An Innovator’s Playground, or an Investor’s Path to Profitability?

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Riptide Ventures

8 min readNov 17, 2022

How SBIR and STTRs create value for investors and founders

Source: https://www.pexels.com/search/Small%20business/

Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs are government-funded contract or grant programs that focus on fostering innovation and technology to both directly and indirectly benefit public health and business opportunities of the United States. Several of Riptide’s portfolio companies, particularly those in the healthcare space — including Capsulomics, have benefited from the SBIR/STTR programs.

The primary purpose of SBIR funding is to help technology companies validate their scientific research and efficiency. By doing so, innovators can bridge the “valley of death” by construction and commercialization of products the government is incentivized to buy. Non-dilutive funding can be helpful for entrepreneurs who have high up-front capital costs for commercializing their technology and want to reduce dilution risks. SBIRs can also be helpful to investors by reducing the dilution they face as well. On the other hand, the program can be a distraction, as the United States government has specific requirements that may be different than a commercial customer. Hence, each founder and investor should form their own opinion for application to the SBIR program on a case-by-case basis.

The goal of STTR funding is to enable the transfer of technology developed by a research institution (Universities and Federally Funded Research and Development Centers) through entrepreneurship of a small business concern. STTR was modeled after the SBIR program and typically grants ~$450 million minimum spend per year. STTRs are more challenging to apply for as they require a collaboration with a non-profit organization.

Support via SBIR and STTR funding facilitates experimentation and analysis, increasing competition, productivity, and economic growth. Funds for pressure testing allow start-ups, entrepreneurs, and innovators to record observed and measurable real-world data that can in turn assist strategic decision making for substantial real-world implications. Over 5,000 new awards are granted every year comparable in size to angel investments in the private sector. To qualify, the business must be a US owned and operated, for-profit firm with under 500 employees. [1, 2]

Riptide focuses on backing companies with SBIRs, but welcomes founding companies with STTRs. Our draw towards SBIRs lies in the fact that by the time companies pitch to Riptide — or other VCs/angel syndicates — for capital, they are no longer eligible for future STTRs — as STTRs target university level strategies that are farther away from commercialization.

On the plus side: The window of opportunity exists.

SBIRs & STTRs are here to stay — at least through September 30, 2025 thanks to the bipartisan legislation introduced by US Senate Committee on Small Business & Entrepreneurship Chair Ben Cardin (D-MD) and US Senator Joni Ernst (R-IA). The SBIR & STTR Extension Act of 2022 holds companies, investors, analysts, and reporters accountable for their actions.

The bill will ensure two things: First, the largest SBIR and STTR winners will leave with a toolkit of hard and soft skills to appropriately progress their technology to market. In addition, winners gain a plethora of vetted expert mentors to traverse through the process. Second, the bill will enforce strict safeguards to protect US R&D patented ideas from maligned foreign country incentives [3,6].

As SBIR & STTRs have a high ROI for the government (returned $22 for every $1 awarded from 1995–2018), not to mention increased sales, products and jobs, it is hard to imagine a world where these programs do not exist [3]. In an economic impact analysis completed by the National Cancer Institute (NIC) in 2018, a total of $9.1B sales of products and services resulted from NCI SBIR/STTR Phase II grants [4].

However, the opportunity is not for the faint of heart.

Funding agencies look for high risk companies seeking needs other than just capital (your team really matters!). Be prepared to manage your expectations up front and have a well-structured plan. A word to the wise, most SBIRs are denied in the first round. Plan for failure in the first round so you can budget and refine at a faster pace the second time around. If applying a second time, know that grants are not allowed for purchasing equipment or commercializing a technology that has already been developed.

There are three phases to both SBIR & STTRs:

Phase I: Concept Development — is your idea economically feasible or technologically vetted? — generally 6–12 months timeline; offered ~$50k-$250k.

Phase II: Prototype Development — this is where the hard work begins — expands on Phase I results — up to 24 month timeline; ~$500k-$1.5M.

Phase III: Commercialization — transition from the lab to the marketplace. No SBIR funds support this phase. Small businesses must raise capital from the private sector or other non-SBIR Federal Agency funds.

Tips for Managing Your Expectations Up Front

There have been over 195,000 SBIR/STTR awards made over the past 40 years, each year with an “exception” to commonly held rules. Decide the best way to present your cost data. Know the relationship between your direct and indirect costs & always keep accurate and timely records of your labor. Know who is at risk and what the penalties are for misrepresenting labor on the government contract.
Federal government & private sector contracts can be VERY different. Agencies may give a choice of advance or progress payments. For Phase I, agencies usually go with a Fixed Firm Price contract/grant. The only deliverables required are monthly reports and a final report (fixed amount paid when each deliverable is made). Risk on the company is small. More agencies are using Fixed Price as well in Phase II to reduce preaward & award audits. For Phase II, some agencies prefer Cost Plus Fixed Fee contracts/grants. The risk here is on the government. These contracts tend to trigger pre-award or halfway through audits (to ensure accurate accounting).
What was true of SBIR/STTR cost proposals and audits a few years ago doesn’t necessarily apply today. Realize subcontract calculation is done differently depending on the SBIR/STTR agency, so understand the agency’s process and stay within limits.
In the time from acceptance of the grant to actually utilizing the capital for the research process, your budget may change based on your company’s progression. Be transparent with your agency and make sure you hit the requirements needed to ensure you have the funds to capitalize on your goals.
On the plus side, contracting officers (CO)/grant administrators (GA) who negotiate a deal with applicants understand the novice role and are more willing to work with you as an entrepreneur rather than a big firm.
Consider key clauses for accounting system requirements made by Federal Acquisition Regulation in additional supplement requirements by agencies for determination of costs.

Opportunities for Investors

The SBIR process is an extensive and rigorous vetting process. You can sleep easy knowing your invested money is supporting a company that went through multiple rounds of peer reviewed and graded feedback from experienced scientists and stakeholders in the field.
You have a guaranteed willingness to commit from the team you invest in — applicants are required to publish outcomes and results to the funding agency.
SBIR/STTR provide a unique opportunity to develop a new product or technology [first mover advantage, niche market attack] — program funding cannot retroactively pay a company for development already accomplished.
SBIRs enable a safe environment for small business innovators to experiment with the path to profitability.
Double down for something good! Become part of a movement that supports the Social Capital Theory — teach your entrepreneurs how to effectively and efficiently extract value from networks — enable cross-sector collaboration, knowledge and technology transfer, and ultimately innovation, in formal and informal links to the social capital you provide.

Challenges for Investors

Depending on the phase of the program — the process could be time consuming.
Success rate of both Phase I and II remain low.
Over the past 10 fiscal years (2012–2021), the SBIR/STTR Phase I success rate has only been ~16%. [5]
For Phase II awards, the nationwide success rate over the past decade was 36%.[5]

Opportunities for Innovators

SBIRs provide a runway for scientists and engineers to identify a gap or pain point for an agency and move from idea to fruition in the growth of a small business with non-dilutive funding.
Of those interviewed, 89% stated the SBIR/STTR program provided funding at a pivotal or critical moment for the small business, aiding in de-risking the company. [4]
Innovators can apply to multiple agencies at one time, but need to work on separate projects if accepted to proceed.
Gain valuable “learning by doing” experience to leverage against rival competitors.
R&D benefits include research cost avoidance, research savings, and access to expensive equipment.
SBIRs force innovators to validate all aspects of the business model to renowned experts — the vision must be clear for market strategy, user experience, and financial modeling.

Challenges for Innovators

Your idea may not be novel, but hey, silver lining, going through the process saves you time and money — onto your next big thing!

Barriers to Entry:

Conflict of interest with SBIR/STTR reviewers — all of your hard earned trade secrets will be explicit on the application.
Is it worth it? — The application is time consuming, government grant funding can be slow, and there is a risk funding may not be awarded upon first application.

Some sample topic ideas already approved for 2023 consist of Cybersecurity, Digital Twin Capabilities, Quantum Computing Hardware, Advanced Fossil Energy and Carbon Management Technology Research.

The Riptide Syndicate is a community of early stage investors that has joined together to leverage the network effects of our experience, perspectives, and connections. Riptide Ventures leverages its network to source, diligence, and support the best early stage companies in consumer, software, and healthcare. If you’re interested in joining the Riptide Syndicate or learning more about angel investing, please fill out our application form here. If you are a company interested in pitching our syndicate, please fill out our application form here.

Participating Agencies for SBIR/STTR Funding

Administration for Community Living (ACL)

Air Force

Army

Centers for Disease Control and Prevention (CDC)

Defense Advanced Research Projects Agency

Department of Agriculture (USDA)

Department of Commerce (DoC)

Department of Defense (DoD)

Department of Energy (DOE)

Department of Education (ED)

Defense Health Agency