The U.S. remains at the forefront of technology innovation due to entrepreneurs that take risks. When combined with access to capital, these risks enable an entrepreneurial ecosystem that gives the U.S. a competitive edge. But where does an entrepreneur turn for capital when either the endeavor is too early stage, involves too much technological risk, and/or targets a market of insufficient size to warrant private investment (i.e., without the potential to deliver on a >10x ROI within three years)?
The U.S. government’s Small Business Innovation Research (SBIR) program, established in 1982, has been a lifeline for these kinds of businesses over the last few decades. SBIR’s mission is to “support scientific excellence and technological innovation through the investment of federal research funds in critical American priorities to build a strong national economy.” In short, it’s a jobs program intended to create the businesses of tomorrow that position the U.S. as a global leader in technology innovation. It is an incredibly powerful program that U.S. taxpayers should be proud of.
Despite its strengths, the SBIR program suffers from abuses that cause critics to see it as corporate welfare. With VC seed deals dropping significantly since last year, according to CB Insights, seed funding from SBIR is critical right now as it’s perhaps the only funding option for entrepreneurs who are too early stage for traditional VC, or involve too much technological risk. So just as the media is warning hedge funds and other businesses not to take advantage of PPP loans, I would like to educate entrepreneurs on the outright abuses of the program and encourage more responsible practices from those who choose to participate during this critical time in our history.
Why SBIR matters
Congress created the SBIR program and its cousin the STTR to grow small businesses, foster their participation in the federal acquisition process, and facilitate commercialization of innovating technologies coming out of U.S. universities and National Laboratories. The funding is administered by 11 federal agencies that allocate a small percentage of their R&D budgets (3.2% as of 2017) to the program. According to the SBA, the SBIR and STTR programs awarded more than $3.5 billion to small businesses in 2019 – certainly not a trivial amount of seed-stage funding.
The obvious attractive feature of SBIR is that the funds are non-dilutive. Unlike a traditional private investor, the federal government does not receive equity in the company, nor do they assume a Board seat. And in many cases, the federal government is the eventual customer. It can be akin to having your customer pay you to develop a product that they need after which you get to sell it to them. Similar to private investment where perhaps only one out of 10 investments will be wildly successful, the SBIR program can also point to several home runs, including Qualcomm, 23andMe, and iRobot, among others. “Sounds great,” you might say – so what’s the catch?
The abuse: ‘SBIR mills’
Once received, SBIR awards can become a steady source of revenue even without a commercial product that generates revenues from sales. For some companies, once they learn this “game,” it can be difficult to turn away from what looks like easy money. The result is a commercially irrelevant company whose sole purpose is writing great SBIR proposals and successfully executing on product research contracts with no real products ever entering the market.
This abuse is common enough that companies addicted to SBIR revenues alone are frequently called “SBIR mills.” For every Qualcomm and iRobot, there are at least several dozen SBIR mills. They’ve collected tens if not hundreds of millions of SBIR dollars, often over several decades. While occasionally commercializing a product, SBIR-associated revenues have and always will be the majority of these companies’ revenues. The practice is inexcusable. It robs taxpayers and consumes precious investment funds that could catapult more legitimate startup companies through the difficult seed-stage. In the current climate, where we need smart people with moonshot ideas more than ever, the practice is especially egregious.
The solution: Introduce a litmus test
Let me be clear: The SBIR program is something that U.S. taxpayers should be proud of. It is a unique program that provides critically needed seed-stage capital to get companies and ideas off the ground that might not otherwise be suitable to a private investment model. If done well, it can create future growth companies as well as enable “hard tech” that private investment ignores due to slow ROI – but is critically needed to ensure the U.S.’ future competitive edge.
So, what should a responsible entrepreneur do? First and foremost, take advantage of the SBIR program as a source of seed-stage capital — but do so responsibly. For example, the two companies that I co-founded in 2012, Roccor and Solid Power, both owe their existence to the SBIR program. Today, neither rely on SBIR funding as their primary source of revenue.
In the case of Solid Power, which is commercializing next-generation all solid-state batteries for future electric mobility markets, funding from programs like SBIR and ARPA-E was used to de-risk the technology to warrant private investment. This transition from public to private investment is necessary for technologies with costly, lengthy development processes that one cannot simply “bootstrap.” However, the massive future market size and positive societal impact warrants these investments.
Similar to Solid Power, Roccor had an early reliance on SBIR funding in order to develop and establish the company’s product portfolio. Today, while the company still leverages the SBIR program for new product development and/or as contract vehicles for procurement, this source of funding has increasingly become a minor portion of the company’s revenues.
So how do we streamline the SBIR program in order to make it more effective? Simple – put limits on the amount of funding a company can receive from the SBIR program, either cumulatively or annually. A key litmus test is the answer to the following question: Will this company be out of business if the SBIR program were to disappear tomorrow? If the answer is “yes” and the company is more than 10 years old, then it clearly has a business model based on being subsidized by U.S. taxpayers and should be allowed to go out of business in order to make room for the next generation of startups.