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Venture-backed firms could become eligible for federal SBIR grants

Madison, Wis. - Members of the small business community fear that changing the legal framework for companies receiving certain federal grants could stifle research.

The U.S. House Small Business Committee will soon consider a proposal that would give small companies majority-owned by venture capital firms eligibility for Small Business Innovation Research grants.

The SBIR program distributes $2 billion annually to American companies with less than 500 employees, regularly developing risky, exotic, and niche technologies in early and conceptual stages.

Through the SBIR program, 10 federal agencies award 2.5 percent of their outside research budgets to small businesses. The National Institutes of Health, for instance, have a budget of more than $500 million per year for its SBIR program.

Congress created the program in 1982 to help companies conduct studies of product feasibility and commercialization potential to meet the federal government's own R&D needs. And by many metrics, the program has succeeded, yielding over 45,000 technology patents and hundreds of billions of dollars in technology innovations.
But some fear that large venture capital firms are lobbying to corrupt the original intent of the program.

If bureaucratic venture capital firms and the firms that control them force their way into SBIR funds through acquisitions of small companies, the program could shift to favor the lower-risk, closer-to-market technologies that large companies favor, according to leaders from the Small Business Technology Council, the National Small Business Association, and others.

The national debate

The debate began in earnest in 2001, when some biotech companies became ineligible to receive SBIR grants because the U.S. Small Business Administration ditched a broader interpretation of the law and began requiring 51 percent ownership by "natural persons."

These biotech firms, which ordinarily require significant amounts of venture capital funding to determine early success or failure of products, have since sought to reverse the ruling.

With the support of the Biotechnology Industry Organization, the National Venture Capital Association, and other large VCs, Sen. Christopher "Kit" Bond, R-Missouri, introduced the amendment last year to alter the eligibility rules. The Senate Committee on Small Business and Entrepreneurship approved the bill in July 2006.

A subdued fallout?

While several observers believe that the proposed eligibility changes, which are contained in an amendment to the SBA reauthorization bill, will pass the House, its impact on research is less certain.

Brian Curry is not worried about the bill's impact. As director of business development for the Wisconsin Procurement Institute, a nonprofit business assistance organization on the local planning committee for the November 2006 Fall National SBIR Conference sponsored by the National Science Foundation in Milwaukee, Curry believes that the changes are are unlikely to result in a drastic shift in the type of innovation coming out of the program.

He said companies controlled by large VCs are not interested in chasing the relatively small amount of SBIR funding, given the time constraints inherent to the program.

"I think, quite honestly, it's going to be a good thing for the United States," Curry said. "If there's a company that has received a tremendous amount of VC backing, I'm not so sure how much they're going to delve into all the work to get some SBIR funding."

With the rule change in place, small high-tech companies that attract between $5 million and $10 million in VC backing, the prevalent type in Wisconsin, "can enter into the SBIR world and it will be a tremendous aid for them," Curry added.

Winslow Sargeant, Ph.D., a managing director of Venture Investors, LLC, who managed an SBIR program in industrial innovation for the National Science Foundation, generally agreed.

"The majority of SBIR/STTR grants will still go to small business," Sargeant said. "The rule limiting the size of a company to 500 employees or fewer would still be in effect. Early-stage research would not change significantly. I could see more partnerships with corporations."

In fact, the change could result in a higher valuations for SBIR-funded small businesses because the SBIR grants are non-dilutive, or do not reduce earnings per share.

"I don't think that lower-risk technologies will crowd out the higher-risk work. Universities will continue to do high-risk research and, at some point, that work could be funded for commercialization," Sargeant said.

However, it still is somewhat uncertain whether Wisconsin companies want an eligibility change, whether it will become law, and what its likely impact would be.

Phil Sobocinski, associate director of University of Wisconsin-Madison's Office of University-Industry Relations, said he is aware of only one company in Wisconsin that has articulated a desire to change the SBIR eligibility structure. He said he would be interested to know exactly where the small business community stands on this issue.

"The dust hasn't settled yet," Sobocinski said. "What's interesting to me is the number of `bio' folks in this state that didn't respond to BIO's plea."

Related links

SBIR Gateway: an SBIR information site

(Provided by Zyn Systems, a technology and management consulting firm)

Wisconsin FAST: a federal and state business mentoring network

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