I was pleased to have Ben Van Roo on the Acquisition Talk podcast to discuss his recent blog posts on the Small Business Innovation Research (SBIR) program and potential reforms. The SBIR program was created in 1982 and is currently funded with 3.2 percent of extramural R&D performed by larger agencies. Coming from a founder and VC perspective, the question Ben asked was whether it was worthwhile for an emerging tech company to pursue SBIR funding at all.
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While it is sometimes call “America’s Seed Fund,” Ben found that some companies will each receive tens of millions in SBIR awards year after year. These firms, sometimes called “SBIR mills,” have by-and-large failed to receive significant DoD follow on contracts, indicating a failure to commercialize. The top 25 firms won $1.5 billion in SBIR awards over a six year period, or more than 20 percent of the SBIR total. Overall, Ben finds that perhaps 50-60 percent of all SBIR funding will go to incumbent firms that have sophisticated proposal writing functions.
Another 20 to 30 percent of SBIR funding goes towards firms that use third-party consultants to write their proposals. These consulting firms often employ former procurement officials who can help navigate difficult parts like large, open-ended cost volumes. This is where you’ll hear “pay to play” in the SBIR world. Ben’s rough estimates for these services are $3,000 to $6,000 per month, and there may be different fee structures where the consultants can receive some equity in the company or a fraction of the award if successful.
That means between 10 and 30 percent of SBIR funding is up for grabs to emerging tech companies, meaning that their likelihood to win is relatively low. While SBIR may be one of the most accessible programs to get into the defense industry, it is not one designed to transition dual-use tech firms into fielded capabilities. Ben notes that comparatively few firms that received DIU or In-Q-Tel funding also won SBIR awards, perhaps because they were more focused on growth opportunities of companies that are already commercializing (Series B or Series C).
What is SBIR For?
This outcome is perhaps not surprising considering all the different views on basic purpose of SBIR. As Ben explained, the one constant he discovered from stakeholders was that SBIR means something different to everyone:
Some people think SBIR is fundamental research, basically you’re augmenting the national labs. Some people think the goal of SBIR is to protect the American manufacturing base or the defense manufacturing base. Some people think it’s look ways to see early technologies. Some people really think it’s about transitioning dual-use technologies. And then some people think this is discretionary funds that the MAJCOMs are going to use.
Perhaps the marketing by AFWERX and a few other organizations had tried to rebrand their own allocation of SBIR to be more about dual-use transition when others did not. However, Ben found that VCs don’t like seeing too many SBIRs being won by a company because its a “false signal” — they aren’t actually commercializing. Even if your view is that SBIR is just a jobs program, should the funding go into firms that remain in a stasis around 100-200 people, or into companies that grow into thousands of employees?
Commercialization is important because it is shows that value is being generated for the customer. If the SBIR mills were generating value for their customers, one might expect them to receive high valuations when they get bought up by a larger company. However, Ben finds that a company like Luna, which received more than $200 million in SBIR over the years (representing 68% of their total DoD business) sold their labs division for about $20 million. That’s about the same as their annual SBIR awards, meaning they did not receive a large valuation that indicated potential growth and profitability from all the SBIR projects. “If they sold for a billion dollars,” Ben said, “OK, clearly they were doing somethings really well. But they’re not.”
What to do?
Ben offers a number of recommendations in his blog posts. One idea is to limit the ability of companies to win too many SBIR awards with an 8/4/2 concept. In other words, a single company could win up to eight SBIR Phase I awards, up to four SBIR Phase II, and up to two SBIR Phase II-and-a-half (e.g., AFWERX STRATFI/TACFI that can be $10 million or more). Those limits are for a single year, not over the company’s life. If this policy were implemented, he found that about $200 million a year would be freed up for other companies.
Ben also recommends doubling down on the idea of SBIR as a mechanism for transitioning emerging tech firms. By culling some awards from SBIR mills, these funds could go towards more of these SBIR II-and-a-half awards that provide more significant support to bridge the “valley of death.” The Agile Procurement Transition (APFIT) fund in FY2022 awarded 10 firms $10 million each, but rather than have some special fund on the side that may draw skepticism from oversight, why not fund these efforts organically through SBIR?
Another place to scrap up SBIR funds for more significant Phase II or II-and-a-half efforts is by potentially killing SBIR Phase I. While SBIR Phase II awards are generally $750,000 to $1.8 million or so, SBIR Phase I are just $50,000 to maybe $250,000. Not only are Phase Is small, they generate an enormous number of proposals and awards. There’s so many, in fact, the government doesn’t have the resources to evaluate them closely. Ben has heard of “dirty rumors” that a lot of people are matrixed in to do really quick reviews. You can check out all of Ben’s recommendations on his blog posts (Part one, two, and three).
Legislative proposals
As the SBIR program heads toward reauthorization, certain congress members have been looking at these issues. The Small Business Committees made three proposals to restrict eligibility of SBIR awardees: (1) based on total number of awards received from inception; (2) based on number of awards over five-year period; and (3) based on enhanced requirements with existing Phase I to Phase II transition rates and other benchmarks.
USD A&S Bill LaPlante and USD R&E Heidi Shyu wrote a joint letter expressing their concerns that the changes could jettison 47 to 95 percent of current SBIR awardees. The second proposal, a cap on awards over five-years, was cited as the “most severe” and impacted 95 percent of small businesses. Ben, however, argues that if companies cannot commercialize over a three-to-five year window, then they are “addicted to the sugar” of SBIR dollars. That is a very different conclusion than the positive spin a 2019 DoD report put on SBIR, finding a 22-to-1 return on investment. Perhaps SBIR efforts go after more deep-tech ideas that simply take longer to commercialize, so coming back to the trough isn’t necessarily a bad thing. That 2019 report was too light on methodological details for me to make heads or tails from it.
Thanks Ben!
I’d like to than Ben Van Roo for joining me on the Acquisition Talk podcast. You can find him on LinkedIn and follow him on Twitter @DavidNorthStar. Be sure to read all three of his blog posts at his Substack, Leave it to BVR – Defense, AI, Policy. You can see a nice interview with Ben on YouTube, and read the various reports he authored and co-authored at RAND.
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