Startups often need outside capital to mature from an ambitious idea to a viable disruptive company. Many startups look first to dilutive funds from angel investors -- think Shark Tank. The catch is that the “sharks” nearly always want equity in your company. What if you do not want to dilute your ownership in your startup and do not want to finance with debt like a loan? One option is to get a spot in the Small Business Innovation Research program (SBIR) program.
Venture capital may be a sub-optimal “funding source” for your startup. Non-dilutive funding, like a Phase I SBIR grant or contract, may poise your company for greater success and yield a higher Return on Investment. The buy-in to win an SBIR award is careful and strategic planning and the payoff is up to $1M in funding, customers, and zero dilution.
Overview of SBIR
The Small Business Innovation Research Program (SBIR) is a part of the nation’s largest federal research and development grant program for early-stage startups and small businesses. This program authorizes 11 agencies to provide funds to US small businesses for projects to develop and commercialize new technologies. SBIR funds take the form of grants and contracts -- up to $250,000 in Phase I and up to $750,000 in Phase II -– to support research and development, determine commercial applications, build prototypes, and procure intellectual property assets in your new technology.
The SBIR program is divided into 3 phases:
In Phase I the awardee establishes the feasibility, merits, and commercial applications of their new technology. Phase I also prepares small businesses for growth during Phase II, although not all Phase I projects will continue to Phase II. Phase I grants and contracts range from $50,000 - $250,000. Phase I of the SBIR program lasts 6 months.
Phase II projects build on technical progress achieved during Phase I. Phase II builds on the proof-of-concept in Phase I and facilitates prototype development. Phase II awards are based on the awardee’s Phase I performance, so it follows that typically only Phase I awardees are eligible to apply for Phase II. Phase II awards are usually $750,000 and delivery is due after 2 years.
Phase III is for commercializing technology developed in Phases I and II. No grants are awarded in Phase III. Instead, participating agencies may provide external funding opportunities OR award contracts for products and services.
Brief History of the SBIR Program
In the 1970s the U.S. government searched for ways to compete in the emerging global economy. One thesis was that small businesses (as opposed to large ones) were driving new technologies and jobs. Time has proven this thesis: according to a 2000 study, large company innovation had a 29% chance of staying relevant in the market after five years, while small company innovations had a 50% chance of remaining market-relevant after five years. Not surprisingly, small businesses also drive job growth: according to the Small Business Administration, small businesses created 66% of new jobs between 2000 and 2017.
In 1977, The National Science Foundation launched an innovation grant pilot program. The first class of grantees included 42 Phase I awards and 22 Phase II awards. The first class of grantees left big shoes to fill: one grantee would later discover the cystic fibrosis gene and complete the Human Genome Map.
The momentum of this strong performance led Congress to recommend extending the SBIR program to all agencies that support research. Thus, Congress created the SBIR program under the Small Business Innovation Development Act of 1982. Specifically, Congress found:
“(1) technological innovation creates jobs, increases productivity, competition, and economic growth, and is a valuable counterforce to inflation and the United States balance-of-payments deficit;
(2) while small business is the principal source of significant innovations in the Nation, the vast majority of federally funded research and development is conducted by large businesses, universities, and Government laboratories; and
(3) small businesses are among the most cost-effective performers of research and development and are particularly capable of developing research and development results into new products” (P.L. 97-219).
The four primary goals of the SBIR program were:
- To stimulate technological innovation;
- to meet federal research and development needs;
- to foster innovation and entrepreneurship by women and socially or economically disadvantaged persons; and
- to increase private-sector commercialization of innovation from federal R&D funding.
Program awards: Grants vs. Contracts
Awards under the SBIR program are either a) grants or b) contracts. (The Department of Health and Human Services and the Department of Education award both grants and contracts).
Here are some key differences between grants and contracts:
- Grants are generally awarded to accomplish a public purpose, address a public problem, or stimulate an activity that is important to the awarding agency. Grants allow for more flexibility and the Principal Investigator (i.e. the person responsible for the small business and project) has considerable discretion in research and development.
- In contrast, the scope of work of a contract is well-defined. Agencies awarding contracts seek to procure goods and services that will directly benefit the government. These contracts proceed according to plans, protocols, and requirements established by the awarding agency.
- Grants are an assistance/investment mechanism that allows for upfront payment regardless of performance.
- Contracts are binding agreements between a buyer – the awarding agency -- and seller – the small business awardee. The awardee is paid for performance based on reporting requirements and milestones.
- Four agencies exclusively award grants. These are the Department of Energy, the National Oceanic and Atmospheric Administration, the National Science Foundation, and the Department of Agriculture.
- Five agencies award only contracts: the Department of Defense, National Aeronautics and Space Administration, Department of Homeland Security, Department of Transportation, and the Environmental Protection Agency.
- Just over half of the $4 billion awarded in 2020 for all government-funded R&D projects was in the form of contracts.
The SBIR program helps overcome the barrier that access to capital represents for many startups and small businesses. This program facilitates disruptive tech innovations by small businesses by leveraging the full faith and credit of the US government. Not only does the government provide capital for leading edge research and development projects but it also facilitates access to additional resources and guidance through the insight and extensive reach of its largest agencies.
Stay tuned for the next installment about the SBIR proposal process and where your SBIR proposal might be going wrong.