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 VENTURE FUNDING
AND THE
NIH SBIR PROGRAM

Committee for
Capitalizing on Science, Technology, and Innovation:
An Assessment of the Small Business Innovation Research Program

Policy and Global Affairs

Charles W. Wessner, Editor

Copyright © 2009. National Academies Press. All rights reserved.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 THE NATIONAL ACADEMIES PRESS 500 Fifth Street, N.W. Washington, DC 20001

NOTICE: The project that is the subject of this report was approved by the Governing
Board of the National Research Council, whose members are drawn from the Councils of
the National Academy of Sciences, the National Academy of Engineering, and the Institute
of Medicine. The members of the committee responsible for the report were chosen for
their special competences and with regard for appropriate balance.

This study was supported by Contract/Grant No. N01-OD-4-2139 (Task Order #99)
­between the National Academy of Sciences and the U.S. Department of Health and
­Human Services. Any opinions, findings, conclusions, or recommendations expressed in
this publication are those of the author(s) and do not necessarily reflect the views of the
organizations or agencies that provided support for the project.

International Standard Book Number-13: 978-0-309-12997-8

International Standard Book Number-10: 0-309-12997-4

Limited copies are available from the Policy and Global Affairs Division, National
­Research Council, 500 Fifth Street, N.W., Washington, DC 20001; 202-334-1529.

Additional copies of this report are available from the National Academies Press, 500 Fifth
Street, N.W., Lockbox 285, Washington, DC 20055; (800) 624-6242 or (202) 334-3313
(in the Washington metropolitan area); Internet, http://www.nap.edu.

Copyright 2009 by the National Academy of Sciences. All rights reserved.

Printed in the United States of America

Copyright © 2009. National Academies Press. All rights reserved.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 The National Academy of Sciences is a private, nonprofit, self-perpetuating society of
distinguished scholars engaged in scientific and engineering research, dedicated to the
furtherance of science and technology and to their use for the general welfare. Upon the
authority of the charter granted to it by the Congress in 1863, the Academy has a man-
date that requires it to advise the federal government on scientific and technical matters.
Dr. Ralph J. Cicerone is president of the National Academy of Sciences.

The National Academy of Engineering was established in 1964, under the charter of
the National Academy of Sciences, as a parallel organization of outstanding engineers.
It is autonomous in its administration and in the selection of its members, sharing with
the National Academy of Sciences the responsibility for advising the federal government.
The National Academy of Engineering also sponsors engineering programs aimed at
meeting national needs, encourages education and research, and recognizes the superior
achievements of engineers. Dr. Charles M. Vest is president of the National Academy of
Engineering.

The Institute of Medicine was established in 1970 by the National Academy of Sciences
to secure the services of eminent members of appropriate professions in the examina-
tion of policy matters pertaining to the health of the public. The Institute acts under the
responsibility given to the National Academy of Sciences by its congressional charter to
be an adviser to the federal government and, upon its own initiative, to identify issues of
medical care, research, and education. Dr. Harvey V. Fineberg is president of the Institute
of Medicine.

The National Research Council was organized by the National Academy of Sciences in
1916 to associate the broad community of science and technology with the Academy’s
purposes of furthering knowledge and advising the federal government. Functioning in
accordance with general policies determined by the Academy, the Council has become the
principal operating agency of both the National Academy of Sciences and the ­National
Copyright © 2009. National Academies Press. All rights reserved.

Academy of Engineering in providing services to the government, the public, and the
scientific and engineering communities. The Council is administered jointly by both
Academies and the Institute of Medicine. Dr. Ralph J. Cicerone and Dr. Charles M Vest
are chair and vice chair, respectively, of the National Research Council.

www.national-academies.org

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
Copyright © 2009. National Academies Press. All rights reserved.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 Committee for
Capitalizing on Science, Technology, and Innovation:
An Assessment of the Small Business Innovation Research Program
Chair
Jacques S. Gansler (NAE)
Roger C. Lipitz Chair in Public Policy and Private Enterprise
and Director of the Center for Public Policy and Private Enterprise
School of Public Policy
University of Maryland
David B. Audretsch Charles E. Kolb
Distinguished Professor and President
Ameritech Chair of Economic Aerodyne Research, Inc.
Development
Henry Linsert, Jr.
Director, Institute for Development
CEO
Strategies
Columbia Biosciences Corporation
Indiana University
W. Clark McFadden
Gene Banucci
Partner
Executive Chairman
Dewey & LeBoeuf, LLP
ATMI, Inc.
Duncan T. Moore (NAE)
Jon Baron
Kingslake Professor of Optical
Executive Director
Engineering
Coalition for Evidence-Based Policy
University of Rochester
Michael Borrus
Kent Murphy
Founding General Partner
President and CEO
X/Seed Capital
Luna Innovations
Gail Cassell (IOM)
Linda F. Powers
Vice President, Scientific Affairs and
Managing Director
Copyright © 2009. National Academies Press. All rights reserved.

Distinguished Lilly Research Scholar

Toucan Capital Corporation
for Infectious Diseases
Eli Lilly and Company Tyrone Taylor
President
Elizabeth Downing
Capitol Advisors on
CEO
Technology, LLC
3D Technology Laboratories
Charles Trimble (NAE)
M. Christina Gabriel
CEO, retired
Director, Innovation Economy
Trimble Navigation
The Heinz Endowments
Patrick Windham
Trevor O. Jones (NAE)
President
Founder and Chairman
Windham Consulting
Electrosonics Medical, Inc.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 PROJECT STAFF

Charles W. Wessner Sujai J. Shivakumar

Study Director Senior Program Officer

David E. Dierksheide Adam H. Gertz

Program Officer Program Associate
Copyright © 2009. National Academies Press. All rights reserved.

vi

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 RESEARCH TEAM

Zoltan Acs Irwin Feller

University of Baltimore American Association for the
Advancement of Science
Alan Anderson
Consultant David H. Finifter
The College of William and Mary
Philip A. Auerswald
George Mason University Michael Fogarty
University of Portland
Robert-Allen Baker
Vital Strategies, LLC Robin Gaster
Innovation Ecologies
Robert Berger
Robert Berger Consulting, LLC Albert N. Link
University of North Carolina
Grant Black
University of Indiana South Bend Rosalie Ruegg
TIA Consulting
Peter Cahill
BRTRC, Inc. Paula E. Stephan
Georgia State University
Dirk Czarnitzki
University of Leuven Andrew Toole
Rutgers University
Julie Ann Elston
Oregon State University Nicholas Vonortas
George Washington University
Copyright © 2009. National Academies Press. All rights reserved.

vii

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 POLICY AND GLOBAL AFFAIRS
Ad hoc Oversight Board for
Capitalizing on Science, Technology, and Innovation:
An Assessment of the Small Business Innovation Research Program

Robert M. White (NAE), Chair

University Professor Emeritus
Electrical and Computer Engineering
Carnegie Mellon University

Anita K. Jones (NAE) Mark B. Myers

Lawrence R. Quarles Professor of Senior Vice President, retired
Engineering and Applied Science Xerox Corporation
School of Engineering and Applied
Science
University of Virginia
Copyright © 2009. National Academies Press. All rights reserved.

viii

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 Contents

PREFACE xi

EXECUTIVE SUMMARY 1

1 INTRODUCTION 5
1.1 SBIR and the Innovation “Valley of Death”, 5
1.2 SBIR Program Structure, 7
1.3 The NRC Assessment of SBIR at NIH, 9
1.4 The SBA Ruling on Venture Participation in SBIR Firms, 9
1.5 Overview of Reactions to the SBA Ruling, 11
1.6 The National Research Council’s Study of the Venture
Capital Eligibility Ruling, 18
Copyright © 2009. National Academies Press. All rights reserved.

2 STUDY METHODOLOGY 22
2.1 Identifying Venture-funded Firms and Estimating the
“Exclusion Effect”, 22
2.2 Methodology for Measuring the Impact of the SBA Ruling, 26
2.3 Case Study and Other Data, 28

3 VENTURE FUNDING FOR NIH PHASE II WINNERS,

1992-2002 30
3.1 Control and Individual Ownership, 31
3.2 Elimination I: Effective Control, 32
3.3 Elimination II: Firm Size and Ownership, 34
3.4 Further Awards to Possibly Excluded Firms, 37

ix

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
  CONTENTS

4 FOCUS ON THE TOP 200 AWARD WINNERS 39

4.1 Methodology, 39
4.2 Additional Research, 40
4.3 Sequencing, 40

5 OTHER SOURCES OF DATA ON THE PARTICIPATION OF

VENTURE-OWNED FIRMS 43
5.1 Non-participant Survey, 43
5.2 NIH-identified Excluded Firms, 46
5.3 Balancing Objectives: A View from Martek’s Experience, 47

6 COMPARING PROJECT OUTCOMES 49

6.1 Caveats, 49
6.2 Respondent Pools and Response Rates, 50
6.3 Outcomes from Surveys, 52
6.4 Firm-level Outcomes from Hoover’s Small Business Database, 57
6.5 Conclusions: Outcomes from SBIR Funding, 59

7 IMPACT OF THE SBA RULING ON THE NIH SBIR PROGRAM:

FINDINGS AND RECOMMENDATIONS 61
7.1 Main Findings, 61
7.2 Recommendations, 65

APPENDIXES

A Venture-funded Firms Among the 200 Most Prolific Winners

of NIH Phase II Awards 1992-2002 71
B NRC Non-participant Survey 76
C NIH List of Firms Excluded on the Grounds of Venture
Capital Ownership 80
Copyright © 2009. National Academies Press. All rights reserved.

D Venture-funded Firms: Data from Hoover’s Small Business Database

and VentureSource 82
E Analysis of the Evidence Submitted by BIO 92
F SBA Administrative Ruling on Appeal of Cognetix, Inc. 95
G Letter from Elias A. Zerhouni, Director, National Institutes of
Health to Hector V. Barreto, Administrator, U.S. Small Business
Administration, June 28, 2005 103
H Testimony by Steven C. Preston, SBA Administrator, to the
House Small Business Committee, March 13, 2008 107
I Bibliography 112

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 Preface

Today’s knowledge-based economy is driven in large part by the nation’s

capacity to innovate. One of the defining features of the U.S. economy is a high
level of entrepreneurial activity. Entrepreneurs in the United States see opportu-
nities and are willing and able to take on risk to bring new welfare enhancing,
wealth generating technologies to the market. Yet, while innovation in areas such
as genomics, bioinformatics, and nanotechnology presents new opportunities,
converting these ideas into innovations for the market involves substantial chal-
lenges. The American capacity for innovation can be strengthened by addressing
the challenges faced by entrepreneurs. Public-private partnerships are one means
to help entrepreneurs bring new ideas to market.
The Small Business Innovation Research (SBIR) program is one of the larg-
est examples of U.S. public-private partnerships. A premise of the SBIR program
is that small businesses are an important font for new ideas, but that they likely
Copyright © 2009. National Academies Press. All rights reserved.

will need some support in their early stages as they translate these ideas into
innovative products and services for the market. Founded in 1982, SBIR is de-
signed to encourage small business to develop new processes and products and to
provide quality research in support of the many missions of the U.S. government.
By including qualified small businesses in the nation’s R&D effort, SBIR awards

 SeeLewis M. Branscomb, Kenneth P. Morse, Michael J. Roberts, and Darin Boville, Managing
Technical Risk: Understanding Private Sector Decision Making on Early Stage Technology Based
Projects, Washington, DC: Department of Commerce/National Institute of Standards and Tech­nology,
2000.
 For a summary analysis of best practice among U.S. public-private partnerships, see National

Research Council, Government-Industry Partnerships for the Development of New Technologies:

Summary Report, Charles W. Wessner, ed., Washington, DC: The National Academies Press, 2002.

xi

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 xii PREFACE

are intended to stimulate innovative new technologies to help agencies meet their
missions in many areas including health, the environment, and national defense.
Governments around the world are increasingly adopting SBIR type programs
to encourage the creation and growth of innovative firms in their economies.
Sweden and Russia have adopted SBIR-type programs. The United Kingdom’s
SIRI program is similar in concept. In the Netherlands, a successful pilot SBIR
program has led the government to expand its scope across the government.
In Asia, Japan, Korea, and Taiwan have adopted the SBIR concept as a part of
their respective national innovation strategies. And India has adopted an SBIR
type program to advance its biotechnology sector. Other countries are actively
adopting SBIR type programs. This level of emulation across national innova-
tion systems is striking and speaks to the common opportunities and challenges
addressed by SBIR awards and contracts.
As a part of the 2000 reauthorization of the SBIR program, Congress called
for a review of the SBIR programs at the Departments of Defense, the National
Institutes of Health, the Department of Energy, the National Aeronautics and
Space Administration, and the National Science Foundation.
HR 5667 directed the National Research Council (NRC) to evaluate the qual-
ity of research and value to the agency mission of the SBIR program. It called
for an assessment of the extent to which SBIR projects achieve some measure of
commercialization, as well as an evaluation of the program’s overall economic
and non-economic benefits. It also called for additional analysis as required
to support specific recommendations in areas such as measuring outcomes for
agency strategy and performance, increasing federal procurement of technologies
produced by small business, and overall improvements to the SBIR program.
These reports are being published by the National Academies Press.
While this study was still in progress, the Small Business Administration
issued a policy directive in 2002 that to be eligible for SBIR the small business
concern should be “at least 51 percent owned and controlled by one or more indi­
viduals who are citizens of, or permanent resident aliens in, the United States,
except in the case of a joint venture, where each entity to the venture must be
Copyright © 2009. National Academies Press. All rights reserved.

51 percent owned and controlled by one or more individuals who are citizens of,
or permanent resident aliens in, the United States.” The effect of this directive
has been to exclude innovative small firms in which venture capital firms have a
controlling interest from the SBIR program.
To better understand the impact of the SBA exclusion of firms receiving
venture funding (resulting in majority ownership), the NRC proposed that the
NIH study be extended to include this empirical analysis by the NRC. This report
seeks to illuminate the consequences of the SBA ruling excluding ­majority-owned
venture capital firms from participation in SBIR projects.

 Access the SBA’s 2002 SBIR Policy Directive, Section 3(y) (3) at <http://www.zyn.com/sbir/sbres/

sba-pd/pd02-S3.htm>.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 PREFACE xiii

Statement of Task
This report presents the NRC analysis of the effect of the Small ­ Business
Administration’s eligibility rules with regard to the majority-owned venture capi-
tal participation in the NIH SBIR program. Using data from SBIR awards made
from fiscal years 1992 to 2002 and with specific attention to the challenges faced
by firms in the biomedical field and employing a combination of surveys and
case studies adapted from the Methodology developed as part of the current five-
agency analysis, the NRC investigated the following questions:

• Which NIH SBIR participating companies have been or are likely to be

excluded from the program as a result of the 2002 rule change on venture capital
company ownership?
• What is the likely impact of the 2002 ruling had it been applied during
the 1992-2002 timeframe and what is its probable current impact?

Key variables include the presence and amount of SBIR support, the receipt of
venture capital funding or other outside funding, and output measures including
those related to commercialization and knowledge generation.
This consensus report contains statistical analysis, case study findings, and
also presents the NRC Committee’s findings and recommendations.

Acknowledgments
On behalf of the National Research Council, we express our appreciation
and recognition for the insights, experiences, and perspectives made available
by the participants of the overall study’s conferences and meetings, as well as
survey respondents and case study interviewees who contributed to elements of
this study. We are also very much in debt to officials from the leading departments
and agencies. Among the many who provided assistance to this complex study,
we are especially in debt to Jo Anne Goodnight, the Program Coordinator for the
Copyright © 2009. National Academies Press. All rights reserved.

National Institutes of Health SBIR program, who was instrumental in facilitating

this review of the impact of policy directive on the NIH SBIR program.
As the lead member of the Committee’s research staff, Dr. Robin Gaster
deserves major recognition for his instrumental role in the research team’s prepa-
ration of this report. Sujai Shivakumar also merits thanks for his careful review,
edits, analysis, and written contributions which were essential for the prepara-
tion of this report. Without their sustained efforts, amidst many other competing
priorities, it would not have been possible to prepare this report.

 National
Research Council, An Assessment of the Small Business Innovation Research Program—
Project Methodology, Washington, DC: The National Academies Press, 2004. Access at <http://www.
nap.edu/catalog.php?record_id=11097>.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 xiv PREFACE

National Research Council Review

This report has been reviewed in draft form by individuals chosen for their
diverse perspectives and technical expertise, in accordance with procedures ap-
proved by the National Academies’ Report Review Committee. The purpose
of this independent review is to provide candid and critical comments that will
assist the institution in making its published report as sound as possible and to
ensure that the report meets institutional standards for objectivity, evidence, and
responsiveness to the study charge. The review comments and draft manuscript
remain confidential to protect the integrity of the process.
We wish to thank the following individuals for their review of this re-
port: Richard Bendis, National Association of Seed and Venture Funds; Douglas
­Doerfler, Maxcyte Inc.; David Goldston, Harvard University; Heidi Jacobus,
Cybernet Systems; Anu Mittal, United States Government Accountability Office;
Carol Nacy, Sequella, Inc.; Michael Rodemeyer, University of Virginia; Donald
Siegel, University of Albany; Michael Squillante, Radiation Monitoring Devices,
Inc.; and Judith Tanur, Stony Brook University.
Although the reviewers listed above have provided many constructive com-
ments and suggestions, they were not asked to endorse the conclusions or recom-
mendations, nor did they see the final draft of the report before its release. The
review of this report was overseen by Robert White, Carnegie Mellon University.
Appointed by the National Academies, he was responsible for making certain that
an independent examination of this report was carried out in accordance with
institutional procedures and that all review comments were carefully considered.
Responsibility for the final content of this report rests entirely with the authoring
committee and the institution.

Jacques S. Gansler Charles W. Wessner

Copyright © 2009. National Academies Press. All rights reserved.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 Executive Summary

The Small Business Innovation Research (SBIR) program was created in

1982 through the Small Business Innovation Development Act. SBIR offers
­competition-based awards to stimulate technological innovation among small
­private-sector businesses while providing government agencies new, cost-­effective,
technical and scientific solutions to meet their diverse mission needs.” 
During the first two decades of the program, some majority venture-funded
companies participated in the program, receiving SBIR awards in conjunction
with outside equity investments. During this lengthy period, the participation of
majority venture-funded firms was not an issue. They participated in the SBIR
program throughout this period without any apparent adverse consequence for
the operation and achievements of the program.
Copyright © 2009. National Academies Press. All rights reserved.

The 2002 SBA Directive

In a 2002 directive, the Small Business Administration ruled that to be eli-
gible for SBIR the small business concern should be “at least 51 percent owned
and controlled by one or more individuals who are citizens of, or permanent
resident aliens in, the United States, except in the case of a joint venture, where
each entity to the venture must be 51 percent owned and controlled by one or
more individuals who are citizens of, or permanent resident aliens in, the United

 Asstated in the Small Business Innovation Development Act (PL 97-219), the program’s goals are
four-fold: “(1) to stimulate technological innovation; (2) to use small business to meet federal research
and development needs; (3) to foster and encourage participation by minority and disadvantaged per-
sons in technological innovation; and (4) to increase private sector commercialization derived from
Federal research and development.”

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
  VENTURE FUNDING AND THE NIH SBIR PROGRAM

States.” This new interpretation of “individuals” resulted in the denial by the

SBA Office of Hearings and Appeals of an SBIR grant in 2003 to Cognetix, a
Utah biotech company, because the company’s equity was more than 50 percent
owned by private investment firms. The ruling, issued by an Administrative Law
Judge, stated that venture capital firms were not “individuals,” i.e., “natural
persons,” and therefore SBIR agencies could not give SBIR grants to companies
in which venture capital firms had a controlling interest. The effect of this direc-
tive has thus been to exclude companies in which venture capital firms have a
controlling interest.

Divergent Claims about the Impact

of the SBA Directive
No empirical assessment of the likely impact of this new interpretation
was made before the SBA ruling was implemented. Since then, claims about
its impact have been made by both proponents and opponents, but both appear
overstated. Those who support the SBA ruling predict that eliminating the new
interpretation of the rule could lead to the participation of firms controlled by
large venture capital firms, including venture capital arms of major industrial
corporations such as General Electric or Intel, and argue that this outcome is
contrary to the mission of the SBIR program. Arguing against this position, the
National Institutes of Health, biotechnology companies, and the Biotechnology
Industry Organization (BIO) have argued that the new eligibility requirements
have a negative impact on the NIH mission and on the ability of high-technology
firms to develop and commercialize promising new biomedical technologies.

Call for an Empirical Assessment by

the National Research Council
To better understand the impact of the SBA exclusion of firms receiving ven-
ture funding (resulting in majority ownership), the NRC proposed that the NIH
Copyright © 2009. National Academies Press. All rights reserved.

study be extended to include this empirical analysis by the NRC. In particular,

 Access the SBA’s 2002 SBIR Policy Directive, Section 3(y)(3) at <http://www.zyn.com/sbir/sbres/

sba-pd/pd02-S3.htm>.
 See Appendix F.
 As the SBIR program approached its twentieth year of operation, the U.S. Congress requested the

National Research Council (NRC) of the National Academies to “conduct a comprehensive study of
how the SBIR program has stimulated technological innovation and used small businesses to meet
Federal research and development needs” and to make recommendations with respect to the SBIR
program. Mandated as a part of the SBIR reauthorization in late 2000, the NRC study has assessed the
SBIR program as administered at the five federal agencies that together make up some 96 percent of
SBIR program expenditures. The agencies, in order of program size, are the Department of Defense
(DoD), the National Institutes of Health (NIH), the National Aeronautics and Space Administration

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 EXECUTIVE SUMMARY 

this empirical analysis addresses two key questions that bear on the policy issue
at hand. These are:

• How many firms have been or are likely to be excluded by the ruling
from participation in the NIH SBIR program?
• What is the likely effect of this exclusion on these firms and on the NIH
SBIR program?

Main Conclusions of the Academies’ Study

The Academies’ study finds that between 4.1 percent and 11.9 percent of
firms that won SBIR Phase II awards from NIH between 1992 and 2002 have
been excluded, or possibly excluded, from the program because of the SBA
­ruling. (See Table 3-4.) While the evidence is narrowly based and is by no means
precise, it does also suggest that the impact of the ruling falls disproportionately
on the most promising firms—i.e., those firms that have repeatedly been selected
by both NIH for their promising technologies and by venture investors for their
commercial potential. Firms that are venture-funded are somewhat less likely to
commercialize but are much more likely to generate substantial sales from their
SBIR-funded projects when they do commercialize than are firms that receive
SBIR funds but are not venture-funded.
Restricting access to SBIR funding for firms that benefit from venture invest-
ments would thus appear to disproportionately affect some of the most commer-
cially promising small innovative firms. To this extent, the SBA ruling has the
potential to diminish the positive impact of the nation’s investments in research
and development in the biomedical area.
It is important to note that the task of identifying firms that have received ven-
ture funding is a challenge. SBIR-funded firms, which are in most cases privately
held, are not required to reveal whether they have received third-party investment.
As a result, this information is not collected and stored by SBIR-funding agencies
or SBA. Chapter 2 of this report explains the study methodology.
Copyright © 2009. National Academies Press. All rights reserved.

By selecting out some of the most commercially promising innovative small

firms, the SBA directive appears to limit opportunities to exploit the nation’s
substantial investments in research at NIH. This is contrary to one of the four key
goals of the SBIR program, which is the commercialization of federal research. 
Although the evidence is not definitive, the implementation of the SBA ruling

(NASA), the Department of Energy (DoE), and the National Science Foundation (NSF). For an over-
view report of this assessment, see National Research Council, An Assessment of the SBIR Program,
Charles W. Wessner, ed., Washington, DC: The National Academies Press, 2008.
 The goal of private-sector commercialization was moved in priority from being listed fourth when

the program was initiated in 1982 to second in the 1992 reauthorization of the SBIR program.

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  VENTURE FUNDING AND THE NIH SBIR PROGRAM

appears to be negatively affecting current participation by firms and the long-term

commercialization potential of the NIH SBIR program.
Based on the Committee’s analysis of the impact of restricting venture fund-
ing on the NIH SBIR program and its experience in the larger evaluation of SBIR
programs at five agencies, the Committee recommends that consideration should
be given either to restoring the de facto status quo ante eligibility requirements
for participation in the SBIR program or to making some other adjustment that
will permit the limited number of majority venture-funded firms with significant
commercialization potential to compete for SBIR funding.
Copyright © 2009. National Academies Press. All rights reserved.

 See the Committee’s findings in Chapter 7 of this report. the Committee has not analyzed the

impact on firms applying for SBIR grants from federal agencies other than NIH. It would be worth
examining the impact of restricting venture funding on the SBIR program at other federal agencies.
 The Committee has published separate assessments of the SBIR programs at the Department of

Defense, at the National Institutes of Health, the Department of Energy, the National Aeronautics and
Space Administration and the National Science Foundation. In addition, the Committee has published
a comprehensive overview report of the program’s operations, achievements, and challenges. See
National Research Council, An Assessment of the SBIR Program, op. cit.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 1

Introduction

1.1 SBIR and the Innovation “Valley of Death”

Created in 1982 through the Small Business Innovation Development Act,
the Small Business Innovation Research (SBIR) is the nation’s largest innovation
program. It provides competitively awarded grants to small high-technology firms
with technically sound and commercially promising but unproven ideas.  In this
way, SBIR helps small businesses bring pioneering technologies to market and
advances the missions of federal agencies.
Because new ideas are by definition unproven, the knowledge that an entre-
preneur has about his or her innovation may not be fully appreciated by prospec-
tive investors. This means that new ideas with commercial potential often do
not attract sufficient private investment. SBIR awards provide this seed capital
and a positive signal to private venture markets, helping entrepreneurs to secure
Copyright © 2009. National Academies Press. All rights reserved.

the funds needed to bring new ideas to market. The term “Valley of Death” has
come to describe the period of transition when a developing technology is deemed

 Fora comprehensive review of the concept and performance of this 25-year-old program, see
­ ational Research Council, An Assessment of the SBIR Program, Charles W. Wessner, ed., ­Washington,
N
DC: The National Academies Press, 2008.
 For an extended discussion of the empirical evidence supporting the finding of high innovation

performance of small firms, see Zoltan J. Acs and David B. Audretsch, “Innovation in Large and Small
Firms: An Empirical Analysis,” The American Economic Review, 78(4):678-690, 1988.
 Joshua Lerner, “Public Venture Capital,” in National Research Council, The Small Business

Innovation Program: Challenges and Opportunities, Charles W. Wessner, ed., Washington, DC:
National Academy Press, 1999. For a seminal paper on information asymmetry, see Michael Spence,
Market Signaling: Informational Transfer in Hiring and Related Processes, Cambridge, MA: Harvard
­University Press, 1974.

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  VENTURE FUNDING AND THE NIH SBIR PROGRAM

promising, but too new to validate its commercial potential and thereby attract
the capital necessary for its continued development.
SBIR is an important source of early-stage funding in the United States.
Although business angels and venture capital firms, along with industry, state
governments, and universities provide funding for early-stage technology de-
velopment, the federal role is significant. Overall, SBIR awards provided over
$2.3 billion in research and seed funding in 2007 to the nation’s innovative small
businesses. In comparison, private venture markets provided $1.2 billion in seed
stage funding in 2007 in the course of only 414 deals.
There are often useful synergies between angel and venture capital invest-
ments and SBIR funding. In many cases, small business entrepreneurs use SBIR
awards in close conjunction with funds from other sources, often at the most
vulnerable stages of their firm’s development. Reflecting this synergy, an initial
NRC review showed about 25 percent of the top 200 NIH Phase II award win-
ners (1992-2005) have acquired some venture funding in addition to the SBIR
awards. In addition, angel investors often find SBIR awards to be an effective
mechanism to bring a company forward in its development to the point where
risk is sufficiently diminished to justify investment.
Today, venture capital markets are retrenching as a result of the current finan-
cial crisis. Venture capital firms are undertaking fewer investments, especially at

 As the September 24, 1998, Report to Congress by the House Committee on Science notes, “At

the same time, the limited resources of the federal government, and thus the need for the govern-
ment to focus on its irreplaceable role in funding basic research, has led to a widening gap between
federally-funded basic research and industry-funded applied research and development. This gap,
which has always existed but is becoming wider and deeper, has been referred to as the ‘Valley of
Death.’ A number of mechanisms are needed to help to span this Valley and should be considered.”
See U.S. Congress, House Committee on Science, Unlocking Our Future: Toward a New National
Science Policy: A Report to Congress by the House Committee on Science, Washington, DC: U.S.
Government Printing Office, 1998. Accessed at <http://www.access.gpo.gov/congress/house/science/
cp105-b/­science105b.pdf>. For an academic analysis of the Valley of Death phenomenon, see Lewis
Branscomb and Philip Auerswald, “Valleys of Death and Darwinian Seas: Financing the Invention
Copyright © 2009. National Academies Press. All rights reserved.

to Innovation Transition in the United States,” The Journal of Technology Transfer, 28(3-4), August
2003.
 National Research Council, An Assessment of the SBIR Program at the National Institutes of

Health, Charles W. Wessner, ed., Washington, DC: The National Academies Press, 2009.
 See the presentation “The Private Equity Continuum” by Steve Weiss, Executive Committee

Chair of Coachella Valley Angel Network, at the Executive Seminar on Angel Funding, University
of California at Riverside, December 8-9, 2006, Palm Springs, CA. In a personal communication,
Weiss points out the critical contributions of SBIR to the development of companies such as Cardio-
Pulmonics. The initial Phase I and II SBIR grants allowed the company to demonstrate the potential
of their products in animal models of an intravascular oxygenator to treat acute lung infections and
thus attract angel investment and subsequently venture funding. Weiss cites this case as an example
of how the public and private sectors can collaborate in bringing new technology to markets. Steve
Weiss, Personal Communication, December 12, 2006.
 See The New York Times, “In Silicon Valley, Venture Capitalists Turn Cautious,” January 5,

2009.

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 INTRODUCTION 

BOX 1-1
How Small Biotechnology Firms Typically Use SBIR

Small biotechnology companies usually have three to five research projects

ongoing at one time. The venture capital funding that they raise is usually tied to
specific research milestones for a given project.a
SBIR often plays a key role in providing small biotechnology firms funding
for other research projects that are more early-stage and higher-risk and are,
thus, not yet attractive to venture or even angel capital investors. Such research
projects may include new alternate applications of a lead project or a completely
new ­project. Given the extraordinary high risk of biomedical product development,
SBIR provides an avenue for small companies to create a more diversified pipeline
that can be essential for the success of small biotechnology businesses.
Most small biotechnology companies do not base their business plans on the
SBIR program alone. Their goal is to raise capital in order to advance product
development to the point of becoming a publicly traded, acquired, or stand-alone
company with actual products in the market. The SBIR program is an important
part of this process, but the focus of the business model is to commercialize a
product—and to graduate out of the SBIR program.

aFor a perspective of a small innovative business, see testimony by Douglas Doerfler

of Maxcyte, Inc., before the House Committee on Small Business, January 29, 2008. For
additional perspectives on the role of SBIR in the development of innovative products and
businesses, see the case studies in National Research Council, An Assessment of the SBIR
Program, Charles W. Wessner, ed., Washington, DC: The National Academies Press, 2008.
Appendix C.

the early stage, and conserving capital to preserve existing investment portfolios.
In this environment, small innovative businesses find SBIR awards to be a stable
and less cyclical source of early-stage innovation funding. Easing, rather than
Copyright © 2009. National Academies Press. All rights reserved.

restricting access to capital is essential for economic recovery and would be con-
sistent with other actions now being taken by the federal government to address
the current economic crisis.

1.2 SBIR Program Structure

Eleven federal agencies are currently required to set aside 2.5 percent of
their extramural research and development budget exclusively for SBIR awards.
Each year these agencies identify various R&D topics, representing scientific

 See Rachel Metz, “Venture Capital Investments Fall 33 Percent in 4Q,” Associated Press, January

24, 2009.

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  VENTURE FUNDING AND THE NIH SBIR PROGRAM

BOX 1-2
Venture Capital Contraction and the
Financial Crisis of 2008-2009

“Venture investments dropped across almost all sectors in the [fourth] quarter
[of 2008] compared with the prior year. For biotechnology and medical device
industries, $1.6 million was invested in 185 companies, which is a 31 percent
decline in dollars and a 22 percent drop in deals.”

SOURCE: Rachel Metz, “Venture Capital Investments Fall 33 Percent in 4Q,” Associated
Press, January 24, 2009.

and technical problems requiring innovative solutions, for pursuit by small busi-
nesses under the SBIR program. These topics are bundled together into individual
agency “solicitations”—publicly announced requests for SBIR proposals from
interested small businesses. A small business can identify an appropriate topic it
wants to pursue from these solicitations and, in response, propose a project for an
SBIR award. At NIH, topics are treated as guidelines, and the agency does fund
projects that do not address specific topics in the solicitation.
The Small Business Administration (SBA) coordinates the SBIR program
across the federal government and is charged with directing its implementation
at all 11 participating agencies. Recognizing the broad diversity of the program’s
operations, SBA has traditionally administered the program with commendable
flexibility, allowing the agencies to operate their SBIR programs in ways that best
address their unique agency missions and cultures.
Reflecting this flexibility, the required format for submitting a proposal is
different for each agency. Proposal selection also varies, though peer review of
proposals on a competitive basis by experts in the field is typical. Each agency
Copyright © 2009. National Academies Press. All rights reserved.

then selects the proposals that are found best to meet program selection criteria,
and awards contracts or grants to the proposing small businesses.
Despite these differences, as conceived in the 1982 Act, the SBIR award-
making process is structured in three phases at all agencies:

• Phase I awards essentially fund feasibility studies in which award

­ inners undertake a limited amount of research aimed at establishing an idea’s
w
scientific and commercial promise. Today, the legislation anticipates Phase I
awards as high as $100,000. Average award size at NIH is significantly higher
(approximately $150,000).

 These higher average award sizes are possible under a blanket waiver provided to NIH by SBA.

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 INTRODUCTION 

• Phase II awards are larger—typically about $750,000—and fund more

extensive R&D to develop further the scientific and commercial promise of
research ideas. Again, average award size at NIH is significantly higher (over
$1 million).
• Phase III. During this phase, companies do not receive additional fund-
ing from the SBIR program. Instead, award recipients should be obtaining addi­
tional funds from a procurement program at the agency that made the award, from
private investors, or from the capital markets. The objective of this phase is to
move the technology from the prototype stage to the marketplace.

1.3 The NRC Assessment of SBIR at NIH

As the SBIR program approached the two decade mark in 2002, the U.S.
Congress requested that the National Research Council (NRC) of the National
Academies conduct a “comprehensive study of how the SBIR program has
stimulated technological innovation and used small businesses to meet Federal
research and development needs,” and make recommendations on improvements
to the program at the National Institutes of Health and other major agencies of
the federal government.10
Based on extensive research, a Committee of the NRC found that the NIH
SBIR program is “making significant progress in achieving the congressional
goals for the program.” It added that “the SBIR program is sound in concept and
effective in practice at NIH.”
The NRC report on the SBIR program at NIH also noted that for firms seek-
ing to capitalize on the progress made with SBIR awards, “venture funding may
be the only plausible source of funding at the levels required to take a product
into the commercial marketplace.”11
The controversy over the issue of majority venture capital funding notwith-
standing, SBIR has been a highly successful program.
Copyright © 2009. National Academies Press. All rights reserved.

1.4 THE SBA Ruling on Venture

Participation in SBIR Firms
During the first two decades of the SBIR program, majority venture-funded
companies participated in the program, receiving SBIR awards in conjunction
with outside equity investments. During this lengthy period, the participation of
majority venture-funded firms was not an issue.
In a 2002 directive, the Small Business Administration ruled that to be eli-
gible for SBIR the small business concern should be “at least 51 percent owned
and controlled by one or more individuals who are citizens of, or permanent
10 NationalResearch Council, An Assessment of the SBIR Program at the National Institutes of
Health, op. cit.
11 Ibid.

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 10 VENTURE FUNDING AND THE NIH SBIR PROGRAM

BOX 1-3
Chronology of the SBA Ruling

1982: The Small Business Innovation Development Act of 1982 creates the
SBIR Program.
2002: SBA proposes a rule to modify the ownership requirement for SBIR
awardees.
2003: (May 29) SBA Office of Hearings and Appeals denies an appeal by
Cognetix.
2003: (June 4 to July 7) The proposed SBA rule is open for public comment.
2004: (December 3) SBA publishes a Final Rule in the Federal Register.
(69FR 70180)
2005: (January 3) SBA Final Rule becomes effective.

resident aliens in, the United States, except in the case of a joint venture, where
each entity to the venture must be 51 percent owned and controlled by one or
more individuals who are citizens of, or permanent resident aliens in, the United
States.”12
During the period when SBA was developing the proposed rule, the SBA’s
Office of Hearings and Appeals received an appeal from a Cognetix, a Utah
biotechnology company that was majority venture-funded and, thus, ineligible
for the SBIR program.13 In denying the appeal, an Administrative Judge of the
SBA Office of Hearings and Appeals ruled that venture capital firms were not
“individuals,” i.e., “natural persons,” and therefore SBIR agencies could not allo­
cate SBIR awards to companies in which venture capital firms had a controlling
interest. 14 The ruling in the Cognetix case signified a change in practice, not in
law.15 In effecting this change, the SBA did not attempt to analyze the impact of
the exclusion of such firms on the operation of the SBIR program at NIH.
Copyright © 2009. National Academies Press. All rights reserved.

12 SBA Policy Directive, published in the Federal Register, September 24, 2002. Access the SBA’s 2002

SBIR Policy Directive, Section 3(y) (3) at <http://www.zyn.com/sbir/sbres/sba-pd/pd02-S3.htm>.

13 See Federal Register, Proposed Rules, 69(232), Friday, December 3, 2004.
14 In his decision, Administrative Judge Blazsik stated that “The term ‘individuals’ in 13 C.F.R. Sec-

tion 121.702(a) means only natural persons and does not include venture capital funds, pension funds,
and corporate entities for purposes of an SBIR award. Thus, a firm that is otherwise eligible for an
SBIR award is disqualified because it is less than 51 percent owned by natural persons.” Access this
decision at <http://www.sba.gov/aboutsba/sbaprograms/oha/allcases/sizecases/siz4560.txt>.
15 See statement by Administrator Steven C. Preston before the House Small Business Committee

on the Reauthorization of the Small Business Innovation Research Program, March 13, 2008. See
Appendix H of this report.

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 INTRODUCTION 11

BOX 1-4
SBA Basis for Venture Disqualification in SBIR

Why does venture firm ownership or control disqualify a firm from SBIR fund-
ing? According to the SBA ruling, there are two issues here:
Breaching the size requirement. Venture capital firms own stakes in many
companies. The 500 employee limit is measured by aggregating the size of the
applying firm, the employees of venture capital firm(s), and all the other firms in
which that limited partnership has a controlling interest.
Breaching the individual ownership requirement. SBIR firms must be
owned by individual U.S. citizens, or by a firm that is itself owned by U.S. indi-
viduals. Venture capital firms are often more than half owned by the institutional
investors who fund them, and hence in those cases these firms fail the individual
ownership test.
SBA on a regular basis aggregates venture capital investors’ other firms in
which it has not only a controlling interest but a minority interest. The SBA uses
tests such as affirmative control (majority ownership, control of board etc.) as
well as negative control which is less clearly defined and can often lead to exclu-
sion of small biotechnology companies, even if they are 51 percent owned by
individuals.

1.5 Overview of Reactions to the SBA Ruling

The administrative ruling has since generated both considerable support
and criticism.16 The claims made by advocates on both sides of this issue are
summarized below. On closer examination, many of these claims appear to be
overstated and lack compelling evidence. In reviewing these claims, it is worth
noting that the SBIR program operated successfully for over twenty years without
the benefit of this “clarification” by SBA.17 However, the impact of this ruling
will very likely change the character of the SBIR program.
Copyright © 2009. National Academies Press. All rights reserved.

Those who support the SBA ruling predict that its elimination could lead
to the participation of firms controlled by large venture capital firms, including
venture capital arms of major industrial corporations such as General Electric

16The issue of whether small businesses can participate in the SBIR program if venture firms hold

some ownership of the firm was addressed by both proponents and opponents in the congressional
hearings to renew the SBIR program. See Small Business Innovation Research Reauthorization on
the 25th Program Anniversary, Hearings before the Subcommittee on Technology and Innovation,
110th Congress, First Session, April 26, 2007, and June 25, 2007, Serial No. 110-23 and Serial 110-
43, Washington, DC: U.S. Government Printing Office, 2008. Hearings were also held by the House
Small Business Committee and the Senate Committee on Small Business and Entrepreneurship.
17The NRC Committee assessing the SBIR program found it overall to be “sound in concept and

effective in practice.” See National Research Council, An Assessment of the SBIR Program, op. cit.,
Chapter 2.

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 12 VENTURE FUNDING AND THE NIH SBIR PROGRAM

or Intel, and argue that this outcome is contrary to the mission of the SBIR pro-
gram.18 Arguing against this position, the National Institutes of Health and many
biotechnology companies have argued that the new eligibility requirements have
a negative impact on the NIH mission and on the ability of high technology firms
to develop and commercialize promising new biomedical technologies.

Supporters of the Ruling Foresee a Negative Impact on the SBIR Program

from Participation by Majority Venture-funded Small Businesses
Supporters of the SBA ruling argue that the SBA ruling is needed to prevent
large venture capital firms and corporate venture firms from exploiting the SBIR
program for their benefit to the detriment of the SBIR mission.19 They claim that
the ruling is necessary on a variety of grounds. These include financial need, the
risk of crowding out, and the attraction of firms backed by corporate venture capi-
tal to the program, especially as “super-sized” awards become more prevalent. 20
Key arguments made by supporters of the SBA ruling are listed below:

• Firms that have venture funding do not need SBIR.

Venture-funded firms have access to the capital and resources they
need; so scarce SBIR resources should be focused on the firms that
cannot or have not obtained venture funding and are therefore most
in need these resources.21
• Venture-funded firms “crowd out” deserving small firms.
Venture-funded firms have more resources and are likely to be in a
better position to apply for SBIR awards, so they could “crowd out”
deserving firms that are not venture-funded.22
• Venture-funded firms have unfair advantages in the application
process, so that these firms will be able to capture a disproportionate role in
the program because of their superior resources.
These resource rich firms will be able to submit better prepared appli­
cations to the SBIR agencies.
Copyright © 2009. National Academies Press. All rights reserved.

As a result, their applications will be seen to be superior and hence

selected by the eleven different agencies that participate in SBIR. 23

18 See, for example, testimony by Mr. Robert N. Schmidt at the April 26, 2007, hearing before the
House Subcommittee on Technology and Innovation.
19 See testimony of Jere Glover, Executive Director, SBTC, before the Subcommittee on Rural

Enterprise, Agriculture and Technology Policy, House Small Business Committee, July 27, 2005.
20 Super-sized awards are actually on the decline.
21 Ibid.
22 See testimony of Michael Squillante of RMD, Inc., before the Senate Committee on Small Busi-

ness and Entrepreneurship, July 12, 2006.

23 See, for example, testimony by Robert N. Schmidt on April 26, 2007 before the Subcommittee

on Technology and Innovation of the House Committee on Science and Technology. In his testimony,
Mr. Schmidt noted that “Thanks to their deep-pocket backing, the companies that the VCs fund will

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 INTRODUCTION 13

• Corporate venture capital can capitalize on SBIR grants.

Large corporations that have set up venture capital arms can use small
firms they control to apply for SBIR. This would have the effect sub-
sidizing large firms, which is not the objective of the legislation that
established the SBIR program.24
The large grants made on occasion by the NIH SBIR program are likely
to motivate large venture capital firms to apply for SBIR awards.25
• Venture capital capture of the SBIR program will change the char-
acter of the SBIR program to its detriment by:26
Shifting the program toward lower-risk technologies that are closer
to the market;
Increasing the geographic concentration of the program (in states
like California and Massachusetts, where venture capitalists are most
active);
Changing the profile of successful and unsuccessful SBIR companies;
and
Leading to calls for a further change in the SBIR rules—for ex-
ample, to allow large institutions such as universities to own SBIR
companies.

Whatever the merit of these observations, and these impacts remain to be

documented, it remains the case that the predicted capture of the program by ven-
ture capital did not take place over the twenty years that the restrictions on major-
ity venture-funded firms were not in place (or were not enforced.)27 It remains
possible, however, that changing patterns of awards, especially significantly
larger awards, could change the level of participation of venture-funded firms.

be able to submit multiple proposals per solicitation. They won’t necessarily be more life-­saving,
but they will be more polished. They will also have features that do well under NIH’s scoring
­system—like impressive looking ‘teams’ and extensive preliminary research. It costs money to submit
multiple proposals, to make them polished, to keep impressive teams on hold until an award decision
Copyright © 2009. National Academies Press. All rights reserved.

is reached, and to conduct preliminary research. That is exactly where large VC-backed companies
will have the edge.”
24 In 2000, at the peak of the Internet bubble, more than $100 billion in venture capital was dis-

bursed, of which about 20 percent was from corporations. See Joseph A. LiPuma, “Corporate Venture
and the Intensity of Portfolio Companies,” Small Business Research Summary, No. 306, June 2007.
Access at <http://www.sba.gov/advo/research/rs306tot.pdf>. This participation ebbs and flows with
the size of the venture capital market. See Hank Chesbrough and Christopher Tucci, “Corporate
Venture Capital in the Context of Corporate Innovation,” DRUID Summer Conference, 2004. More
recently, Venture Capital funding has been level at about $28 billion in 2007.
25 See testimony of Michael Squillante of RMD, Inc., before the Senate Committee on Small Busi-

ness and Entrepreneurship, July 12, 2006.

26 See testimony of Jere Glover, Executive Director, SBTC, before the Subcommittee on Rural

Enterprise, Agriculture and Technology Policy, House Small Business Committee, July 27, 2005.
27 See National Research Council, An Assessment of SBIR at the National Institutes of Health, op.

cit., Chapter 2, Finding G on “Venture Funding and SBIR.”

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 14 VENTURE FUNDING AND THE NIH SBIR PROGRAM

BOX 1-5
Characteristics of Majority-owned Venture-
funded and Non-venture-funded SBIR Firms

Captured below are some expected general differences between SBIR firms
that have secured venture funding and those that have not secured venture fund-
ing. Making such analytical distinctions sharpens the unique feature of each. In
practice, however, these distinctions may not be as distinct.
Financial constraints. Businesses that receive venture capital support are
often believed to face fewer financial constraints than non-venture-funded firms.
This support is thought to give venture-funded firms greater resources in:

• Proposal preparation.
• Supporting complementary research and development.
• Filing patents and protecting their intellectual property.
• Identifying and assessing market opportunities.
• Gaining access to business strategy experts.
• Purchasing technical and marketing consulting and advisory board services.
• Affording larger scale commercialization activities and capabilities.

Focus on high returns. Venture-funded firms are expected to “swing for the
fences” more of the time. In other words, we would expect venture capitalists
to identify and fund firms that are working on technologies with large market
potential. By comparison, non-venture-funded firms are more likely to work on
technologies that, while important, are not seen to have market potentials that are
as large. While some technologies may address specific and important mission
needs of a sponsoring agency, they may have a smaller potential for widespread
commercialization.
Possible selection effects. Given these advantages and focus, it is possible
that venture-funded firms are more likely to identify and seek to win competitions
for SBIR topics with high commercialization potential topics than non-venture-
funded firms.
Copyright © 2009. National Academies Press. All rights reserved.

Critics of the SBA Ruling Predict That It Will Deter Small

Business Innovation, Especially in Biomedicine
Critics of the SBA ruling believe that the ruling does not take proper account
of the real world challenges of financing early-state funding in innovation re-
search, especially the high risk and long horizon needs of biomedical research.

Impact on the NIH Mission

Perhaps most telling is the criticism of this ruling by the leadership of the
National Institutes of Health. In a letter to the Small Business Administration,

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 INTRODUCTION 15

Dr. Elias A. Zerhouni, then the NIH director, noted the new eligibility rules
“unduly restrict the ability of the National Institutes of Health (NIH) fund high
quality, small companies that receive venture capital (VC) investment.” 28 This,
he claimed, will have a negative impact on the mission of the National Institutes
of Health and on the goals of the SBIR program.

Impact on Small Biotechnology Firms

Some high technology industries, notably the biotechnology industry, and
representatives of the venture capital community have also expressed dismay at
this ruling, calling it a new interpretation of the venture capital-small business
relationship by SBA.29 The Biotechnology Industry Organization (BIO) and the
National Venture Capital Association (NVCA), as well as some individual biotech
firms, have testified before congressional committees against the new interpreta-
tion.30 Criticisms of the SBA ruling center on the following arguments:

• The ruling does not take into account the realities of biotechnology
research.
The scale of biotechnology research calls for multiple sources of
funding. For firms seeking to capitalize on the progress made with
SBIR awards, venture funding may be the only plausible source of
funding at the levels required to take some products into the com-
mercial marketplace. It can take several hundred million dollars and
an average of eight years to develop a drug from concept through to

28 See Dr. Zerhouni’s letter to H. Barreto, Small Business Administration, June 28, 2005. See Ap-

pendix G.
29 See National Venture Capital Association, “NVCA Supports Clarifications to SBIR Eligibility

Requirements,” November 9, 2005. Access at <http://www.nvca.org/policy.html>. Mark Heesen,

president of the National Venture has noted that “by eliminating venture-backed companies from the
Copyright © 2009. National Academies Press. All rights reserved.

pool of SBIR applicants, the SBA is effectively dismissing the most promising organizations—ones
that have been vetted by professionals and have the most chance of succeeding as viable, ongoing
businesses. The current dynamic is now hobbling young companies across the country, particularly
in the life sciences sector, where the cost and time associated with bringing a discovery to market
is colossal.”
30 See, for example, testimony by Thomas Bigger of Paratek Pharmaceuticals before the U.S. Sen-

ate Small Business Committee, July 12, 2006. See the statements by Ron Cohen, CEO of Acorda
Technologies, and Carol Nacy, CEO of Sequella, Inc., at the House Science Committee Hearing on
“Small Business Innovation Research: What is the Optimal Role of Venture Capital,” July 28, 2005.
Dr. Nacy’s testimony captures the multiple sources of finance for the 17-person company (June 2005).
They included—founder equity investments; angel investments; and multiple, competitive scientific
research grants, including SBIR funding for diagnostics devices, vaccines, and drugs. SBIR funding
was some $6.5 million out of a total of $18 million in company funding. Dr. Nacy argues that SBIR
funding focuses on research to identify new products while venture funding is employed for product
development.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
 16 VENTURE FUNDING AND THE NIH SBIR PROGRAM

the market.31 In the absence of product revenue, biotechnology firms

are almost entirely reliant on capital markets and other sources of
financing during this period. As a result, biotechnology companies
often seek venture investment to push products towards the market
while relying on grants, e.g., SBIR as funding sources, to fund their
early-stage, high-risk research and development.32
Small biotechnology companies must often develop multiple lines
of research. Representatives of small biotechnology companies point
out that sustaining multiple lines of research is necessary for an in-
novative small business to diversify its risks. The venture capital
funding raised by a small business to support its lead product is often
tied closely to milestones in that product’s development.33 In order to
develop secondary or tertiary candidates or therapies, a company has
to find secondary sources of capital. SBIR grants can and do play an
instrumental role in supporting projects at the very earliest stages of
development.34
• The SBA ruling is based on a misunderstanding of the roles and
objectives of venture funding.
Venture capital does not focus on very early-stage funding. It is this
type of activity that the SBIR program has historically supported in
the past. Venture capital dollars are normally applied later in the life
cycle, and are used to bring promising discoveries to market.35
SBIR and venture funding address the needs of small businesses at
different stages of the innovation process. And as noted, small inno-
vative businesses often have multiple projects in their development
31 See, for example, testimony by Gary McGarrity , a member of BIO, on April 26, 2007, before the
Subcommittee on Technology and Innovation of the House Committee on Science and Technology.
Dr. McGarrity noted in his testimony that “Promising biotechnology research has a long, arduous
road from preclinical research, through Phase I, safety, Phase II, efficacy, and Phase III broader
population clinical trials, and ultimately to FDA approval of a therapy. It is estimated that it takes
97.7 months, or 8 years to bring a biotechnology therapy to market and costs between $800 million
Copyright © 2009. National Academies Press. All rights reserved.

and $1.2 billion. For the majority of biotechnology companies that are without any product revenue,
the significant capital requirements necessitate fundraising through a combination of angel investors
and venture capital firms. The role and importance of private equity fundraising in the biotechnology
industry cannot be understated.”
32 See testimony by Douglas Doerfler of Maxcyte, Inc., before the House Committee on Small

Business, January 29, 2008.

33 See testimony by Mark G. Heeson of the National Venture Capital Association before the House

Committee on Small Business, March 13, 2008.

34 See testimony by James C. Greenwood, President of BIO, before the House Committee on Small

Business, March 13, 2008.

35 See testimony by Mark G. Heeson of the National Venture Capital Association before the House

Committee on Small Business, March 13, 2008. For a comparison of the trajectories of venture-funded
firms with those without venture funding, see Manju Puri and Rebecca Zarutskie, “On the Lifecycle
Dynamics of Venture-Capital- and Non-Venture-Capital-Financed Firms,” EFA 2007 Ljubljana Meet-
ings Paper, June 2007, available at SSRN: <http://ssrn.com/abstract=967841>.

Venture Funding and the NIH SBIR Program, National Academies Press, 2009. ProQuest Ebook Central,
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LETTER

Ireland
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