GAO: Agencies aren’t tapping venture capital-owned companies for innovation

Though federal agencies are hungry for new technology solutions, a report from the Government Accountability Office says they may be missing out on a key avenue of innovation.

The Dec. 21 report found that in past three fiscal years, less than 3 percent of grant funding from the Small Business Innovation Research (SBIR) program to went to companies that are majority-owned by multiple venture capital companies, hedge funds or private equity firms, despite being provided the authority to work with such businesses.

The SBIR program awards contracts to small businesses for the purpose of promoting research and development, and innovation efforts at 11 federal agencies, including the departments of Agriculture, Commerce, Defense, Homeland Security and others.

The program is overseen by the Small Business Administration, but each agency determines the R&D areas it wants to focus on and the grants it will award. The SBIR’s phases of award are:

• Phase I awards contracts of at most $150,000 to test scientific and technical merit and feasibility of research ideas for six months to a year.
• Phase II awards up to $1 million for two years of continued R&D for programs that advanced past Phase I.
• Phase III tests the commerciality of the programs and solicits funding from the private sector and the agency that offered the initial SBIR awards.

Since 2011, agencies in the SBIR program have been able to award a select portion of their grant budget to small businesses owned by a group of venture capital companies, hedge funds or private equity firms, which often invest in companies developing new technologies and products.

Per the SBIR Reauthorization Act of 2011, the Department of Energy, National Science Foundation and National Institutes of Health can award no more than 25 percent of their SBIR funding to venture capital-owned businesses, while the remaining SBIR agencies are capped at 15 percent of their funds.

But the GAO report found that between fiscal 2015 and fiscal 2018, agencies awarded between 0.1 to 2.7 percent of their total SBIR obligations to venture capital-owned businesses.

Only NIH, DOE’s Advanced Research Projects Agency-Energy (ARPA-E) and the Department of Education’s Institute for Education Sciences made SBIR awards to venture capital-owned companies during that span, totaling 62 awards worth $43.6 million.

The rules governing SBIR grant awards seem to have impacted at least some of the agencies’ approach to venture capital-owned businesses, the report found.

Officials at three agencies said that the caps on grants that could be awarded to venture capital-owned businesses limit the amount of funding they could receive, not allowing many to advance past the early phases of the program.

Other agency officials requested information on the success of SBIR grants given to venture capital-owned businesses, but NIH and ARPA-E officials told the GAO “it was too early for them to evaluate the impact of the authority.”

And finally, some agency officials claimed that because the venture capital-owned businesses possess enough funding and have technologies in later-stage development, they didn’t believe that the SBIR program would attract those businesses.

GAO had previously called for policy guidance changes in 2015 to make the requirements for awarding SBIR grants to venture capital-owned businesses easier for agencies to understand, with the hope it would bolster the use of the authority after noting that 12 awards were made between fiscal 2013 and 2014.

While awards to venture capital-owned businesses did increase following the policy changes, those agencies said they did so because their technology needs often required significant private investment.

“One reason that NIH decided to allow small businesses majority-owned by multiple investment companies and funds to participate in its program is that it would increase the chances of promising technologies reaching the marketplace,” the report said. “The written determination states that very few small businesses are capable of commercializing their technologies without private investment funding because of the significant cost needed to take a biomedical product from idea to market.”

The report also noted that the Department of Defense had explored awarding SBIR grants venture capital-owned businesses for satellite imagery projects related to the Defense Advanced Research Projects Agency (DARPA) in fiscal 2016. DOD officials said because of the costs of launching satellites, some small businesses raised capital by selling equity shares to venture capital interests and hedge funds.

In its written determination of the authority, DOD officials said “providing such small businesses with incentives to gear their research toward DoD-relevant problems would meet a demonstrated need and substantially contribute to DARPA’s mission.”

GAO offered no recommendations and none of the 11 SBIR agencies provided comments on the report.