Looking for venture capital? Consider asking the federal government to invest in your R&D

Editor’s Note: James Norment is a member of the Government Representation Practice Group of Ward and Smith, P.A.

The old saying goes that when someone from the government tells you that they're here to help, hold onto your wallet. The federal Small Business Innovation Development Act, though, tries to help by actually funding private research and development through the Small Business Innovation Research ("SBIR") and Small Business Technology Transfer ("STTR") programs. The SBIR and STTR programs are relatively small by government standards, but eligible businesses can receive up to $850,000 in support for the development of innovative products or scientific methods that have both governmental and private-sector applications.

What is the SBIR Program?

SBIR funding is money received from the federal government for research, development, and commercialization of technology on a grant basis. Grant basis means that the money does not have to be repaid and no equity is given up by the small business. Grants may be made to individuals or any form of business entity, but only for-profit businesses with no more than 500 employees are eligible. Also, venture capital firms can own no more than 49% of the business entity. Participating federal agencies publish annual solicitations and descriptions of research they are willing to fund. Interested companies or individuals submit written proposals responding to a research topic identified in the agency solicitation. If funding is received, the rights to any and all technology developed is retained by the grantee, with the government getting only a royalty-free license for internal government use.

SBIR funding comes directly from federal agencies and is coordinated by the SBA. The aim of SBIR grants is to transfer innovations out of the small business laboratories and workshops into the marketplace in order to create new technologies and build new businesses around them. There are three phases of SBIR grants:

• Phase I: This is a screening or idea phase to determine whether a technical idea is promising and whether the applicant is able to do high quality research and development. Funding is for up to six months and up to $100,000 for basic and applied research.

• Phase II: Only recipients of Phase I grants are eligible for Phase II funding which is intended to fund continued research and development initiated in Phase I and, if appropriate, the production of a prototype. Funding is for up to two years and $750,000.

• Phase III: Phase III is for the commercialization of the results of Phase II. There is usually little or no SBIR or STTR funding in Phase III, depending upon the particular agency and contract. The agency's primary objective in Phase III is to ensure that the business receives private sector funding. By the end of Phase III, the business should have a product that it can market to the federal government as well as to the private sector.

How does the STTR Program Differ?

Like SBIR, STTR is a very competitive three-phase program. However, under the SBIR program, the principal investigator must be employed primarily by the small business concern at the time of award and for the duration of the project period, while under the STTR Program, agencies are given greater flexibility by allowing the principal investigator to be employed by the applicant or an associated research institution. Another significant difference is that the STTR program requires research partners at universities and other non-profit research institutions to have a formal collaborative relationship with the small business concern. As part of this formal agreement, at least 40 percent of the STTR research project must be conducted by the small business concern and at least 30 percent of the work must be conducted by a single, "partnering" research institution. The partnership must propose a plan to move ideas from the laboratory to the marketplace, to foster high-tech economic development, and to address the technological needs of the federal government. Such technology transfer can be from a non-government related activity as well as from the federal government to the private sector.

SBIR/STTR Funding Complications

Many entrepreneurs and inventors – the primary targets for the programs' funds – do not know that the federal government is a potential source of funding. An interested entrepreneur must search each agency's solicitation website to identify a particular program that might lead to funding of the applicant's project. This is a daunting task for a small business new to the SBIR and STTR programs. Even those who identify an attractive funding source find that the SBIR and STTR application process often is more complex than bidding on a typical federal government contract. The business must justify its research and development ideas, agree to extensive monitoring and audits by the funding agency, and agree to make the results of the research and development available to the federal government.

Equally important, the government imposes significant regulations on how participants can spend federal grant dollars. Each funding agency has its own criteria for how the grant dollars may be spent within each phase. These restrictions are set out in the grant contract and vary from grant to grant. At a minimum, the Federal Acquisition Regulation's contract cost principles and procedures for payment apply. In addition, there may be phase-specific limits. As a general rule, grant participants must pay their own patent costs for inventions in which they retain title, which can put the participant at a competitive disadvantage if it cannot afford the patent application costs on its own. In limited circumstances, and depending upon the particular conditions of a grant, the government may allow some patent-related costs to be paid by grant funds. For example, the National Institutes of Health has allowed grant dollars to be used for general legal expenses related to patent matters such as an attorney's advice on patent laws, regulations, and clauses. Grant participants should review the terms of their award carefully in order to determine which, if any, patent-related costs are allowable.

Becoming a Successful Applicant

The main requirement for becoming a successful grant applicant is to have a product, idea, or research project that falls within the SBIR and STTR program mandates. The most important SBIR and STTR mandate is the requirement that the proposed project is one that the government actually needs. Although the SBIR and STTR programs are intended to allow unsolicited proposals, the highly competitive nature of the grant process results in most applications being responses to specific agency solicitations. In reality, this usually means that only projects which are submitted in response to a specific solicitation eligible for SBIR or STTR funding are considered. Most applicants focus on high-tech engineering projects, computer programming, and sophisticated theories rooted in scientific research. In addition, the STTR program requires the business to already be engaged with a research institution in its offered product or research.

Second, the applicant for either the SBIR or STTR programs must register with the federal government's Centralized Contractor Registration ("CCR") system, which is the primary contractor database for the federal government. Applicants are required to complete a one-time registration to provide basic information relevant to procurement and financial transactions. Successful applicants (now called "contractors") must renew their registration annually to maintain active status as a contractor. Registration is free, but it does require an investment of time and effort to assemble the many pieces of required information.

Finally, the potential applicant must research each agency's SBIR and STTR programs carefully. Although an applicant might think that the applicant's idea has military applications only, it is very possible, for instance, that the U.S. Department of Agriculture also would be interested in the project. There is no official central clearinghouse of SBIR and STTR opportunities, but there are SBIR and STTR trade associations that can assist in a search. Even if an applicant is selected for Phase I funding, the agency will not contract with the applicant unless an applicant is found to be "responsible." Among other criteria, the applicant must be able to demonstrate that its business (1) has adequate financial resources; (2) is able to meet deadlines; (3) has a satisfactory record of performance and ethics; (4) has the necessary organization, experience, and accounting controls; and (5) has the necessary equipment and skills to complete the contract. Fortunately, the agency will provide extra assistance to SBIR and STTR participants to help meet these criteria.

Knowledge of the steps needed to become competitive in the SBIR and STTR programs goes a long way to improve an applicant's chance of winning investment dollars. For access to a tremendous amount of SBIR, STTR, and federal contracting information, see www.sba.gov, www.ccr.gov, and www.fedbizops.gov. Unfortunately, the volume of information can be overwhelming. Many businesses interested in SBIR and STTR funding benefit from additional assistance when faced with the application process, including help with legal, accounting, and business organization issues.

Other Benefits for Successful Applicants

The direct investment funding helps, of course, but perhaps even more valuable is the added credibility of being an SBIR or STTR business. Private investors usually are more interested in investing in a business that has earned the support of a federal agency and has successfully performed on a federal contract, not only because it provides an imprimatur of worthiness, but also because it provides non-dilutive funding. Further, the SBIR and STTR programs specifically try to channel participants to lucrative federal contracts with terms that extend well beyond the end of the SBIR or STTR phases.

© 2008, Ward and Smith, P.A.

Ward and Smith, P.A. provides a multi-specialty approach to the representation of technology companies and their officers, directors, employees, and investors. Mr. Norment practices in the Government Representation Practice Group, where he concentrates his practice on state and federal government contracts. Comments or questions may be sent to jwn@wardandsmith.com.

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.