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How to Leverage America’s Seed Fund: The U.S. Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) Programs

Client Update / Oct 28, 2020

Article by Guy Milhalter and Austin Ochoa

The Challenges of Raising Capital during COVID-19

The ability to raise capital is crucial for the growth and development of startups and innovative technology companies. Capital for early-stage funding is projected to decline significantly in 2020 as the global coronavirus pandemic continues to affect many of the world’s economies.[1] In the United States, for the period between April and June, startup funding has dropped 12% since the first quarter of the year, and dropped 18% as compared to the same time a year ago to just under $30 billion.[2]

The total amount of venture capital deals has decreased by 44%, to only 541 deals made in the seed to Series B stages, between March to June of this year as compared to the same three-month period in 2019.[3] The decrease in venture capital activity has had the biggest impact on seed-stage deals, which dropped by 57 percent this year between March and June from 483 deals in 2019 to 209 deals in 2020.[4]

According to a survey conducted by 500 Startups, 42% of investors responded that they would allocate less investment to startups as a result of COVID-19.[5] Moreover, 80% of respondents reported that the pandemic is having a negative impact on early-stage investment activity.[6]

In the U.S., seed-funding is critical to the entrepreneurial ecosystem. According to studies conducted by the National Venture Capital Association and Stanford University, more than a fifth of the U.S. gross domestic product is provided by companies that were helped to maturity by VC funding.[7] That accounts for more than $4.3 trillion in revenue, and nearly 12 million jobs in the U.S.[8]

An Overview of “America’s Seed Fund”

America’s Seed Fund, which is a congressionally-mandated program administered by the U.S. Small Business Administration (SBA), invested more than $3.5 billion in small businesses last year to support scientific excellence and technological innovation.[9] With early-stage funding significantly declining since last year, seed funding through the Fund’s two programs, the Small Business Innovation Research (SBIR) and the Small Business Technology Transfer (STTR) Programs is more important than ever as it may provide a significant viable funding option for entrepreneurs.

The SBIR and STTR are highly competitive awards-based programs that encourage small businesses to engage in research and development activities with the potential for commercialization.[10]

Established in 1982, these two programs (the Programs) seek to support scientific excellence and technological innovation through the investment of federal research funds in critical American priorities, through a government-led effort to build a strong national economy.[11]

The Programs, funded by 11 federal agencies and run by the SBA, were created to help small businesses grow, foster their participation in the federal acquisition process, and facilitate the commercialization of innovative technologies.[12]

As of 2019, over 179,000 awards to startups have been made totaling more than $54.3 billion.[13] Some of the Programs’ success stories include funding industry-leading companies such as 23andMe, Sonicare, and Qualcomm.[14]

Unlike recent federal lending programs, venture-backed companies are not excluded from participating in the Programs. Entrepreneurs should be aware of the Programs given the sizeable amount of seed-stage funding available and the startup-friendly eligibility requirements.

Eligibility Requirements

In order to be eligible for funding under the Programs, an entity applying for SBIR or STTR must meet the following eligibility requirements:

  • Organized for profit, with a place of business in the U.S., which operates primarily within the U.S. or which makes a significant contribution to the U.S. economy through payment of taxes or use of American products, materials or labor;
  • In the legal form of an individual proprietorship, partnership, limited liability company, corporation, joint venture, association, trust or cooperative; and
  • More than 50% owned and controlled by one or more individuals who are citizens or permanent resident aliens of the U.S., or by other small business concerns that are each more than 50% owned and controlled by individuals who are citizens or permanent resident aliens of the U.S., or any combination of these; and
  • No more than 500 employees, including affiliates.[15]

Additionally, an eligible company, which meets the size requirements to be a small business concern (SBC) must focus on performing R&D – not purchasing equipment, commercializing a technology that has already been developed, or one that has very low risk and only needs capital.[16]

Comparing SBIR and STTR Programs

There are key differences between the SBIR and STTR programs. The STTR program requires the small business to team up with a non-profit research institution, which is typically a university or federal laboratory.[17] Another difference is that the STTR program is focused on the transfer of technology from the research institution to the small business and ultimately to the marketplace through a three phase developmental process.[18]

Additionally, the principal investigator for an SBIR project must be primarily employed by the small business.[19] Meaning, the principal investigator cannot work full time anywhere else.[20] In contrast, the principal investigator for an STTR project can be employed by either the research institution or the small business.[21]

Further, up to 60% of the work for an STTR project can be subcontracted, whereas only 33% of the work can be subcontracted during Phase I of an SBIR project.[22] The SBIR subcontracting limit increases to 50% in Phase II, but it is still less than what is allowed by the STTR program.[23]

Three-Phase Funding Process

The Programs’ funding agreement is a contract, grant, or cooperative agreement entered into between an SBIR or STTR participating Federal Agency and an SBC for the performance of research, experimental, or developmental work funded by the Federal Government.[24]

The Programs award funding in three phases. Initially, the Programs fund an SBC’s concept development for six months to a year.[25] The objective of Phase I is to establish the technical merit, feasibility, and commercial potential of the proposed Federal Research and R&D efforts, and to determine the quality of performance of the SBC awardee prior to providing further Federal support in Phase II.[26] Phase I includes seed-funding of $50,000 to $250,000.[27]

Phase I awardees are eligible for Phase II, where funding is based on the results achieved in Phase I and the scientific and technical merit and commercial potential of the project proposed in Phase II.[28] The objective of Phase II is to continue the Federal Research and R&D efforts initiated in Phase I.[29] The Programs will fund prototype development for a 24-month period of performance.[30] Phase II includes seed-funding of $500,000 to $1.5 million.[31]

The STTR program awards funding for Phase III, whereas the SBIR program does not participate in the funding of Phase III. The objective of Phase III is for the SBC to pursue commercialization resulting from the Phase I and Phase II Federal Research and R&D activities.[32] Phase III may involve STTR funded R&D or production contracts for products, processes or services intended for use by the U.S. Government.[33]

SBIR Program in Detail

In 2019, the SBIR program had an investment budget of $3.2 billion, with an additional Research and Development budget of $100 million.[34] Participating SBIR federal agencies, along with each agency’s 2019 spend, include:

  • Department of Agriculture ($30 million);
  • Department of Homeland Security ($17 million);
  • Department of Education ($8.4 million);
  • Department of Transportation ($5.2 million);
  • Department of Commerce ($3.9 million); and
  • Environmental Protection Agency ($3.6 million).[35]

Under the SBIR program, the awardee fully owns the data it develops under an award.[36] The data is protected from disclosure by the participating SBIR agency for a period of not less than 4 years from delivery of the last deliverable of the Phase I, II, or III award.[37]

The SBIR program’s work requirements include limitations on the amount of subcontracting a qualifying SBC may seek. In the concept development phase, a qualifying SBC may subcontract up to 33% of its work.[38] And in the prototype development phase, a qualifying SBC may subcontract up to 50%.[39] In addition, 50% or more of the qualifying SBC’s employment must be hired by the SBC.[40]

Additional SBIR Eligibility Requirements

The SBIR program allows a qualifying SBC to be majority VC-owned, so long as VCs do not have control of the SBC and so long as their affiliation with the SBC, if any, does not put the SBC over the size limit of 500 employees.[41] However, an exception to this exists if the VC is itself more than 50% directly owned and controlled by one or more individuals who are citizens or permanent resident aliens of the U.S.[42] In such a case, that VC is allowed to have majority ownership and control of the awardee.[43] In that case, the VC and the awardee, and all other affiliates, must have a total of 500 employees or less.[44]

Some participating SBIR agencies may make a portion of their awards to qualifying SBCs that are majority-owned by VC operating companies, hedge funds, or private equity firms.[45] This is allowed only if no one VC operating company, hedge fund, or private equity firm holds more than 50% of the stock.[46]

STTR Program in Detail

In 2019, the STTR program had an investment budget of $435 million, with an additional Research and Development budget of $1 billion.[47] Participating STTR federal agencies, along with each agency’s 2019 spend, include:

  • Department of Defense ($1.8 billion);
  • Department of Health and Human Services ($1.15 billion);
  • Department of Energy ($308 million);
  • National Science Foundation ($212 million); and
  • National Aeronautics and Space Administration ($183 million).[48]

Unlike the SBIR program, the STTR program does not allow qualifying SBCs to be majority VC owned.[49] However, the STTR program permits qualifying SBCs to partner with research institutions.[50] The partnering research institution must be located in the U.S. and meet one of the following definitions: (1) non-profit college or university; (2) domestic non-profit research organization; or (3) Federally Funded Research and Development Center.[51]

Work requirements for STTR program awardees include regulating the percentage of work that must be completed by an awardee and its research partner. Accordingly, a minimum of 40% of the work must be completed by the qualifying SBC and a minimum of 30% of the work must be done by the partnering research institution.[52]

Under an STTR award, the awardee and partnering research institution must, prior to the award, sign an intellectual property agreement identifying the sharing of rights to data.[53] The data developed under an STTR award is similarly protected from disclosure by the participating agency as data developed under an SBIR award.[54]

Contracting Agencies

Participating agencies are classified as either a contracting agency or a granting agency under the Programs. The participating agency’s classification determines the level of involvement the agency will have in the qualifying SBC’s work.[55]

Contracting agencies include the Department of Defense, Department of Homeland Security, National Aeronautics and Space Administration, Environmental Protection Agency, Department of Transportation, and Department of Education.[56]

Contracting agencies establish plans, protocols, and detailed work requirements on highly focused topics.[57] Further, contracting agencies are permitted to establish more rigid fiscal requirements and qualifying SBCs receive funding based on work progress.

Granting Agencies

Unlike contracting agencies, granting agencies are very flexible, allowing considerable latitude to the principal investigator.[58] Granting agencies include the National Science Foundation, Department of Energy, U.S. Department of Agriculture, Department of Commerce which includes National Institute of Standards and Technology and National Oceanic and Atmospheric Administration. The Department of Health and Human Services is considered both a contracting agency and granting agency, however, it mostly issues grants.[59]

Unlike contracting agencies, granting agencies require the principal investigator to initiate the approach and the work topics are not required to be highly specified.[60] Further, granting agencies permit more flexible fiscal requirements and allow upfront funding to qualifying SBCs, as funds support a public purpose and best efforts in research.[61]

SBA’s Role

The SBA provides oversight and guidance on the Programs.[62] The SBA’s responsibilities include developing policy and program guidance, along with gathering, analyzing, and reporting the Program’s data.[63] The SBA is also responsible for leading federal-wide outreach and building of the support ecosystem to both private and public network and tech entrepreneurs.[64]

How to Apply

Applications for SBIR and STTR program awards are submitted in response to agency solicitations.[65]  You can find links to the solicitations and technical topics from the participating agencies and submit your application on the Programs’ website


 

[1] CB Insights, How COVID-19 Could Impact Seed-Stage Startup Investing, March 20, 2020.

[2] The Wall Street Journal, Tech Startup Funding Declines as Pandemic Drags On, July 23, 2020.

[3] CrunchBase, How COVID-19 Changed the VC Investment Landscape in the US, June 23, 2020.

[4] Id.

[5] 500 Startups Survey, The Impact of COVID-19 on the Early-Stage Investment Climate, 2020.

[6] Id.

[7] National Venture Capital Association, The Economic Importance of Venture Capital-Backed Companies to the U.S. Economy, Fifth Edition; Stanford University, How Much Does Venture Capital Drive the U.S. Economy?, October 21, 2015.

[8] Id.

[9] https://www.sbir.gov/about.

[10] Id.

[11] Id.

[12] Id.

[13] Id.

[14] https://www.sbir.gov/news/success-stories.

[15] https://www.govinfo.gov/content/pkg/CFR-2020-title13-vol1/pdf/CFR-2020-title13-vol1-sec121-702.pdf; https://www.sbir.gov/sites/default/files/elig_size_compliance_guide.pdf.

[16] https://www.sbir.gov/about.

[17] https://www.sbir.gov/sites/all/themes/sbir/dawnbreaker/img/documents/Course1-Tutorial3.pdf.

[18] Id.

[19] Id.

[20] Id.

[21] Id.

[22] Id.

[23] Id.

[24] https://www.sbir.gov/faqs.

[25] Id.

[26] Id.

[27] Id.

[28] Id.

[29] Id.

[30] Id.

[31] Id.

[32] Id.

[33] Id.

[34] https://www.sbir.gov/sites/default/files/SBA_SBIR_Overview_March2020.pdf.

[35] Id.

[36] https://www.sbir.gov/faqs/data-rights.

[37] Id.

[38] https://www.sbir.gov/sites/default/files/SBA_SBIR_Overview_March2020.pdf.

[39] Id.

[40] Id.

[41] https://www.sbir.gov/faqs/vc-participation.

[42] Id.

[43] Id.

[44] Id.

[45] Id.

[46] Id.

[47] https://www.sbir.gov/sites/default/files/SBA_SBIR_Overview_March2020.pdf.

[48] Id.

[49] Id.

[50] Id.

[51] https://www.sbir.gov/about.

[52] https://www.sbir.gov/sites/default/files/SBA_SBIR_Overview_March2020.pdf.

[53] https://www.sbir.gov/faqs/data-rights.

[54] Id.

[55] https://www.sbir.gov/sites/default/files/SBA_SBIR_Overview_March2020.pdf.

[56] Id.

[57] Id.

[58] Id.

[59] Id.

[60] Id.

[61] Id.

[62] https://www.sbir.gov/sites/default/files/SBA_SBIR_Overview_March2020.pdf.

[63] Id.

[64] Id.

[65] https://www.sbir.gov/faqs/eligibility-requirements.

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