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Financing Small Firm Innovation in the United States

Ronald S. Cooper, Ph.DOffice of TechnologyU.S. Small Business Administration

The Small Business InnovationResearch (SBIR) program

and related programs

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Public innovation programs—U.S.Public innovation programs—U.S.

• “U.S. experience” -- many US experiences: national, state, local-- replicate → models, practices, lessons

• Targeting small firms and individual entrepreneurs:

-- 15% of R&D $, 55% of innovations-- incentive: possibility of high private returns-- risk is manageable, failure is an option

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SBIR ProgramSBIR Program

I. Structure & operation

II. Evolution and learning:• outreach & links with private $• university research

III. Economic impacts

IV. Lessons learned

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SBIR programSBIR program

• Enables US small businesses to engage in federally-funded R&D—with potential for commercialization

• Enables/requires federal agencies to utilize the innovation advantages of small firms

• National program, providing $2 billion each year to small businesses for innovation

• Over 5,000 grants to over 1,500 firms each year

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National policy shiftNational policy shift 1950s, 60s -- Federal role was to support basic

research in Federal labs and large businesses

1970s, 80s -- Policy shift towards: - commercialization of federal R&D - government-industry partnerships - greater role for small business

– “Stevenson-Wydler Act” of 1980

– “University and Small Business Patent Procedure Act” of 1980 (Bayh-Dole Act)

– “Small Business Innovation Development Act” of 1982 established the SBIR program

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Concern over competitiveness of US industry—productivity

Disconnect between invention and innovation

Economic contextEconomic context

• only 5% inventions in federal labs licensed

• VC industry

• no good “angel” investor networks

• funding gap (“valley of death”) for early- stage innovation

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Federally Funded Basic

Research Creates New

Ideas Applied Research

&

Innovation

Capital to Develop Ideas

No Capita

l

The Valley of Death Early-Stage Funding Gap

To Innovation

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Objectives of SBIR program:

Stimulate technological innovation

Use small business to meet federal R&D needs

Increase private-sector commercialization of innovations derived from federal R&D

Small Business Innovation Small Business Innovation Research (SBIR) ProgramResearch (SBIR) Program

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SBIR’s 3-Phase StructureSBIR’s 3-Phase StructurePHASE I

Feasibility of idea, proof of concept

$100,000 (1 year)

PHASE II Full R&D, prototype $750,000 (2 years) Commercialization plan

“PHASE III” Commercialization stage Use of non-SBIR funds

(private capital or federal follow-on)

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Small business located in the U.S.

500 or fewer employees

Organized for-profit U.S. business

At least 51% owned and controlled by U.S. citizens (individuals)

Principal Investigator’s primary employment must be with the small business

Research partners are allowed/encouraged (up to 1/3 of Phase I, up to 1/2 of Phase II)

SBIR eligibility requirementsSBIR eligibility requirements

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Federal agencies with “extramural” research budgets of over $100 million per year must reserve a percentage for small business through the SBIR program.

Amount of R&D budget to be set-aside for SBIR:

1982-86 1987-92 1993-94 1995-96 1997-present1997-present

0.2+% 1.25% 1.5% 2.0% 2.5%2.5%

Source of funds for SBIR:

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U.S. federally-funded R&DU.S. federally-funded R&DTotal: $85 billion in 2002

Small Business 5%

Big Business 27%

Univ. & Colleges 34%

Non-Profit 7%

Extramural 74%

Federal Labs 27%

$62B

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Program StructureProgram Structure

Each participating Federal agency administers its own SBIR program– Solicitations (with technology topic areas)

– Proposal review & selection (scientific merit / commercial)

– Highly competitive: 16% of proposals accepted - Phase I ½ of Phase I projects win Phase IIs

SBA has oversight and outreach responsibilities

- Policy directive - Monitoring - National conferences

- Evaluation - Outreach programs - Reporting to Congress and activities

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• Defense (DOD) 600 • Health (HHS,NIH) 487 • Space (NASA) 110 • Energy (DOE) 95 • Science (NSF) 78 • Agriculture (USDA) 17 • Commerce (DOC) 7 • Education (ED) 7 • Environment (EPA) 6 • Transportation (DOT) 6

SBIR participating agenciesSBIR participating agencies

TOTAL ~ $2 BTOTAL ~ $2 BFY 2004FY 2004

(FY2002)

$ millions SBA (oversight)

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Project selectionProject selectionIntegrity of selection process—key to program success

1. Independent review panel of experts (volunteer)

2. 3-5 proposals e-mailed to each reviewer

3. Reviewers grade proposals scientific/technical merit commercialization potential

4. Review panel convenes, ranks proposals(1) must fund, (2) award if funds available, (3) X

5. Agency official makes awards [choice]

Balance between very new ideas & commercial viability

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Key featuresKey features

Grants & contracts not loans, no direct pay-back

truly early-stage, no debt burden

program continues to fund high-risk research (avoids bureaucratic drift towards downstream)

Small business owns intellectual property government must protect IP for 4 years

agency retains royalty-free license for government use only of technical data (IP)

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SBIR program evolution1982

FederalGovernment

SmallBusinesses

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SBIR program evolution1982

SmallBusinesses

StateGovernment

Quasi-Government Corporations Economic Development Entities Technology Centers

FederalGovernment

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Support outreach & assistance programs/initiatives

• Outreach to bring in new firms is needed:

1. to maintain quality of proposals, cutting-edge research

2. to improve geographic dispersion (political support)

• Federal support as catalyst for state/local assistance programs targeting innovation

Survey: “63% of SBIR projects need assistance with commercialization activities”

SBA’s Federal & State Technology Partnership (FAST) program

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Federal and State Technology Partnership Federal and State Technology Partnership (FAST) Program(FAST) Program

• Purpose: to provide support to state-level organizations that help small businesses in, or interested in, the SBIR program– Mentoring networks: Business advice & counseling

• Matching grants to state-level organizations– 1:2, 1:1 (incentive for states with lower SBIR participation)

– administered by SBA

• Target: All states eligible, one grant per state Governor endorses proposal

• Funding: FY 2001: $3 million, 30 grants (Grant size: $100K) FY 2002: $3 million, 27 grants

FY 2004: $2 million, 10 grants

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State/regional assistance programsState/regional assistance programs Non-profit org (model: “KTEC” in state of Kansas)

Matching funds established with state govt funding (1:2)

Firms required to find commercial partners

Firms receive funds in installments only when they pass business milestones:• Business plan, management structure, marketing strategy, secure

private risk capital

Assistance also includes: matching with VCs, angel network, business mentors (networks), university research & incubators, export assistance

Conditional loan with payback: • 0 – low interest, pay only if successful

• 5% of sales, - 2-3 times original investment

• Program self-financing after +/- 5 years

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Modified 3-phase structureModified 3-phase structurePHASE I

Feasibility of idea $100,000 (1 year)

PHASE II Full R&D, prototype $750,000 (2 years) Commercialization plan

PHASE III Commercialization stage Use of non-SBIR funds

(private capital or federal follow-on)

“PHASE IIb” (NSF)≈ $400,000 initially

→ $350,000 only with matching invest.

$700,000 cash

$1,450,000$1,450,000

PrivateInvestor

Connecting with

private sector

investors

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SBIR program evolution1982

SmallBusinesses

StateGovernment

Quasi-Government Corporations Economic Development Entities Technology Centers

FederalGovernment

Academia University Research Parks Faculty & Graduate Students Technology Incubators Research Foundations

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Promoting Small Business-University CollaborationPromoting Small Business-University Collaboration

Small Business Technology Transfer Program Small Business Technology Transfer Program (STTR)(STTR)

• Set-aside program to facilitate cooperative R&D between small businesses and U.S. research institutions

• Established 1992, recently extended through 2009

• Similar structure to SBIR, administered by SBIR offices

• Funding: – Set-aside = 0.3 % of extramural R&D →→ $200 million– Agencies (5) with extramural R&D > $1B must participate

• FY2002: 356 Phase I awards 114 Phase II awards

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STTR - SBIR DifferencesSTTR - SBIR Differences

• STTR requires research institution partner University or college / non-profit research org. / FFRDC

• Research partner share: min.= 30% max.= 60%

• Award always goes to small business

• Requires written agreement allocating IPRs

• Principal Investigator’s primary employment can be with the small business or the research institution

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SBIR program impactsSBIR program impacts

Enables new startups, spin-offs, is often only source of funding

Induces further entrepreneurial activity (“demonstration effect”)

Enables small firms to develop innovative capacity

Complements private ventures (reduces risk)

“Success rate”: 39% of projects had sales attributable to SBIR (55% had sales or additional investment)

Possible measure: current market value of companies started with SBIR projects

Catalyst for innovation by addressing early stage finance “gap”

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SBIR addresses innovation finance gapSBIR addresses innovation finance gap

Dimensions of the Gap Public program

1. Information Certification effect, outreach

2. Short Timeframe Awards/grants

28Source: MoneyTree Survey—PricewaterhouseCoopers, Thompson Venture Economics, NVCA.

1.4%

62.7%

19.2%

16.7%

Expansion

Early Stage

Late Stage

Start Up

US Venture Capital InvestmentsUS Venture Capital Investments by Stage, 2002by Stage, 2002

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US Venture Capital Investments by Stage

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1995 1996 1997 1998 1999 2000 2001 2002

Source: MoneyTreeSurvey

Later Stage

Expansion

Early Stage

Startup/Seed

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SBIR addresses innovation finance gapSBIR addresses innovation finance gap

Dimensions of the Gap Public program

1. Information Certification effect, outreach

2. Short Timeframe Awards/grants

3. Size of financing Small grants (< $1m)

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US Venture Capital Disbursements by size of financing round

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

Source: NVCA and Venture Economics, special tabulations.

Mill

ions

of 1

998

dolla

rs

> $10 million

$1-$10 million

< $1 million

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SBIR addresses innovation finance gapSBIR addresses innovation finance gap

Dimensions of the Gap Public program

4. Few (fad) technologies Wide range of technologies

5. Geographic specialization Broad geographic coverage

1. Information Certification effect, outreach

2. Short Timeframe Awards/grants

3. Size of financing Small grants (< $1m)

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LessonsLessons learned learned

• There is effective role for government in funding early-stage small-firm innovation; grants and loans

• One program cannot do everything: - use different programs for different stages

• Eligibility: restrict to for-profit small businesses

• Proposal selection: integrity, quality, balance (between very new ideas and commercial feasibility)

• Small firms must own the IP (incentive), public programs must protect it

• Need to design so that it compliments and coordinates with private risk capital (angel, VC, etc.)

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Lessons learned Lessons learned (cont’d)

• Must have university-specific part of program, or separate (linked) program (like STTR) to deal with IP and promote spin-offs

• Must coordinate with regional/local business assistance programs

• Outreach is needed to maintain program at cutting-edge (new blood)

• Outreach (not quotas) to achieve geographic dispersion--helps create political support

• Program flexibility where possible: local initiative

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SBIR & STTR ProgramsSBIR & STTR ProgramsOffice of Technology

U.S. Small Business Administration

For more information• Contact individual agency websites• Cross-agency websites:

www.sba.gov/sbirwww.sbirworld.com

Ronald S. Cooper

ronald.cooper@sba.gov

(202) 205-6455