An Early Investor’s Primer on SBIR Grants
Championed as an excellent source of non-diluting capital, the funding mechanism carries a risk of decelerating and distracting teams on the way to market.
Small Business Innovation and Research grants — and their kin Small Business Technology Transfer grants — are commonly encountered in the financials of very early life science and deep-tech companies.
Early investors from time to time consider backing companies that have previously received these awards. At other times, a company’s future fundraising may rely on the receipt of an SBIR award.
These federally administered grants are financially non-dilutive, making them attractive to founding teams. They provide working capital to small companies without an expectation of payback or exchange for equity. Furthermore, the awards are highly competitive. Receipt of an SBIR award is a signal to investors that a company, at least from a technical perspective, may deserve a closer look.
But not all that glitters is gold
Pursuing these grants may take a company’s eyes off more crucial objectives such as product-market-fit and engagement of early users and strategic partners. This risk is heightened by an evaluation process that primarily engages experts who are accustomed to reviewing more purely scientific, non-commercial proposals. As reviewers are not often customers or follow-on investors, neither their approval nor rejection may shed much light on a business’s fitness. Compounding these matters is the slow pace of decision-making within the federal government. The price paid for non-dilution may be an 18-month delay in much-needed capital.
To cut to the chase, I’ll start with the big idea:
If you’re engaging a company that’s received previous SBIR funding, great! Just be sure you understand what that success does and does not signify about the opportunity. Proposing something a reviewer wants is not necessarily the same as proposing something a customer wants.
If you are engaging a company that is planning on SBIR funding as part of their fundraising plan going forward, proceed with caution and coach them accordingly. The likelihood of success is low, delays in award decisions easily extend beyond a year, and the review process is more closely related to academic scientific review than investor diligence. Thus there’s risk of both deceleration and distraction from key business goals.
In this post, I’ll review the SBIR program from the standpoint of an early-stage investor, and how I think about these awards when they come up. For additional background, you may want to refer to my recent post on Bioeconomy.XYZ that discusses the SBIR program from the standpoint of economic development and the national research enterprise.
America’s Biggest Biotech Angel
The NIH’s Billion Dollar Annual Boost to US Biotech Ecosystems
History of the Program and Types of Awards
The SBIR program was created by the Small Business Innovation Development Act in 1982. The stated goals of the legislation were four-fold:
- To stimulate technological innovation;
- To increase small business’s contribution to federal research and development goals;
- To foster and encourage participation by minority and disadvantaged persons in the nation’s technological innovation enterprise; and
- Increase private-sector commercialization of innovations derived from federal R&D spending.
Commercialization of new technology was viewed by Congress as comprised of three phases, progressing from confirming technical feasibility (Phase I), through assessment of commercial potential (Phase II), and finally, market-entry (Phase III). The SBIR program was developed to address unmet needs in Phases I and II. Securing capital for Phase III was considered the responsibility of the small business and is not supported by SBIR-related federal grants.
Any federal agency that provides more than $100m in annual R&D grants is required to participate. These are listed in Figure 1. My perspective here will be on the NIH process, the agency with which I have the most first-hand experience.
Dollar Amounts and Inflation Adjustment
An SBIR grant can be thought of as a milestone-gated, two-tranche vehicle in which the second tranche is usually not received. Phase I supports demonstrating technical feasibility. If this is accomplished, recipients can apply for an additional tranche, ‘Phase II’ funding. Phase I grants support 6-month projects and currently have a ‘soft’ cap of $259, 216. Phase II awards may support additional work for as much as 2 additional years, and typically don’t exceed $1,730,751, or $865,375 annually. For both phases, special exceptions are made fairly often for larger budgets.
Of note, recently there have been modifications to the structure of SBIR awards, with a ‘fast track’ mechanism allowing Phase I and II proposals to be reviewed concurrently and an ‘IIb’ award to provide ongoing funding to promising Phase II-funded efforts.
In Figure 2, I plot the award size for every Phase I and II award from the NIH since 2000, as well as a fitted trend line for both types of grants. The upper panels plot the current value of each award. In the lower panels, I’ve plotted the same data in FY2000-constant, BRDPI-adjusted USD. The cost of research suffers greater inflation than consumer goods as reflected by the Consumer Price Index (CPI). Usefully, the NIH tracks a separate inflation measure, the Biomedical Research and Development Price Index (BRDPI), which is usually ~ 2x the CPI. As you can see, the NIH has done a good job of holding the awards steady against inflation.
Application Review, Reviewer Perspective, and Time-to-Award
At the NIH, SBIR applications are accepted on three submission deadlines each year. Each application is assigned to an initial review panel (i.e., a ‘study section’) possessing the necessary, primarily technical, expertise to score the grant. A first review occurs several months after submission, after which a series of administrative processes determine if an award will be granted. In most cases, the NIH encourages applicants of rejected grants to re-apply after taking into consideration comments from the first review.
From my perspective, interpreting an SBIR grant acceptance or rejection requires understanding who the reviewers were that evaluated the proposal.
Primarily, SBIR reviewers come from academia. Start-ups and larger companies are represented less frequently, and investor representation on a panel may be unheard of.
To provide a sense of the composition of SBIR review panels within the NIH, I looked at the most recent reviewer rosters of 5 randomly sampled panels as reported by the NIH’s Center for Scientific Review. I classified each member (of a typically~ 20 person panel) as representing either academia, a publicly-traded company, a start-up that had not yet received a venture investment, a start-up that had taken investment, or a small business that didn’t rely on investment. To better categorize the types of businesses from which reviewers were selected, I used Crunchbase to look for evidence of prior investment. The membership distributions for these panels is shown in Figure 3. As you can see, the majority of members come from universities. In none of the sampled panels was a self-declared early investor present, and reviewers who had first-hand experience raising investment appeared either under-represented or entirely absent.
In addition to the sharp skew of application review, it’s important to understand the timeline of SBIR submission, review, and award. In Figure 4, I plotted an example timeline for an SBIR application submitted on the annual September deadline. The time to decision is in excess of 6 months, with the earliest possible award (that is, cash in the bank) occurring nearly a year after submission. Most grants are not accepted for an award in the first submission, so with resubmission, the clock restarts for a second review.
The tempo of NIH review, while perhaps appropriate for long-term enterprises such as university research laboratories, is slow relative to the time horizon of very early companies. It is also slow relative to typical friends-and-family, angel, or seed investment opportunities.
Success Rate and Number of Awards Given
Most SBIR applications are rejected, even after resubmission. That is true for both Phase I and Phase II awards. Nevertheless, there are thousands of applications annually. Figure 5 provides the results of applications in the most recent year for which data are available.
Of note, the COVID pandemic did not materially impact overall success rates from prior years.
Even though most applications fail, hundreds of awards are made to small businesses every year. To give a sense of how abundant awards are in total, in Figure 6 I’ve plotted SBIR awards by municipality along the I-95 corridor — the New York Angels’ backyard — from 2016–2020. The area of circles in this plot reflects the relative amount of NIH investment, by city. In this region of the country, over $1b in support was injected into the economy to support life sciences and health care start-ups. The leading cities were familiar — Boston and Cambridge, New York, Philadelphia, and Rockville — although dozens of companies in many suburbs also benefitted.
Spectacular Success Stories
Yes, the SBIR program has important limitations that both founders and their investors need to understand. However, the program has plenty of home runs in its portfolio. Companies like the synthetic biology company Gingko Bioworks, the consumer genetics house-hold name 23andMe, and the cell engineering company SQZ Biotechnologies all have received SBIR awards. Many other great start-up stories have one of these awards in their early chapters.
The Big Picture: The Pros and Cons of SBIR Grants
SBIR awards are a commonly-encountered source of cash among certain types of early-stage companies, mostly in the life- and hard- sciences. The benefits of working capital without exchange for equity or debt may be meaningful, or at least attractive when a company is working hard to sort out technical feasibility and beginning to point towards market.
From the perspective of an early investor, a company’s receipt of an SBIR award checks an essential box because it means that technical experts have favorably vetted the company’s technology, sometimes to an extent that an individual angel may be unable to match.
These are good things, but it’s important to point out several important limitations of the mechanism, including:
- The companies are evaluated primarily by university-based, rather than start-up or industry scientists. As a group, this reviewer community may overemphasize scientific novelty, may underweight important aspects of the company’s plan related to product-market fit or strategy, and has limited if any experience with what’s required to unlock subsequent funding from early-stage investors. As such, a company pursuing favorable grant review may be moving in a direction out of alignment with what the company is there to do in the first place: search for a repeatable business model. That is, they can become distracted. An investor looking at a company with prior SBIR awards should consider those accolades a reflection of scientific newness, but not necessarily a marker of commercial viability or even investability. Likewise, a company that has attempted and failed to receive an SBIR should by no means be discounted out of hand.
- The money is not especially ‘smart.’ Receiving NIH support doesn’t come with important intangible assets brought by investors — first-hand experience, access to a network of commercialization, manufacturing, and regulatory experts, and introductions to later-stage investors.
- The money is slow for the size of the grant being made. Especially for Phase I awards, waiting a year or more for a less than 15% chance at $250,000 may not be the best strategy for companies trying to move as quickly as possible to begin testing their business hypothesis. In my experience this timeline also risks deceleration — a team taking their feet off the gas and accidentally establishing a wait-and-see tempo within the start-up that will ultimately ill-serve the company.
Taken on balance, I feel that the benefit provided by SBIRs (foregoing a sale of equity and dilution of founders’ ownership) is oftentimes outweighed by its downsides. Reviewer needs do not necessarily align with the customers’, strategic partners’, investors’, or company’s needs. Bandwidth spent engaging reviewers could be spent with customers, early investors, or strategic partners. Perhaps most importantly, the process is ultimately one that provides too little chance of raising too little money after far too long a delay.
Nevertheless, SBIRs may be a smart choice for some companies when at least three conditions are met. First, the commercial value proposition should be in impeccable alignment with the features that technical reviewers are looking for during proposal evaluation. Secondly, the company should be at an early enough point in their development when a 15–20% chance of a modest-to-moderate-sized cash infusion 9–18 months in the future is impactful. Lastly, the management team is working hard to identify angel or early institutional funds in parallel — ‘wait and see’ is unlikely to be a useful mindset.
Notes on data sets and analysis. Data of NIH funding activity over the last 2 years were pulled primarily from NIH Reporter. While not perfect, these data are exhaustive and generally well-curated. To produce the plot of SBIR funding by municipality, I used Google’s geocoding API. For characterization of individual grant review panel composition, a sample of most-recent study section rosters was drawn from the NIH Center for Scientific Review (CSR) website.
About the Author
John Younger is the Managing Director at ArgoPond, LLC, a life science advisory and investment company that provides analytics and diligence services to companies and funds engaging the life science space. Prior to founding ArgoPond, John had a 20-year career as a physician scientist at the University of Michigan and was the co-founder of Akadeum Life Sciences, a venture-backed life science tool company that manufactures materials for advanced cell and analyte separation and purification. John sits on the Board of Directors of New View Surgical, a Boston-based start-up creating new visualization tools for minimally invasive surgery. He has served for years as a reviewer and strategic advisor to the NIH and has provided congressional testimony on how best to support early-stage biotech companies. That testimony can be seen here. He represents ArgoPond as a member of the Life Science Group of New York Angels.
John’s LinkedIn profile and contact information are here.