIR awards totaling $883,370. “From that, we’ve now brought in over $5 million in investment, and we’re now on our way to becoming a real company, where we’re actually getting partnerships and people buying licenses to the technology.”

    Another Save SBIR member, CFD Research, won 418 SBIR awards totaling $104.9 million between 1987 and 2010 for innovations in the biomedical, energy, and aerospace sectors. The program has been critical in allowing the company to perfect its technologies into some 50 patents, four of which have been licensed to partners, Ashok K. Singhal, Ph.D., CFD’s president, noted.

    “SBIR is a commendable program as compared to dozens and dozens of initiatives of government,” he added. “To me, SBIR is working and producing return on investment. It has allowed a company like ours to diversify in response to changing times. If it were not for SBIR, there is no way a large corporation would give you even a chance to see that you may have a viable idea.”

  • Proponents Say Investors Are a Filter

    Michael Greeley, general partner with Flybridge Capital Partners, counters that allowing companies owned by investment firms to receive SBIR funds would help ensure that the program funds start-ups with the best prospects of success.

    “The venture industry is a fabulous filter,” Greeley said. “We look at hundreds of companies just to make one investment. We are more than passive investors. We hire people. We find customers. We give input on strategy. We work to build companies.

    “The government should use all input to make a decision, and I think an important aspect to consider is if private investors have voted with their wallets and put money in. To exclude a whole cohort of companies means there’s an adverse selection issue. The government is going to be picking from a bunch of companies that weren’t good enough to be backed by sophisticated private investors. That’s a bad allocation of capital.”

    Greeley also pointed out that “by the second or third round of institutional capital, companies are just not going to bother with SBIR. The reality is, if companies have raised a lot of money, they just don’t have the time to deal with trying to find another $100,000 grant.” He added that review of SBIR applications can take as many as nine to twelve months. “It’s just a terrible use of time.”

    Members of the House who support HR 1425 justify this part of their bill by saying that they expect it to increase participation in SBIR. “Representative Graves believes that the capital structure of a small business concern is irrelevant for the purposes of the SBIR program,” his spokeswoman said.

    She cited a series of hearings conducted by the small business committee over the last four years plus a May 2009 study by the National Research Council. They urged a return to majority VC-owned companies taking part in SBIR.

    The current policy of blocking majority investor-owned start-ups from the program does not gel with SBIR’s mandate of helping small businesses. Lifting the block, however, may have negative ramifications.

    The Senate came closer to balancing both concerns by setting smaller percentages than the House. As Dr. Prudent correctly notes, the SBIR program is a no-brainer at a time when political leaders are talking about creating jobs. The hope is that they get the balancing act right.

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