To grow innovative small businesses, reform America’s seed fund

The U.S. economy depends on small companies that grow big. Companies such as Symantec, 23andMe, and Qualcomm have helped create new industries virtually from scratch over the past 40 years.

But to realize their full potential, small start-ups must cross the so-called “valley of death” — that precarious stage when their technologies are not yet perfected, investors are still skittish, and customers are scarce.

There is a federal program devoted to helping them make this passage: the Small Business Innovation Research (SBIR) program. But unless Congress strengthens SBIR, future Symantecs, 23andMes, and Qualcomms may fail to take off in the first place. Lawmakers must reform SBIR so it better embodies its slogan of “America’s Seed Fund.”

SBIR requires federal agencies with large research budgets to set aside about 3 percent of their extramural research expenditures for small businesses. Over the past 35 years, the program has provided billions of dollars in early stage funding to thousands of companies—including the three mentioned above — that went on to generate 70,000 patents, launch nearly 700 initial public offerings, and garner approximately $41 billion in follow-on private investment. In addition to driving economic growth, these SBIR-funded small businesses have helped to tackle some of the nation’s greatest challenges, including health care, national security, and environmental protection.

Yet despite its track record of success, the SBIR program is overdue for reform for two reasons.

First, the program often funds companies that have no ambition to grow. Some companies come back to SBIR time and again, relying on recurring contracts to stay alive. If they were to grow, they might no longer be eligible. Nearly 20 percent of all major SBIR awards have gone to companies that have obtained 50 or more such awards. Research shows that the companies that receive multiple SBIR awards produce fewer patents and are less likely to commercialize their work. In other words, these companies offer little bang for SBIR’s buck.  Oftentimes, the only reason these companies receive funding is because Congress puts its thumb on the scale by telling agencies that they must buy R&D services from small companies.

To be sure, some agencies, such as the National Science Foundation, prioritize building strong businesses and only fund awardees once or twice. But others, such as the Department of Defense and Department of Energy, frequently fund companies multiple times, in part because they have highly specialized agency missions and the SBIR law requires them to fund small firms, even if they are not the best fit for agencies’ R&D needs.

Second, there are a lot of companies that want to grow and could make better use of SBIR funds. Unfortunately, the “valley of death” is getting wider, while venture capital (VC), the largest source of private funding for high-risk, high-reward start-ups, is getting harder to obtain. That’s because VC funding increasingly concentrates on a small number of industries, flows overseas, and tilts toward more mature companies. Crunchbase News reports that VC deals under $1 million, an appropriate size for most SBIR applicants, declined by half from 2014 to 2018, even though the overall pool of VC funding has increased. That’s the gap that SBIR should fill.

Congressional action should refocus SBIR on the most promising growth opportunities.

To address the problem of repeat awardees, Congress should lower the SBIR set-aside percentage by half (from 3.2 percent to around 1.6 percent) for agencies that continue to fund high numbers of repeat awards, and let agencies make their own choices about what kinds of firms best serve their needs. SBIR should focus on funding innovative companies once or twice, and agencies could spend the newly freed-up funds on whatever companies, big or small, provide the best value.

Small businesses aren’t inherently better at research. In fact, small firms are less productive on average, and they pay lower wages. A small business set-aside program should focus on the unique opportunities and challenges that small businesses face, specifically their high growth potential and need for public funding to mature. If agencies want to keep their original set-aside percentage they should be able to do so as long as they focus on funding new small companies with a small number of awards. But otherwise, they should be allowed to have a lower set-aside.

In addition to lowering the set-aside for some agencies to give them more flexibility in extramural R&D, Congress also should pass the Research Advancing to Market Production (RAMP) for Innovators Act H.R.3839/S.2127 in order to sharpen the program’s focus on promoting viable companies. Introduced in July, this bipartisan, bicameral legislation would empower agencies to select and support companies with high growth potential. While it does not address the issue of SBIR set-asides, it does include reforms that would require agencies to prioritize commercialization potential in funding decisions, permit awardees to use a portion of awards for non-research activities that support commercialization, mandate data collection around companies’ commercialization efforts, and strengthen linkages among awardees and the U.S. Patent Office.

The United States needs more innovative, growth-oriented small businesses to help solve some of our most pressing national challenges. If SBIR were to truly become “America’s Seed Fund,” more small businesses would be given the chance to create the industries of tomorrow.

NOTE: This post has been updated from the original to add Symantec in the first and third paragraphs; it replaces a company erroneously listed as having participated in the SBIR program.

Robert Rozansky (@rob_rozansky) is a senior policy analyst focusing on clean energy innovation at the Information Technology and Innovation Foundation (ITIF), the leading think tank for science and technology policy. Robert D. Atkinson (@RobAtkinsonITIF) is ITIF’s president.