SBIR Overhaul Stalls In the Senate, to the Detriment of VC-Backed Innovation

5/6/11Follow @allegiscapital

Venture capital-backed startups got a slap on the back this week, but that was followed by a slap in the face in the latest round of Washington political gamesmanship over how much lawmakers should or should not encourage venture capital-backed innovation. So far, the battle to enhance U.S. innovation is taking yet another hit.

What I’m talking about is the effort in the capital to help venture capital-backed startups glean a bigger piece of the pie of a federal government multi-agency program that awards R&D contracts to small companies. This is exactly what the United States needs. But as we were once again reminded this week, the way it is being handled in Congress is exactly what the country does not need.

The Senate and the House have been at odds about the funding provisions of the Small Business Innovation Research (SBIR) program. Earlier this week, movement in the House looked promising. On Thursday, however, a cloture vote to bring the matter to the floor of the entire Senate failed, putting the philosophical debate about the access of venture-capital startups to SBIR money back to square one.

This is highly unfortunate. The House of Representatives on Wednesday finally agreed to open up SBIR funding to young companies heavily backed by venture capital. The Senate Committee on Small Business and Entrepreneurship did not share the position that the House now takes, but things might have changed once the measure got before the full Senate.

The latest turn of events underscores once again that the United States has to take steps to aggressively implement innovation, not just talk about the issue or even hotly debate it.

The SBIR program is intended to ensure that federal government and taxpayers have access to cutting edge and cost effective innovation while simultaneously supporting the growth of small business, which generates the vast majority of new jobs in America. Given our current high levels of unemployment and our need to reinvent the U.S. economy, common sense would dictate that the SBIR program be opened to the broadest cross-section of the best qualified candidates.

Unfortunately, special interests have for years sought to restrict participation in the SBIR program based upon how a small business has financed its growth. If a company got much venture capital, its participation in the SBIR program was severely restricted, regardless of its merits. An entrepreneur who financed his company with a loan or savings or investments from friends, family or angel investors has no such restrictions.

This time around, the House has been more active than the Senate in working to open more SBIR funding to VC-backed startups. The House version of the legislation gives VC-backed firms access to 45 percent of SBIC funding, and, with its latest changes, doesn’t mandate that VC interest in these startups be limited to a 49 percent ownership stake, as previous rules did. The Senate at this point not only rejects this provision but would give VC-backed firms access to only 25 percent of the award dollars from three federal agencies, including the National Science Foundation, and to 15 percent from eight others.

So despite movement in the House, entrepreneurs who have been able to attract venture capital in the competitive marketplace of ideas are still being penalized. This is ridiculous. All entrepreneurs should be able to compete on an equal footing for capital. The only parameter should be which put forth the best ideas. The loser in this game of political football is not any particular startup but U.S. innovation in general.

The latest flap in Congress is hardly the only example of government missing the big picture. The U.S. still makes it far too difficult for gifted foreign entrepreneurs to stay in the country, which forces them to return to their home countries to form competing startups. A green card should be stapled to every advanced degree awarded by leading U.S. universities in science, engineering and mathematics. And then there is Sarbanes-Oxley, which burdens small entrepreneurial businesses with the same regulatory and statutory burdens that are applied to multi-billion-dollar enterprises, costing them millions of dollars annually in additional fees they cannot afford.

The U.S. government must view the global economy as it really exists and realize that the twin pillars of innovation—talent and capital—are the two most portable assets in the world, poised to move to whatever environment embraces and rewards them. U.S. venture capital inflows have improved, but they would improve a lot more if an increasing amount of venture capital wasn’t leaving the U.S. for places like China and India.

Venture capital-backed startups have created the backbone of Silicon Valley and continue to do so. Technology giants such as Intel, Apple, Cisco, Google, Salesforce.com and Facebook were all once obscure startups. We have to pull out all the stops to make sure this evolution doesn’t end.

Citizens need to call their congressmen and urge them to vote to level the playing field for entrepreneurs and allow VC-backed startups full access to SBIR program participation. To build the future, America must do everything possible to relentlessly out-innovate the rest of the world.

Bob Ackerman Jr. Ackerman is the founder and a managing director of Allegis Capital, an early-stage Silicon Valley venture capital firm that invests heavily in cybersecurity. Follow @allegiscapital

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  • http://www.twitter.com/greenmacgal Ann Stovel

    The SBIR phase I grants are typically under $150,000 for feasibility studies. Whereas a VC backed company is usually beyond the feasibility stage. SBIR grants are an opportunity for very early stage companies to find funding. There are very few options to have an “idea” funded in the early stages, so it’s my opinion that SBIR is fine the way it’s administered now.

  • http://www.idahotechconnect.com Rick Ritter

    Robert,
    You need to check your information/sources. The House for the last two to three years have supported VC backed companies. This is not new to them. They have kept the reauthorization has been blocked by their unwillingness to compromise on this issue. This article also demonstrates your lack of understanding of the intent of the program. The fact that you are with Allegis Capital probably explains your position.

  • Bob Ackerman

    Rick -

    Thanks for your comments. While I am the founder of a venture capital firm, I was previously the founder of two start-up companies. As a venture capitalist, my firm invests primarily in pre-revenue companies -many at the basic idea stage. I also advise a great many entreprenuers who are working to get their ideas off the ground for the first time. I’m not advocating an advantage for venture-backed start-ups. Rather, that all entreprenuers have the same opportunity in pursuing SBIR grants. Level palying field – plane and simple. The fact that this discussion has become a political football at a time when we are in critical need of innovation in our economy is frustrating. My point is that SBIR grants should be open to all comers – regardless of capital structure.

  • Bob Ackerman

    Ann -

    Thanks for your comment. As an very early stage investor, I agree that there is a chronic shortage of capital at the proof of concept stage. This inculdes companies that many go on to be backed by venture capital firms. My advocation is for a meritocracy – let the best ideas and entreprenuers win – as long as they are a small business – regardless of their capital structure. Equal opportunity – nothing more.

  • http://www.eriknilsson.com Erik Nilsson

    I agree with Rick RItter that the author doesn’t seem very well informed about the SBIR program and its legislative history.

    Prior to 2001, eligibility of VC-backed companies for SBIR money was at least ambiguous, however, VC-backed firms did not heavily use the program. It’s hard to know how many VC-backed companies would be using SBIR today, but in many ways the SBIR program would work less well for VC-backed firms today than in the past, especially in life science.

    Inflation has made SBIR grants smaller in real dollars than in 2001, and that won’t be changing any time soon at least at the NIH.

    Meanwhile, the amount life science companies raise from VC has gone up drastically, mostly because VCs are investing in companies later, with seed money often coming from angel investors.

    SBIR often starts even earlier than angel money, and angel investment doesn’t normally disqualify SBIR grantees. By the time VCs are pouring in tens of millions of dollars, does it make sense for key personnel to be distracted by revenue source of a few million dollars a year that requires specific changes to companywide accounting, ethics, and management practices? Probably not all that often.

    So why are VCs so anxious to get at the SBIR program? I suspect that a major factor is that, like Ackeman, many VCs don’t understand the SBIR program very well.

    Conversely, companies that make their living preparing SBIR grant proposals for other companies benefit by having a large number of small grants, whereas grantee companies are better off with a relatively smaller number of larger grants.

    The result? Compromise deals in congress that continue to limit the size of SBIR grants below what they were historically, in return for easier rules on VC access.

    Does any of this back-room dealing create jobs or benefit the economy? Of course not. Congress doesn’t even seem to be aware of the most important issue. In terms of VC access, what companies need is a rule that ALL companies that have SBIR grants can finish off the grants they have, even if they receive VC funding. Ideally, they should also be able to apply for phase II grants on phase I grants that were awarded before VC funding. There’s nothing wrong with a company doing years of good research for the federal government through SBIR, but once VC money comes in, it should be clear that the company will age out of the SBIR company soon.

  • http://www.eriknilsson.com Erik Nilsson

    @Bob Ackerman “My point is that SBIR grants should be open to all comers – regardless of capital structure.”

    In that case, why not level the playing field further, and eliminate the requirement that a company have fewer than a certain number of employees or revenue below a certain level? Why not eliminate the requirement that there be any American ownership at all, or that the work be performed in the United States? Why insist that the capital structure of the company be organized as a for-profit entity?

    Then the SBIR program would be… the other 97% of federal research funds, much of which VC-backed companies can already apply for, but don’t win very often.

    SBIR was created because quite small companies are able to do high quality work for the government, often at a fraction of the cost of a larger organization, and create jobs at the same time. But, small companies are not nearly as good as larger organizations at applying for federal research money. SBIR as it is today does level the playing field, to the vast benefit of the American people. Ackerman advocates an approach that is different than the current program, but is in no way more inherently fair or “level.”

  • Michael R Squillante

    The issue of VC participation is not about financing, it is about ownership and control. And, it has to do with the definition of a small business: Any company which has more than 500 employees including those of its affiliates is not a small business, and thus not eligible for SBIR. This rule applies to all firms participating in SBIR whether VC backed or not. Firms with VC control, where the VC and all of its affiliates are less than 500 employees can participate in SBIR with no restrictions. Firms with VC financing where the VC firm(s) own less that 50% can participate in SBIR without restriction regardless of the VC affiliates.

    I too believe in having a “level playing field”. Everyone plays by the same rules. It is reasonable and fair that the requirements for SBIR should be the same for all participants and there should not be a segment of firms with special rules or waivers.

    Most of the organizations who negotiated the VC participation issue, including BIO and NVCA, agreed to the bipartisan compromise incorporated in the Senate bill. After many years of work on this compromise now is not the time to reopen negotiations. We are all hurt by the partisan fighting going on in congress and we should work together to get the Senate version of the bill, S.493, passed.

  • Scott Thacher

    I have two comments: first, the current eligibility rules that limit VC ownership actually energize and enable the entrepreneurs that have technology that is too early for VC investment. The “merit” that Robert Ackerman talks about is too easily confused with “later stage of development”, and allowing unfettered access of VC-controlled firms to SBIR grants would starve the earlier and riskier projects that can’t be funded any other way.

    Second, an earlier post by Erik Nilsson gave the impression that a majority VC investment would trigger loss of ongoing SBIR grant funding. My inquiries to the NIH contradict this point. Once you have been awarded a grant, even if it is a multi-year grant, you keep that award regardless of new investors or new ownership down the road. There is no provision that I know of that forces you to give up an ongoing SBIR grant in order to accept VC funding.

    Finally, S.493 is a great compromise. My only criticism of the bill is that the gradual increase in the SBIR allocation over the next 10 years (from 2.5% to 3.5%) should be accelerated to the first year and increase to 4.0%. Why? Not only is competition for SBIR funds now much, much tighter at the NIH, but the influx of applications from VC-controlled firms will make SBIR grants even harder to obtain. As many reviews by the National Academy of Sciences show, SBIR funding is a proven and productive route for commercialization. In my opinion, an increased allocation for SBIR funding would be a great way to enhance the NIH mission of translational research.

  • Bob Ackerman

    Eric Nilsson’s hypothetical point on “constraints” around who should be able to qualify for a potential SBIR grant is well made. I have both worked with and supported as an investor, companies that have received SBIR grants. I’m a fan of the program and its intent to provide an element of seed corn for cutting edge innovation under taken by “small business”. I’m also aware of the ebbs and flows in the program (and its rules) over the years – much of it driven by special interests looking to tilt the playing field one way or another. For me – it’s really simple: three start-ups are interested in applying for SBIR grants each of which has raised $1M in capital. In one case, a previously successful founder bank roles his new company personally. Another raises the money from friends, family and angels. The third raises the same dollar amount from an early-stage venture firm. From my perspective, all three companies should be able to “compete” for the grants. Let the most qualified win.

    There is truth that many venture capital investors have moved towards later stage investing – writing large checks in the process. My firm is not one of these – we will make investments as small as $250,000. We have groups of angles making investments up to $5M and former angle investors now being rebranded as “super-angles” – which are hard to distinguish from the traditional seed and early-stage venture investors.

    I accept the premise that the vast majority of venture-backed start-ups have not actively pursued SBIR grants in the past. Each company needs to decide how and with whom to build its business. I am simply suggesting that the largest number of financing alternatives available to the largest number of entrepreneurs is in our national interest. I don’t expect to see a massive upswing in start-ups with venture financing – however that is defined – chasing SBIR grants, but why should we limit their ability?

  • http://www.eriknilsson.com Erik Nilsson

    @Scott: “There is no provision that I know of that forces you to give up an ongoing SBIR grant in order to accept VC funding.”

    That seems to be the NIH policy. AFAIK, other agencies take a different position. The guidance I got from NSF was not so optimistic. My preference would be to continue to restrict phase I grants to firms that meet the current small business definition, but allow any company that successfully completes a phase I grant to apply for and be awarded a phase II grant, regardless of size or ownership.

    Otherwise, I agree with your comments and your analysis of S.493.

  • http://www.eriknilsson.com Erik Nilsson

    @Bob Ackerman: I don’t disagree with much of anything in your comment, given your specific example. Although I’d point out that a company that raises $1M where management plus the largest VC don’t own 51% of the company had a pretty low pre-money, so I wonder how often that really happens.

    I am not sure that Congress is on track to deliver an SBIR reauthorization bill that particularly addresses your purpose, however. The current compromise seems to be around a carve-out within SBIR, where companies declare they are VC-backed in the application process, and can then win funds from the carve-out.

    As you noted, that’s not your level playing field. The big problem I see is, frequently companies apply for their first SBIR grant before they have any funding at all. So it happens that very early stage companies apply for SBIR grants without knowing if they may soon be venture-funded or not. It would be silly to put companies in a catch-22 where if they guess wrong about future funding, they lose a grant, but that’s exactly what I’ve heard discussed. (Although it’s hard to come by reliable information about what is really in consideration.)

    Of course, your proposed configuration of the SBIR grant would not have this problem, nor would mine. The danger is that congress arrives at a compromise that agencies implement administratively in a way that is significantly less effective that the current program. I think the risk of this is serious.

  • Jose Bohorquez

    “My advocation is for a meritocracy – let the best ideas and entreprenuers win – as long as they are a small business – regardless of their capital structure.”

    If Phase 1 SBIR reviewers were really looking for a great idea and team engaging in true “feasibility” studies, I wouldn’t disagree with this point. What I have found, however, is that the inclusion of data supporting the project has become a practical requirement. In other words, reviewers pretty much want to see that you have already proved feasibility before you apply. This gives companies that are already well funded a huge advantage and makes it much harder for early stage startups to compete. With VC funded companies in the mix, that will only get worse.

    Also, as mentioned previously, small companies don’t get disqualified until they are 51% owned by the VCs. To me, that either means one of two things: 1) they have already raised a large series A or B, or 2) the team/technology is not that great (why else would they so diluted so quickly?).

    Frankly, I think VCs should be careful what they ask for. All trends show that the amount of VC money going to early companies has dropped significantly. SBIRs help keep the pipeline flowing so VCs can have their choosing of later stage companies with less technical risk. If later stage companies start taking SBIR money, there may be a dearth of risk-mitigated innovation.

    What I do find abhorrent, and hasn’t been discussed here, are SBIR “milling” companies that raise millions of dollars a year from SBIRs and rarely perform true commercialization. I hope better greater safeguards are implemented in the new legislation to deal with that issue.

  • Bob Ackerman

    Good comments from both Erik and Jose.

    A couple of additional thoughts:

    I absolutely agree with Erik’s caution on the risk of agencies implementing rules through their own independent administrative procedures. Complexity is the enemy of effectiveness when it comes to entrepreneurs applying to these programs.

    Jose’s point on demonstrated feasibility also resonates. At the same time, most venture backed companies with significant funding and momentum are unlikely to divert their funded development plans to pursue smallish innovation grants. Where these programs could be particularly useful is in assisting research projects in making the transition to fundable start-up – putting a little more meet on the bones. University or lab research projects come to mind as examples.

    I would also echo Jose’s point on SBIR recipients who fail to take the next step to commercialization. This is where the job growth typically takes place and we all benefit as a society. Having looked at these opportunities myself, management is often the biggest challenge. That said, if SBIR grants are seed corn, if would be nice to see supportive infrastructure that could help these recipients grow and prosper.

  • http://cmdevices.com Jose Bohorquez

    Bob,

    I really appreciate that you’ve taken the time to respectfully respond to people’s comments. Hopefully you have the time to answer some questions:

    1. Why would VC’s even want their companies to apply for SBIRs? Here’s why I ask: I have found SBIR cycles to be way too long, for relatively small amounts of cash. At NIH, it’s about 8 months from the time you submit to when you get the cash. Also, while many companies apply for multiple SBIRs to increase the amount of cash they raise, that results in having to do multiple projects that, while related, must be significantly different. I have heard experienced investors and entrepreneurs state that for a startup to succeed, it should have laser-like focus on getting their first product to market. I have seen startups lose that focus by spreading themselves thin trying to take on multiple SBIR projects. What’s your take here?

    2. On the Allegis website it says your firm usually invests $3-5M and usually seeks to own about 20% equity after first round (pre-money of $12-20M?). What are the typical milestones you expect a company to have completed to command that type of valuation?

    3. Once you invest, I would imagine you want to see the company at least reach break-even within 3-5 years, right? If a company applies for a Phase 1 today, they are likely to receive the money in 8 months (if they get it the first time around). Then it takes 6-12 months to complete project, and another 8 months to get Phase 2 (again if they get on first try). So that’s 1-2 years already, and Phase 2 grants are usually 2 years. That means the “research” won’t even be done for 3-4 years. How does that even line up with a VCs expectations?

    4. Finally, as a VC how much value do you place on SBIR success when evaluating a company? Is there value beyond the fact that non-dilutive cash has been raised? Technical validation?

  • http://www.enGrant.com Dale Harrison

    Here’s a current list of NIH SBIR Grant Awards: http://search.engrant.com/sp/sbir?X01

  • Bob Ackerman

    Jose –

    I will do my best to address your questions… First, let me state that I tend to take an “entrepreneur’s perspective” on these and many other issues as opposed to a pure investor or “money” point of view. I still think of myself as an entrepreneur working with the next generation to build businesses from ideas..

    With respect to your first question – In general, investors do want to see a “laser-like” focus once they fund a company. At the same time, venture capitalists are not the owners of a company – they are the entrepreneurs “partners”. Sure, they may have a significant equity position for which they have invested significant dollars. I don’t see a head long rush on the part of venture-backed companies to file SBIR applications for the reasons you outline. At the same time, I would like to see the SBIR option open to the venture backed entrepreneur (or any other entrepreneur) if he can make the case to his investors/Board of Directors and believes he/she can bring something to the process.

    Earlier in my career, I started a company based upon an engineering prototype that came out of an internal innovation project working off a $100,000 grant. The Company went on to be venture-backed and was subsequently sold for more than $300M. The technology within that company created the foundation upon which a multi-billion dollar marketplace is being built today. In my case, we were not involved in a SBIR grant. But the dollars were very small and comparable to SBIR grants in size. Again, I want entrepreneurs to have every option possible open to them.

    Regarding your #2 – As an early-stage firm, we typically invest in the Series A (or earlier) of a company’s financing. We will write checks as small as $250,000 to flush out an “idea”. We also make early stage investments of $2 to $5M – mostly on the lower end of the range. When we write these larger checks, it is usually alongside of another investor in a syndicate. It is not unusual for the first round of financing for a company – particularly very early stage companies – to result in 40 to 50% dilution. Remember, the majority of these companies will fail with the loss of all investor dollars. These numbers move around based upon the market, the idea, the management team as well as other factors. The 20% figure on the Allegis website is the percentage of a company that we would like to own after multiple rounds of financing – at which point we will have typically invested $10M or more.

    Regarding #3 – When we invest – as an early stage investor – our firm is looking out 6 to 7 years. Average exits today are 8+ years out. Where I think you may see SBIR grants come into play here is when a company may be interested in exploring adjacent or derivative applications of their innovation/technology.

    Regarding #4 – Personally, I like looking at companies who have successfully engaged in the SBIR process. The rigors of the process are an indicator of “value”. While the questions of potential market and commercial opportunity remain, SBIR success is a viable screen for potential follow-on investment.

    Hope these answers help. If you have further questions, feel free to send me a note at Allegis Capital.

  • http://www.eriknilsson.com Erik Nilsson

    I echo Jose’s comment. Thanks for taking the time to engage in thoughtful discussion, Bob.

  • http://www.eriknilsson.com Erik Nilsson

    @Dale: NIH’s RePORTER web site is much better organized than the link you provided, and includes all NIH grants, so you can search for just SBIRs or more broadly, as you wish.

    http://projectreporter.nih.gov/reporter.cfm

  • http://www.eriknilsson.com Erik Nilsson

    @Jose “What I do find abhorrent, and hasn’t been discussed here, are SBIR “milling” companies that raise millions of dollars a year from SBIRs and rarely perform true commercialization. I hope better greater safeguards are implemented in the new legislation to deal with that issue.”

    SBIR “milling” is largely a myth. You can stop worrying about it. The people who harp on “mills” are generally not friends of SBIR or small business.

    There are one or two companies that have won hundreds of SBIR grants. (All of them funded by DoD, I think. I don’t think such a large number has ever gone to one company from NIH.) But, those companies provided high-quality work for much lower cost than big-company competitors would have, so “milling” saves taxpayer money, so although it’s not what congress may have had in mind, it’s still not all bad.

    There’s a double-standard here anyway. Nobody harps about how highway construction companies shouldn’t be “highway fund mills,” even though such companies are utterly dependent on federal contracts.

    But regardless, it’s a minor feature of the program. SBIR money is spread pretty thin and wide. Actually, too thin, in my opinion, in that inflation-shrunk grant sizes mean the significant cost of applying for and managing a grant gains less money than it used to. So I wish we had a bit more “milling” in the sense of larger average awards.

    But to your point, it takes a few SBIRs to turn a complicated idea into economic value. Sometimes, it takes more than a few. If you accept Bob’s point that capital structure shouldn’t have any bearing on SBIR eligibility, then why should we discriminate against a good idea, just because it came from a company that recently got an SBIR for a different good idea?

    My opinion is that it’s probably healthy for a *small* part of the SBIR program to go to companies that are professional research organizations, so long as they do good work and create economic opportunity proportionate to their awards. The bulk of the program should continue to go to companies with realistic plans to commercialize their ideas, realizing that in life science, getting an idea anywhere near commercialization can take a while.

  • Jerry Kashmerick

    Giving 45% of SBIR funds to Venture capital firms essentially eliminates a huge number of small SBIR awards to companies with promising innovations. It is another Republican effort to help their big business friends and reduce Small Business Innovation Research opportunities. So much for helping small businesses.

  • Bret

    Some thoughts:
    - SBIR projects are peer reviewed, so the best research projects should be selected regardless of whether the company is VC backed or not
    - SBIR funds high risk research (or is supposed to) as opposed to product development – primary domain of VC funding

    SBIR funds complement VC or angel funding in most respects. As an investor, I would be most concerned with the potential diversion of focus and additional added risk (gap between Phase I and II funding).

    Why not implement the VC supported SBIR model in one or two agencies and evaluate the impact before making this change to all agencies? A noble goal would be increased ROI on SBIR funding and increased commercialization outcomes.

  • http://researchentrepreneur.blogspot.com Jonathan Pearl

    Many fruitful comments. Bob, thanks for your even-handed management of these discussions. I think one point that is often overlooked in the arguments about VC involvement is the one that Ann Stovel first pointed out, the small size of Phase I awards.

    To my mind, the issue of VC involvement is far less important than the matter of ABSOLUTELY WITHOUT COMPROMISE preserving Phase I as a 6-12 month feasibility study at a relatively low level of funding. For today, $100k-250k max seems about right (with possible and carefully vetted exceptions made for capital intensive areas of research along with proper degrees of oversight).

    If Phase I bypass is clearly prohibited, and the dollar level of funding is preserved at a range that supports those feasibility studies Jose Bohorquez speaks about, then the only VC-controlled firms that would have any interest in competing would be a very small set indeed, and one that likely would not distrort or pervert the intended mission of SBIR: to drive efficient, cost-effective, highly innovative R&D from American startups and small businesses.

  • Bob Ackerman

    Erik -

    I whole heartedly agree with your point on the size of SBIR grants. I would like to see the size of the grants as well as the dollars available to the program, expanded. Research is the seed-corn of innovation (and job growth) and the trend line in this area is negative in America. Our once vaunted corporate labs (think Bell Labs, PARC) are shadows of their former selves. Large corporations have cut their investment in R & D in America by more than 50% in the last 30 years. Universities are increasingly more focused on applied research as opposed to core “invention”. I have talked with a number or researchers who have left the US for other parts of the world where investments in research are increasing, as opposed to being cut. At a time when we need to reinvent our economy, we need to remember the critical and essential role of research in supporting an innovation economy. We have the talent (though we are being challenged) and the academic excellence; capital however is required if the machine is going to function…

  • Bob Ackerman

    From my perspective, the size of the enterprises qualified to apply for SBIR grants is an important one. If we use the less than 500 employee definition – I’m comfortable. If you apply the 500 employee test to venture-backed start-ups, you will find that 95% of venture-backed companies have fewer than 500 employees.
    Interesting fact – while investments in R & D by American corporations with 25,000 or more employees has been cut in half in the last 30 years (from 70% to 35% of the US figures) – small corporations – under 5,000 employees – have gone from 10% of industrial R & D in America to 40%. The R & D dollars are flowing to where they are most efficiently deployed – smaller businesses in many cases.

  • http://www.techlinkcenter.org Ray Friesenhahn

    Bob,

    I appreciate both your thoughtful perspective on the SBIR reauthorization issues, as related to VC-backed firms, and the fact that your firm is engaged in early-stage investments in innovative entrepreneurial firms. As some of the previous discussions indicate, VC backing may not be as big an issue in terms of SBIR eligibility as some perceive, in that many VC-backed firms are currently still eligible for SBIR, given less than 51% ownership or control, or if the owning VC firm or syndicate is classified as “small.” Should the eligibility rules change, it’s unlikely that a “flood” of VC-owned firms would begin to compete for SBIR, given the small size of Phase I awards, and such firms’ “laser-like focus” on current commercial goals – although the House version of reauthorization allowing direct to Phase II awards would eliminate this first argument. The potential for multi-million dollar Phase II awards (especially at NIH) has been a big factor in raising the interests of VC firms in the SBIR program.

    However, given that SBIR is a federal program using taxpayer funding from throughout the nation, we need to look beyond the perspective of “fairness” to individual companies, towards what’s in the best interests of our nation as a whole. VC is highly concentrated geographically, with more than 2/3 of VC funds going to just 2 states (CA & MA) in recent quarters. Perhaps not coincidentally, these two states alone received 1/3 of all Phase I SBIR awards in 2009. The commercialization strategy and team qualifications factor very highly in reviews of SBIR proposals, more than enough to overcome small differences in research quality or innovativeness. Government reviewers (for contract SBIR agencies such as DoD or NASA) and academic peer reviewers (for grants such as at NIH) are highly influenced by the indication of VC investment and placement of a VC member on the Board, as strong validations of commercial viability and team business experience. If VC-owned firms are allowed to compete without restriction, we are likely to see a significant shift in SBIR awards going more to those few states where VC (and SBIR funding) is already highly concentrated, even if only a very small percentage of these firms chose to compete for SBIR.

    Having assisted hundreds of SBIR proposals in over a dozen states, it’s obvious to me that great innovative ideas are not concentrated in just a few states, and our nation will lose many technological and economic opportunities if less SBIR funding is made available in the nation’s “heartland” and other regions that are more than an hour’s drive from a Venture Capitalist’s office. Yes, these fast-growing innovative companies can leave their home states to move closer to the sources of capital, and many do each year, but I question the national wisdom of concentrating so much of our technological innovation and industry growth in these regions. Technology “clusters” can indeed stimulate business growth, but this major concentration based on access to capital could have negative long-term repercussions. Consider the analogy of a wildlife feeding station set up to allow hunters easier game harvests. Massive supplies of food facilitate the heavy concentration and growth of the game population, but other problems begin to arise, and what happens if the artificial source of food (funds) is cut off?

    I greatly respect the efforts put into the Senate compromise version of SBIR reauthorization, and see the increase in allocated funds as ameliorating most potential effects of a limited increase in VC participation. The mere possibility of significant shifts in regional funding patterns indicates compromise is in order in terms of how much participation is allowed by VC-owned firms, before opening wide the gates. Reauthorization is still a first priority to continue our nation’s long-term competitive growth, but we need to also think about the long-term consequences that could result from “geographic favoritism” in capital investments.

  • http://www.eriknilsson.com Erik Nilsson

    @Jerry:

    The pressure to allow VC-backed firms to get SBIR money started with the Democratic chair of a house committee. VCs are more politically-diverse that you imagine. In fact, in my experience politically-active VCs are somewhat more likely than not Democrats. VCs don’t seem to have any trouble getting the ear of Democrats in congress, particularly in the house.

    Frank opposition to the SBIR program comes usually from academia’s lobbyists, who see the program as stealing money from their pockets. I think that’s short sighted, in that the SBIR community makes a good ally in supporting overall increases in R&D spending that more than make up for the small share going to SBIR. Regardless, that opposition is real, and academia is far more likely to be liberal and support Democrats than the general population.

    So I hardly see this as a Republican plot.

  • Bob Ackerman

    Great points Ray.. Reauthorization is an absolute priority and kudos to the politicos who are taking a positive approach to reinvigorating this critical program.
    I also hear you on the geographic issue. This is a tough one as innovation clusters are a fact of life – often tied to universities and labs doing cutting edge research work. Access to capital, is one of the essential ingredients in the transformation from successful research project to commercial success and sustainability. Venture capital is concentrated as you point out. At the same time, we are seeing some positive signs that the venture pool is spreading into previously un-served geographies – which is good news. When you come down to the Chicken and Egg part of this conversation, my observation has always been that capital and talent are the two most mobile assets in the world. Talent will flow to the capital if necessary and capital will follow the talent if it leaves the neighborhood.
    For me, this all points back to why I would like there to be as many options as possible through which entrepreneurs can seek funding and financial support – where merited – for growth.

  • Scott Struthers

    Very nice discussion here.

    However, I’m afraid our community has done itself a disservice by focusing too much on our differences (e.g. eligibility of VC owned companies) rather than our common interests (e.g. stable reauthorization and expansion of the SBIR program). Given the very large issues the federal government is currently grappling with, I’m afraid we may be a low priority, especially with a divided voice. Remember, there is a large proportion of the nation that doesn’t care about this issue at all, and a strong academic lobby that wants to kill the program and keep the money at the universities.

    The senate bill S.493 seems to be a logical and well thought out compromise and perhaps we should all try to get behind it. Then I hope we can turn to improving some non-legislative aspects of the program such as turnaround times and the peer review process.

  • http://www.techbizsolutions.us Mike Anderson

    The SBIR program has worked well in this country for many years. I really don’t see why congress can’t continue the program as it has been. Sometimes we “overthink” issues. Venture Capital has it’s place in financing new companies but SBIR funding should be kept separate. Let’s pressure our congressional representatives to support re-authorizing this important program.

  • Bob Ackerman

    Scott and Mike –

    I agree with both of you when it comes to the continuity of the SBIR program. While I would personally like to see some of the changes we have discussed implemented, it is essential for innovation in America that the program be reauthorized at a minimum and hopefully, expanded.

  • Cornelius Diamond

    Like most VCs, this author has an overinflated opinion of himself and his profession, and uses this to opine on topics he knows nothing about. Entrepreneurs fund companies and create jobs, NOT VCs. They are just money, and have just the purpose of creating more, and will always err on the side that benefits them rather than on creating jobs or better science & technology. If they now want more of the crumbs that are thrown true innovators (eg 150K) then they can take it out of their carry benefit that they get as being a VC.
    But you wouldn’t see them do that, now, right?

  • http://www.precision-combustion.com Kevin Burns

    Currently, nothing prevents companies with VC investment from participating, so long as the VCs do not control. Fictions aside, control is control, as is well known by every member of the House of Representatives. Why would we want to shift money from true small businesses doing highly-selective R&D (only 1 in 20 reaches Phase II) to help reduce the investment costs of wealthy VC and hedge fund investors? This is the issue pure and simple – do we want to give yet more Federal money to the wealthiest investors in the country, especially when taken from other highly productive small businesses?
    This said, the Senate bill is a compromise, to which all the parties including NVCA and BIO have already agreed to. The House version is trying to take three more bites out of the apple and single-handedly convert the SBIR program into a VC-subsidy program (while also freezing the overall percent, when we need jobs more than anything). The best advice here is for all parties to line up behind the Senate compromise, which is a true compromise on the issues, actually strengthening the program with a greater share of Federal R&D while also providing a long enough reauthorization to permit agencies to work longer term to build their programs, while also allowing in majority VC companies.

  • Bob Ackerman

    Hi Kevin -

    Thank you for your thoughtful comments..

    A couple of thoughts that come to mind, describing venture capitalists is a bit “loaded” from my self- serving perspective (Yes, I’m an ex-entrepreneur who is now a venture capitalist). Venture Capitalists are managers of other people’s money – most University Endowments, State Employee Pension Funds, Non-Profit Foundations, etc. Frankly, I want these investments to be successful and profitable given the nature of the underlying investors. Don’t ask me to defend Hedge Funds – have never found one that builds anything..

    Secondly, I think it’s important to encourage successful investors – regardless of the title on their business card. Successful investors help create jobs! Unsuccessful investors don’t – period. Let’s ensure we are doing everything we can to get those who can most successfully contribute to innovation and job growth in America to step-up.

  • http://researchentrepreneur.blogspot.com Jonathan Pearl

    Bob,

    You’re skipping a few steps, like defining your terms. You indicate that “describing venture capitalists is a bit ‘loaded’”, but you don’t flinch at using the loaded term “successful investors”.

    From all the investors I’ve spoken with, the principal measure of success is $, not jobs created. You speak of your desire to see investments be successful AND profitable. What’s the difference? Investors whether successful or not do not create jobs (other than those for other money managers). Their measure of success varies little whether they’re creating profits for a million pensioners or for a dozen billionaires.

    Outside investors provide funding, and only potentially guidance and advice, to assist an entrepreneur in building a business, which creates jobs. Outside investors are only one possible source of funding. SBIR is far more efficient in putting funds directly toward the innovation, without diluting it through the need for profits beyond the immediate R&D! Jobs are created directly because the funds are expended to produce a result. Bottom line: businesses create jobs; small businesses create the most; entrepreneurs create businesses.

    SBIR currently supports potentially transformative ideas that have great potential for creating or expanding small businesses which are for the most part unsupported by any other investment! It’s all a matter of stage . Angels, VCs, Hedge Funds all enter the game when profits measured in dollars are imminent. SBIR supports the earliest stage of technological development, which permits an entrepreneur or small business with a high-risk/high-reward idea to test it (Phase I) and build it (Phase II).

    Investors are welcome to support those stages. But if not, you can wait to invest in Phase III companies. There is no reasonable argument to do away with Phase I. Until investors are open to supporting entrepreneurs and businesses at that point, there is no reasonable argument for letting VCs or Hedge Funds into SBIR!

  • Bob Ackerman

    Jonathon -

    In using “a bit loaded” my reference was to “Rich Venture Capitalists” – I should have been clearer. My point is that a small portion of the profits from successful investments goes to the managers (when they are successful) – as in effectively all asset classes – with the bulk of the profits going to investors in the underlying venture funds. These returns are important to the investment models for the groups of everyday folks and institutions depending upon these investments. I see virtue here. Lower returns equate to lower pensions – and we all know people who will be effected for the worse – and they aren’t rich.

    In looking at the measure of success from an investor’s point of view – I agree. That said, from an economic policy perspective, I would prefer to see more successful and innovative companies go public and continue to grow as independent companies. These companies create jobs whereas job growth is capped in financially successful investments where the exit is an M & A transaction. We need jobs in innovative and competitive industries in America and we need to examine the institutional changes necessary to support young companies growing jobs while also generating profits for investors. Call it a double bottom line but I would like to see financial returns AND significant, prolonger job growth.

    As for investors adding value – I’ve seen it both ways. The earlier the stage of investment, the greater the potential for an investors to have an impact on a young company – good and bad. Good seed and early-stage investors can have a positive impact on a young company by bringing their expertise, experience AND capital to the start-up. No guarantees but I have a long list of entrepreneurs with a short list of investors who they believe have added value and contributed to their success. Do I wish the list was longer – certainly.

    Regarding your comments on the SBIR program – we largely agree and I am fan of the program. My concern relates back to coffer damns between ideas, innovators and sources of capital. In my perfect world, the best ideas and entrepreneurs would have access to all available capital sources. When I as an early-stage investor back a company, I am typically looking 6, 7 or 8 years down the road – hardly at the threshold of “imminent profits”. Any barrier between an innovative entrepreneur and potential sources of capital is a lost opportunity.

  • http://Icogenex.com Fred Hagen

    I agree with a number of responders, the SBIR program needs to be “REAUTHORIZED”. The program is too important to be scuttled over differences about participation by VC majority owned companies. The senate S.493 bill is a good compromise. Therefore, we should all get behind the passage of this bill in a united front. Call your Washington representatives and make your voice heard.

    The SBIR program is important to keeping America strong in science and innovation and creating American jobs. The SBIR program has generated 75,265 patents, employed 400,000 scientists and engineers, making the program the largest concentration of scientific and engineering talent in the United States, exceeding the combined total of all American academic and non-profit institutions. Currently 38% of American scientists and engineers work in small companies, 27% in large companies, 16% for universities, 13% for government, and 6% for nonprofits. On 2.5 % set aside for the SBIR program, it generates 38 % of patents versus 3 % for universities.(1) This important American scientific resource must be saved with “REAUTHORIZED”. The multitude of continuing resolutions is really hurting the program.

    The SBIR program was established to provide funding for very early stage companies with great ideas but little or no money that could not compete for federal money with large public companies or majority owned VC backed companies. Majority owned VC backed companies do not need SBIR money. VC backed companies typically get millions right out of the gate and much more if they hit milestones and are successful. These are not companies that need to be helped with federal dollars. It is the unknown unvalidated scientific founders with good ideas that are in greatest need for SBIR money to validate their idea to move them to VC funding level status. Allowing full access of majority VC backed firms to SBIR funding would not “LEVEL THE FIELD” for all entrepreneurs but rather would provide a distinct advantage to majority VC backed firms with their greater financial capability for packaging, reviewing, and employing paid experienced writers to submit polished fundable grant applications.

    It is my experience that VCs are not typically interested in having their supported companies apply for SBIR money because 1.) the application effort is not compensated with enough dollar return (typically Phase I money), 2.) grant money diffuses VC “control” from the focused effort of a company, and 3.) the grant application and funding timeline is lengthy compared to goals/milestones of a typical VC funded company. However, these paradigms change with larger grant awards and direct to Phase II awards. Such changes would greatly diminish the pool of SBIR funds for fledging small startup companies with good ideas but low capability of raising money without validation of their technology. SBIR money gives such a company a means to technology validation and future funding from other sources.

    Providing greater access to SBIR application by majority owned VC backed companies by itself will not greatly increase SBIR participation but accompanied by larger grants and direct to Phase II funding will certainly do so. This will greatly reduce the pool of money available to the small startup companies who need the funding the most. We need to have a united front in support of passage of senate S.493 bill for SBIR Reauthorization.

    1. Testimony by Jere W. Glover before the Subcommittee on Technology and Innovation, Committee on Science and Technology, United States House of Representatives, 23 April 2009.