Each year about $2 billion in Small Business Innovation Research (SBIR) contracts are awarded by the federal government. Surprisingly, for the past five years none of these grants have gone to small businesses in which venture capitalists own a majority stake. However, a compromise bill addressing this issue has emerged in Congress with strong support in both houses and is expected to become law next month.
The compromise bill, which was unanimously approved by the Senate Committee on Small Business and Entrepreneurship on July 30, 2008 and is slated for a full Senate vote in September, will allow the National Institutes of Health to award up to 18 percent of its SBIR funding to VC-owned firms. Other agencies will be able to award up to eight percent of their SBIR funds to VC-owned firms.
The SBIR program was created by Congress in 1982 and requires that certain federal agencies award a portion of their outside research budgets to small businesses. Re-authorization of the grant program for the upcoming fiscal year beginning on October 1, 2008 has been held up over the issue of whether small businesses owned by venture capital firms should be eligible for SBIR grants.
In 2003, the Small Business Administration ruled that companies in which venture capital firms hold an equity stake of 50 percent or more do not qualify as small businesses. For the past five years, the eligibility of VC-owned firms for SBIR grants has been debated in Congress.
On one side of the debate, the Biotechnology Industry Organization (BIO) and the National Venture Capital Association have urged Congress to overturn the SBA's ruling, arguing that venture capital is essential to fund some types of small businesses, especially biotech start-ups – where the costs of bringing new therapeutic products to market can be extraordinarily high. They have argued that VC-owned companies should not be penalized based on their financial structure. On the other hand, the Small Business Technology Council and others contend that companies owned by VC firms should not be considered small businesses because they have access to the deep pockets of their VC funds. They argue that awarding SBIR grants to these ventures will displace small businesses that truly need support.
Last April, the House of Representatives passed legislation that would restore the SBIR eligibility of venture-owned small businesses, so long as no single VC firm owns a majority stake. The companion SBIR reauthorization bill now being considered in the Senate has been drafted in consultation with the sponsors of the House bill. In the Senate version, even small companies that are majority-owned by a single venture capital firm will once again be eligible. However, the Senate compromise will limit the number of SBIR contracts that can be awarded to VC-owned firms to ensure that most of the awards go to small businesses that are not VC-controlled.
In addition to the eight percent cap (or 18 percent cap for NIH) on federal agency awards to VC-owned companies, the Senate bill also proposes an overall increase in SBIR's share of agency R&D budgets from 2.5 percent to 3.5 percent, except at NIH. In addition, the size of SBIR awards would increase under the Senate bill, from $100,000 to $150,000 for first-phase awards, and from $750,000 to $1 million for second-phase awards.
Assuming the Senate bill becomes law, companies in which venture capitalists hold majority stakes – as well as companies contemplating such funding in the future – may wish to take another look at SBIR grants as another source of support.
This advisory was prepared by Thomas Engellenner, co-chair of Nutter's Life Sciences practice, Deborah Miller, a member of the Life Sciences practice, and Richard Kimball, co-chair of the Emerging Companies practice.
This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.
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