Nondilutive US Government Funding for Small Businesses Through SBIR Awards

Co-author, David Fletcher

The US government invests billions of dollars each year to fund research and development by US small businesses through the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs. These programs are managed by the Small Business Administration (SBA) and exist to support the dual policy goals of promoting scientific and technological innovation for eventual commercialization and providing financial support in the form of nondilutive funding to small business concerns.

Understanding the eligibility rules for the programs – which go beyond merely qualifying as “small” – is critical for any business contemplating pursuing an award. Failing to understand these requirements can result in a lost opportunity or a company receiving government funding improperly, in turn potentially creating issues during diligence for later funding rounds or a sale of the company or even leading to enforcement activity. For companies that qualify, the SBIR and STTR programs provide a potentially valuable source of nondilutive capital for development work that can propel them toward commercialization and facilitate long-term success.

This article provides an overview of these programs and their requirements, so you can consider whether this may be an opportunity for your company to access this source of nondilutive funding.

Overview of the programs

The SBIR and STTR programs are broken down into three phases:

• Phase I is the “concept” phase and is used to explore the feasibility and scientific and technical merit of a technology or idea that may have commercial potential.  Phase I awards are generally 6 – 12 months in duration and range in size from $50,000 to $275,000.
• Phase II is the “technology development” phase and continues the research and development efforts from Phase I. The typical duration of a Phase II award is 24 months, and the funding ranges from $750,000 to $1.8 million.
• Phase III is the “commercialization” phase, where a Phase I or II awardee seeks to commercialize the results of their Phase I and II efforts. Phase III awards utilize non-SBIR/STTR funding from other sources, such as the private sector or other federal agency funds, and therefore are not subject to the small business eligibility rules applicable to Phase I and II awards (described in more detail below). There also is no limit on the number, duration or value of Phase III awards.

Basic eligibility rules for SBIR/STTR awards

The SBIR and STTR programs are designed to provide support to small, independent business concerns in the US. Thus, to be eligible for Phase I or II SBIR and STTR awards, companies must meet certain size and domestic ownership and control requirements.

The purpose of these requirements is to target companies with an economic interest in driving an idea or research to commercial application, increase the likelihood that the government funding provided through the programs will encourage innovation domestically, and provide capital to small businesses, which often have a unique capacity for innovation but may have difficulties finding other sources of funding. Below is a high-level summary of these requirements:

1. Size eligibility. The company must be a “small business,” defined as a for-profit entity, with a place of business in the US and operating primarily in the US or making significant contributions to the US economy, with no more than 500 employees. This includes both full-time and part-time employees, as well as employees of a company’s “affiliates” (as the SBA defines that term).
2. Ownership eligibility. In addition to the first requirement, the company must be more than 50% directly owned and controlled by one of the following:
   1. One or more individuals who are US citizens or US permanent resident aliens (i.e., “green card” holders).
   2. One or more other small business concerns, each of which is in turn more than 50% directly owned and controlled by individuals who are US citizens or US permanent resident aliens.
   3. An Indian tribe, Alaskan Native Corporation or Native Hawaiian Organization (or a wholly owned business entity thereof).
   4. A combination of a, b and c above.

For certain SBIR awards, companies may meet the ownership eligibility requirement if they are more than 50% owned by multiple US-based venture capital operating companies, hedge funds and/or private equity firms (collectively referred to as VCOCs), so long as no one such VCOC owns or controls more than 50% of the company’s equity. The 50% ownership measurement considers warrants, options, convertible notes and similar securities, not just outstanding stock.

Additionally, if a US company has a non-US parent, it would meet the ownership eligibility requirement through Section 2b above only if the parent is directly majority owned by individuals who are US citizens or permanent resident aliens of the US, has a place of business in the US, operates primarily in the US or makes significant contributions to the US economy, and qualifies as “small” under the primary North American Industry Classification System (NAICS) code. It would not be sufficient for the US subsidiary (the entity applying for the SBIR award) to have US operations if the parent does not meet this test.

As noted, Phase III awards are not subject to the same size eligibility criteria as Phase I and II awards. Phase III awards also are unique in that they can be made as direct contracts with the government or as subcontract awards with another entity acting as the prime contractor. However, to be eligible for a Phase III award, a company must demonstrate that the proposed efforts will extend, derive from or complete prior Phase I or II work.

Post-award performance requirements

Following an SBIR or STTR award, awardees will be subject to several performance obligations that applicants should be aware of at the outset. For example, all work performed under an SBIR/STTR award must be done in the US, and awardees are limited in the volume of work that can be subcontracted to other entities. Additionally, the principal investigator (the designated individual with overall responsibility for the project) must be primarily employed by the eligible small business during the period of the award – or, for STTR awards with certain agencies, by either the eligible small business or the nonprofit with which the small business is collaborating on the project.  Understanding these and other requirements and obligations that will accompany an SBIR or STTR award is critical before any company invests time and resources in developing a proposal.

The SBIR and STTR program eligibility criteria can be complex for businesses to work through, but doing so is an important and worthwhile exercise before applying. With upfront attention to the programs’ requirements, eligible small businesses have a unique opportunity to receive nondilutive funding from the US government to develop innovative technologies and move them meaningfully toward commercialization.