Federal aid for small-business R&D is getting smarter, but remains … – Niskanen Center

In September, Congress reauthorized the Small Business Innovation Research (SBIR) program through 2025. The three-year extension was the result of bipartisan negotiation that aimed to curb abuse of the program, address national security concerns, and increase small-business innovation leading to commercialization.
The SBIR program requires federal agencies with R&D budgets exceeding $100 million to allocate 3.2 percent of their research budgets to awards and contracts for small businesses. Since its establishment in 1982, SBIR has distributed over $40 billion dollars through competitive awards and contracts to young companies engaged in early-stage research and development, helping to commercialize new technologies while meeting specific federal R&D needs. 
However, as the program marks its 40th anniversary, funding for entrepreneurs has increasingly been funneled to firms that don’t intend to produce commercial products. 
SBIR “mills” were a major point of contention going into reauthorization. Mills are firms that specialize in writing SBIR grant applications, often submitting hundreds of applications every award cycle. Winning early-phase awards for basic research and feasibility studies allows mills to bring in short-term revenue while rarely, if ever, commercializing a product. Rand Paul, the ranking member of the Senate Small Business and Entrepreneurship Committee, refused to reauthorize SBIR without action on this issue.  
As we noted over the summer, SBIR mills capture a disturbingly high share of total awards, undermining the program’s role as a springboard for genuine startups. In our piece, we argued that the simplest and more direct way to curb SBIR mills was to impose a lifetime cap on the number of awards a single business could win. It is not uncommon for an SBIR awardee to be engaged in multistage research that requires multiple awards and many years of work to achieve a viable product. There is no sound justification, however, for allowing a single firm to receive dozens or even hundreds of Phase I awards over the span of decades.
Such firms are largely the result of weak oversight. Often, federally-funded academic centers and federal R&D facilities will use SBIR grants to farm out in-house R&D to friendly contractors. In this way, agencies skirt their mandated set-aside and divert SBIR funding towards projects that are not truly going to a “new” enterprise. Geographic proximity is key to building relationships and winning contracts, which is why mills cluster around federal R&D facilities.  The complexity and competitiveness of SBIR awards itself creates an incentive for mills to form as sophisticated intermediaries. The merit of a business idea is thus diminished relative to having the right contacts and experience navigating the application process. 
A hard cap on lifetime awards would eliminate mills as a business model, and with the added virtue of being straightforward to enforce. Unable to turn to the same handful of companies year over year, federal agencies would be forced to invest in identifying companies with bona fide commercial potential. The pool of available awards would also open up significantly, reducing administrative burdens while enhancing access to less established firms.
Instead, the reauthorization strengthens performance benchmarks to curb mills. This sounds great in theory, but a closer look reveals the new benchmarks amount to a slap on the wrist with no significant consequences for failing to comply. As shown in the table below, multiple award winners (MAWs) will now face stricter reporting requirements. The transition ratio is the number of awards-to-companies that moved from Phase I to Phase II, as SBIR intended. The commercialization ratio is the number of companies that moved from Phase II into full commercialization. 
Under the new benchmarks, firms must commercialize products during the investment period (in the window that they’re receiving money from the government). Under the old benchmarks, firms were not required to move towards commercialization as they received funding. Firms could win Phase I funding, and go on to win Phase II funding without demonstrating progress towards commercialization. This lax oversight led SBIR mills to exploit both Phase I and Phase II constantly. 
The measure of commercialization success was expanded beyond just patents to include a reasonable amount of follow-on contracts, sales, or investment. This will hopefully curb patent-filing abuse and help filter for firms engaged in actual commercial activity. 

Unfortunately, the penalties for failing to comply with the new benchmarks amount to a slap on the wrist. Firms that fail to meet the new performance standards are subject to a cap on the number of SBIR awards they can earn the next year. A firm that fails to meet performance standards cannot receive more than 20 Phase I/Direct to Phase II awards per agency. In principle, a firm could still receive 100 Phase 1 awards in a given year by soliciting 20 awards from five different agencies. This is quite feasible in the defense space, where firms routinely get separate awards from the armed services (Army, Navy, and ) and multiple other defense agencies, like the Defense Advanced Research Projects Agency and U.S. Special Operations Command. The effectiveness of these new benchmarks is dubious given such large workarounds.
The Small Business Administration (SBA) is tasked with ensuring firms comply with the enhanced performance standards, and must submit a list of firms that failed to meet the new benchmarks to Congress every year. In addition, the SBA Inspector General must audit the firms that failed to meet the new benchmarks to ensure they pursue compliance. However, there is no clear consequence for continued failure to comply. Taken together, these reforms are a step in the right direction but insufficient to properly tackle SBIR mills. A lifetime cap on awards, even if set quite high, is still needed as a guardrail against the small number of mills that drive the lion’s share of abuse. 
Notably, a Government Accountability Office study on MAWs was also mandated. GAO must evaluate the effectiveness of the new benchmarks at promoting commercialization and their impact on seeding new entrants and technologies. Collecting this data is a critical step in building the evidence needed to motivate efforts to curb SBIR mills in the future.
The reauthorization strengthened SBIR’s role in promoting commercialization in a number of smaller ways as well: 
National security concerns also featured prominently in the debate around SBIR’s reauthorization after a Pentagon report on China exploiting the program. As the Wall Street Journal explained earlier this year: 
The April 2021 report, which has been circulating among lawmakers on Capitol Hill, details eight case studies it says have “national and economic security implications.” The studies include examples of program participants who dissolve their American companies, join Chinese government talent programs and continue their work at institutions that support the People’s Liberation Army, the armed wing of the Communist Party.
The report also documents instances of SBIR recipients taking venture-capital money from Chinese state-owned firms and of working with Chinese entities that support the country’s defense industry. The report concludes that the SBIR program needs a due-diligence process to identify entities of potential concern that would then receive a more detailed review.
As part of the reforms, agencies participating in the SBIR program are now required to vet applicants for a range of ties to hostile nations, including China, North Korea, Russia, and Iran. SBIR applicants must disclose foreign connections, including: 
SBIR awards will now be denied to firms considered a national security risk. Additionally, the onus is on agencies to recover funding awarded to businesses that have a post-award change in ownership or structure that is deemed to be a national security risk. A subset of agencies (the Defense, Energy, and Health and Human Services Departments and the National Institutes of Health and National Science Foundation) must further submit a report to Congress identifying malign foreign influence in their SBIR/Small Business Technology Transfer (STTR) programs and related national security risks. 
On the positive side, the SBIR and STTR Extension Act of 2022 demonstrates that lawmakers were aware of the need to reform the SBIR program. Tougher performance benchmarks, stronger national security oversight, and increased focus on commercializing products will help the program fulfill its core mission. Unfortunately, the weak penalties for misusing the SBIR program are unlikely to curtail the SBIR mills’ worst abusers. At best, the measures contained in this legislation provide a starting point for further action on SBIR mills. Congressional data collection is a critical step to document abuses and build support for curbing SBIR mills in future legislation. With the next reauthorization only three years away, opportunities for Congress to strengthen the SBIR program are just around the corner.

Photo credit: iStock


Related Articles

Leave a Reply

Your email address will not be published. Required fields are marked *

Back to top button