Startup Operations Guide
Indirect Rates for SBIR Grants and Contracts:
What are they and how do I get them?
If you’re like most entrepreneurs, submitting your first proposal for a Phase I SBIR can seem like a journey through a never-ending labyrinth. The deeper you’re immersed in the process, the more it seems like you’re stuck in an endless maze of forms, website logins, and random registration requirements, with no clear path to the finish line. The official SBIR website puts it best when they say, “The truth of the matter is there is nothing enjoyable about the task of completing on-line registrations.”
If you manage to leap the necessary hurdles of:
- ̶G̶e̶t̶t̶i̶n̶g̶ ̶a̶ ̶D̶U̶N̶S̶ ̶N̶u̶m̶b̶e̶r̶ (replaced by UEI on April 4, 2022)
- Registering in SAM and getting a CAGE code
- Getting an SBC ID
And one or more of the following hurdles:
- Registering on DSIP (DoD)
- Registering on EHB (NASA)
- Registering on ASSIST (NIH)
- Registering on Fastlane (NSF)
- Registering on FedConnect (EPA, others)
- Registering on grants.gov (DoE, NIH, NSF, many others)
- Registering on eRA Commons (many portals run through this)
Then you’ve made it to the final challenge of the labyrinth: actually writing your proposal and budgeting your project, which requires knowing how the heck indirect rates work. Understanding the application of indirect rates and how to propose them is critical to avoid leaving money on the table, but also to avoid unnecessary proposal effort.
What are indirect rates and how do I get indirect rates for my SBIR?
To understand indirect rates and how important they are, we first need to know the difference between direct and indirect costs.
Direct Costs
Direct costs are costs incurred by performing specific work on project, contract, or grant objectives. Typically, these are engineering or research labor costs as well as supplies, materials, subcontractors or “Other Direct Costs (ODC)” that are incurred specifically to fulfill a contracted objective. Example: I am contracted by a federal agency to paint a piece of equipment. So, I buy a barrel of paint to paint the piece of equipment, I travel to the site of the equipment, I pay a subcontractor to clean the equipment, and finally I paint the equipment. In this example, all the materials, travel, subcontractor, and labor costs spent painting that piece of equipment are direct costs.
Indirect Costs
Indirect costs are costs incurred that keep the business running but aren’t tied to a specific contract. Things like office rent, insurance, legal & accounting fees, software subscriptions (that are not specifically purchased for a project) and administrative labor not related to a project, i.e. finance folks, marketing, sales etc., are all Indirect costs. These are sometimes referred to as “Overhead (OH),” “General and Administrative (G&A),” or “Selling, General, and Administrative (SG&A)” costs depending on who you’re talking to. In the Government Contracting world, “Overhead” and “G&A” can technically mean different things.
The government really only wants to pay for the thing they’re getting: a painted piece of equipment. That said, they know that if they only reimburse direct expenses, very few vendors would work with them because there are more costs to running a business than just the direct work you do. In the commercial world, this is covered by the markup you create on the goods/services you produce for customers. Take the one-month P&L example to the left. If the raw materials, labor, and travel costs total $21,412 we’d want a healthy 65% Gross Profit margin to cover the rest of the business operating costs, so we’d charge customers $61,177 to hit that margin, cover the indirect operating expenses of the business, and leave a bit of profit left over. The greater the margin, the more successful the business will be.
* IR&D counts as a Direct cost in terms of calculating indirect rates
**Advertising and marketing, interest expenses, and IP legal fees are considered “Unallowable” in terms of calculating indirect rates
How do I get indirect rates for a DoD SBIR?
For the DoD, your company’s indirect rates are calculated every year using a nasty 29-tab spreadsheet called the ICE model which you submit to the Defense Contract Audit Agency (DCAA). Plug in your books and it calculates what percent of your costs are Fringe, Overhead, and G&A. You can also choose a one-tier model (just G&A), or two-tier model (G&A and Fringe) when using the ICE model to simplify the process slightly. Regardless, it’s not a very fun:
How do I get indirect rates for an NSF or NIH SBIR?
NSF and NIH negotiate what they call a “Facilities and Administrative” (F&A) rate which can only be applied against salaries and wages. The NSF will typically accept rates from other agencies unless the NSF is the “cognizant organization” i.e. they provide the “preponderance of funding.” So if you get the majority of funding from the NSF, you’ll negotiate a Negotiated Indirect Cost Rate Agreement (NICRA). Procedure guide is here. If you have a NIH SBIR, you’ll go through the Division of Financial Advisory Services (DFAS), not to be confused with the Defense Finance Accounting Service (DFAS) which handles payment remittance for the DoD.
The awesome thing about the NSF and the NIH is that they offer a “safe rate”, which means that anything below a certain percentage (40% for NIH, 50% for NSF) requires no backup documentation or negotiation. This is really designed for them to avoid having to negotiate with every single contractor, but it also can be a great benefit to startup organizations and first-time grant/contract awardees by eliminating the heavy administrative burden of calculating the rates. In some cases, for lean teams, it can also provide a higher rate than could have actually been attained if negotiated. These safe rates are very helpful for Phase I SBIRs to get the process moving quickly; however, you are required to negotiate rates in Phase II contracts. Therefore, as you grow, it is critical to keep tabs on what your actual rates are and use them in your proposed budgets to avoid leaving money on the table.
The importance of indirect rates: understanding your gross profit
Most entrepreneurs don’t understand what a huge impact your indirect rates can have on your budget and your overall reimbursement on a project. Below are two examples of the most common rate structures we see with our client base (DoD and NSF) and what they might produce on an invoice to the government. For the DoD example, if we assume our indirect rates are 20% for Fringe, 20% for Overhead, 30% for G&A, and the contract has a 7% fee, $1 of personnel expense would allow us to charge $2 to the government.
$1 labor x 1.2 Fringe x 1.2 Overhead x 1.3 G&A x 1.07 Fee = $2 revenue
Only the G&A rate and the fee apply to ODC so the $1 in material costs would get us $1.39 in revenue:
$1 materials x 1.3 G&A x 1.07 fee = $1.39 revenue
Together the $2 we spent between labor and materials would get us $3.39 in revenue, which translates to essentially a 41% gross margin. Labor-intensive contracts usually have a better profit margin, because you often get multiple rate multipliers on top of labor cost.
For the NSF, the F&A rate can only be applied to salaries and wages, so $1 in labor would get us $1.61 in revenue and the materials will get us $1.07, for a gross margin of 34%.
$1 labor x 1.5 F&A x 1.07 fee = $1.61 revenue
$1 materials x 1.07 fee = $1.07 revenue
Having accurate indirect rates that cover the indirect operating expenses of your business is crucial. Frequently entrepreneurs will submit a Phase II proposal with low indirect rates. Often these rates are “capped” by the contract, meaning regardless of the changes in your business, these rates cannot be changed over the course of the project. We’ve seen this mistake cost companies as much as $200,000 over the course of a 2-year $1.5M project.
What should my indirect rates be?
When starting a new company, your rates have the potential to swing substantially year-to-year based on growth and changes in your company. What your exact Fringe, G&A, and Overhead percentages turn out to be are sometimes more a matter of how you decide to categorize expenses, so it’s not very useful to compare to other companies. The more important comparison is the overall multiplier (the DoD example above had a 2.0x multiplier based on a combination of the 20% Fringe, 20% OH, 30% G&A, and 7% fee). For DoD SBIRs, there’s a nice rule of thumb breakdown from Jameson & Company:
Provisional vs. final actual rates
The last complication in the world of indirect rate negotiation is found between your “provisional” rates (your best guess at what your rates are going to be for the year, which you submit to DFAS, DCAA, NSF, etc. at the beginning of the year based on your annual budget) and your “final actual” rates (the calculation you submit at the end of the year showing what actually happened). You want to try and get as close as possible to reality. If your provisional rates are too low, you’ll have extra cash come back to you at the end of the year, which is nice, but it means you missed out on the opportunity to have better cash flow into your organization. If your provisional rates are too high, you may be in a situation where you need to give money back at the end of the year (never a fun place to be in).
Where do I go if I want someone to do all of this for me?
If you’re not enthused at the idea of navigating the indirect rate labyrinth alone, give us a call at 412–882–5383 or shoot me an email: cmillard at donnelly-boland dot com.
We’re experts at helping startups set up their accounting infrastructure and manage their government contracts. We also have a range of operational accounting services from bookkeeping to fractional CFO work that are designed to help you scale your organization quickly and affordably.
