Venture Funding and the NIH SBIR Program (2009) / Chapter Skim
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1 Introduction
1 Introduction
Pages 5-21
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From page 5... ...
SBIR awards provide this seed capital and a positive signal to private venture markets, helping entrepreneurs to secure the funds needed to bring new ideas to market. The term "Valley of Death" has come to describe the period of transition when a developing technology is deemed 1 For a comprehensive review of the concept and performance of this 25-year-old program, see National Research Council, An Assessment of the SBIR Program, Charles W
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Reflecting this synergy, an initial NRC review showed about 25 percent of the top 200 NIH Phase II award win ners (1992-2005) have acquired some venture funding in addition to the SBIR awards.5 In addition, angel investors often find SBIR awards to be an effective mechanism to bring a company forward in its development to the point where risk is sufficiently diminished to justify investment.6 Today, venture capital markets are retrenching as a result of the current financial crisis.7 Venture capital firms are undertaking fewer investments, especially at 4As the September 24, 1998, Report to Congress by the House Committee on Science notes, "At the same time, the limited resources of the federal government, and thus the need for the govern ment to focus on its irreplaceable role in funding basic research, has led to a widening gap between federally-funded basic research and industry-funded applied research and development.
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1.2 SBIR PROGRAM STRUCTURE Eleven federal agencies are currently required to set aside 2.5 percent of their extramural research and development budget exclusively for SBIR awards. Each year these agencies identify various R&D topics, representing scientific 8 See Rachel Metz, "Venture Capital Investments Fall 33 Percent in 4Q," Associated Press, January 24, 2009.
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The Small Business Administration (SBA) coordinates the SBIR program across the federal government and is charged with directing its implementation at all 11 participating agencies.
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Congress requested that the National Research Council (NRC) of the National Academies conduct a "comprehensive study of how the SBIR program has stimulated technological innovation and used small businesses to meet Federal research and development needs," and make recommendations on improvements to the program at the National Institutes of Health and other major agencies of the federal government.10 Based on extensive research, a Committee of the NRC found that the NIH SBIR program is "making significant progress in achieving the congressional goals for the program." It added that "the SBIR program is sound in concept and effective in practice at NIH." The NRC report on the SBIR program at NIH also noted that for firms seek ing to capitalize on the progress made with SBIR awards, "venture funding may be the only plausible source of funding at the levels required to take a product into the commercial marketplace."11 The controversy over the issue of majority venture capital funding notwith standing, SBIR has been a highly successful program.
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SBA Final Rule becomes effective. resident aliens in, the United States, except in the case of a joint venture, where each entity to the venture must be 51 percent owned and controlled by one or more individuals who are citizens of, or permanent resident aliens in, the United States."12 During the period when SBA was developing the proposed rule, the SBA's Office of Hearings and Appeals received an appeal from a Cognetix, a Utah biotechnology company that was majority venture-funded and, thus, ineligible for the SBIR program.13 In denying the appeal, an Administrative Judge of the SBA Office of Hearings and Appeals ruled that venture capital firms were not "individuals," i.e., "natural persons," and therefore SBIR agencies could not allocate SBIR awards to companies in which venture capital firms had a controlling interest.
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Those who support the SBA ruling predict that its elimination could lead to the participation of firms controlled by large venture capital firms, including venture capital arms of major industrial corporations such as General Electric 16The issue of whether small businesses can participate in the SBIR program if venture firms hold some ownership of the firm was addressed by both proponents and opponents in the congressional hearings to renew the SBIR program. See Small Business Innovation Research Reauthorization on the 25th Program Anniversary, Hearings before the Subcommittee on Technology and Innovation, 110th Congress, First Session, April 26, 2007, and June 25, 2007, Serial No.
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These include financial need, the risk of crowding out, and the attraction of firms backed by corporate venture capital to the program, especially as "super-sized" awards become more prevalent. 20 Key arguments made by supporters of the SBA ruling are listed below: • Firms that have venture funding do not need SBIR.
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This would have the effect sub sidizing large firms, which is not the objective of the legislation that established the SBIR program.24 The large grants made on occasion by the NIH SBIR program are likely to motivate large venture capital firms to apply for SBIR awards.25 • Venture capital capture of the SBIR program will change the character of the SBIR program to its detriment by:26 Shifting the program toward lower-risk technologies that are closer to the market; Increasing the geographic concentration of the program (in states like California and Massachusetts, where venture capitalists are most active) ; Changing the profile of successful and unsuccessful SBIR companies; and Leading to calls for a further change in the SBIR rules -- for ex ample, to allow large institutions such as universities to own SBIR companies.
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Given these advantages and focus, it is possible that venture-funded firms are more likely to identify and seek to win competitions for SBIR topics with high commercialization potential topics than non-venture funded firms. Critics of the SBA Ruling Predict That It Will Deter Small Business Innovation, Especially in Biomedicine Critics of the SBA ruling believe that the ruling does not take proper account of the real world challenges of financing early-state funding in innovation re search, especially the high risk and long horizon needs of biomedical research.
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investment." 28 This, he claimed, will have a negative impact on the mission of the National Institutes of Health and on the goals of the SBIR program. Impact on Small Biotechnology Firms Some high technology industries, notably the biotechnology industry, and representatives of the venture capital community have also expressed dismay at this ruling, calling it a new interpretation of the venture capital-small business relationship by SBA.29 The Biotechnology Industry Organization (BIO)
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From page 16... ...
It is this type of activity that the SBIR program has historically supported in the past. Venture capital dollars are normally applied later in the life cycle, and are used to bring promising discoveries to market.35 SBIR and venture funding address the needs of small businesses at different stages of the innovation process.
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39 The rules do not reflect the reality that micro small businesses often rely on a syndicate of investors: According to the current SBA in terpretation "a private company with 400 employees, $200 million in venture capital from multiple venture capital firms that equal 49 percent of equity with additional angel investment dollars" is eli gible, whereas "a private company with 20 employees, $50,000 in annual revenue and $8 million in venture capital by multiple venture capital funds equaling 56 percent of equity -- even though no one venture capital firm has more than 35 percent of total equity -- is ineligible."40 36 See testimony by Mark G Heeson of the National Venture Capital Association before the House Committee on Small Business, March 13, 2008.
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The GAO did conduct a study of venture capital activity within the NIH and DoD SBIR programs, and while this study broke some important new ground and 41 See testimony by James C Greenwood, president of BIO, before the House Committee on Small Business, March 13, 2008.
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SOURCE: NIH SBIR Program. 1-1 provided the first estimate of the number of firms affected by the ruling, it did not address two key questions that bear on the policy issue at hand.
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To better understand the impact of the SBA exclusion of firms receiving majority venture funding (resulting in majority ownership) , the NIH commis sioned this empirical analysis by the National Research Council.
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from the participation of a limited but significant number of small innovative firms that were majority owned by venture capital firms in the SBIR program. 46 45 For a summary report of this first comprehensive assessment of the SBIR program, see National Research Council, An Assessment of the SBIR Program, op.
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