David Williams: This is David Williams, co-founder of MedPharma Partners and author of the Health Business Blog. Since the early 1980s, the federal government has provided Small Business Innovation Research (SBIR) grants to fund research and development projects. In 2003, the Small Business Administration ruled that companies that were majority owned by venture capital funds would no longer be eligible for such funding.
The biotech industry and its supporters complained that the policy was choking off innovation. And now, a bill that would restore eligibility of companies whose majority owners are VCs is before Congress.
The Office of Management and Budget, the National Small Business Association, and Small Business Technology Council have all come out against the legislation, arguing that it would allow large businesses and universities in the door and deny funding for many deserving small businesses. SBIR grants represent only two and a half percent of federal research dollars, they argue, and independently owned, non-dominant players should be entitled to it.
Alan, thanks for speaking with me this morning.
Alan Eisenberg: Sure, my pleasure.
David: Alan, what is the SBIR program?
Alan: The SBIR program is a federal grant and contracting program that was passed by Congress in 1983 to help the US in terms of its competitiveness, and specifically with respect to small business and helping them to commercialize innovative technologies.
David: And how big of a program is it?
Alan: Well, agency by agency, it varies. But overall, it is 2.5 percent of each agency’s research budget. Of the budget that it provides in grants to external entities, to businesses or otherwise, 2.5 percent has to be allocated to the SBIR program.
David: About how many awards are given out on an annual basis?
Alan: I don’t have all the statistics here with me, but for example, with NIH, it’s about a $600 million program.
David: Are the grants large? Are they small? Is there a fixed amount on a per-grant basis?
Alan: There are a couple of stages. There is the Phase I grant. And the Phase I grant can be perhaps up to $70-75,000. There can be slight variances agency to agency. Then, Phase II grants can be up to about three-quarters of a million dollars, with some variance agency by agency. So NIH grants might be slightly north of there, but again, you’re talking about that sort of size.
David: And have there been successes coming out of the program?
Alan: There are a number of very good success story from this type of program. Many companies in the biotech industry have received SBIR grants–some of the early, and now very successful, biotech companies: Chiron, Genzyme, Gilead Sciences, MedImmune, Millennium. Each have received SBIR grants over their lives. For example, MedImmune’s product, Synagis, was helped along by an SBIR grant. There are many good stories, many fantastic stories.
David: When you talk about the program being for small businesses, what did Congress have in mind about small businesses, and why were small businesses singled out? And then, as a follow-on to that, it sounds like there was some change of interpretation of what a small business meant, as of 2003. Maybe you can tell us about that as well.
Alan: In the law, small businesses are defined differently by the industry that they’re in. In the biotech industry, it’s defined as 500 employees or fewer. The change you’re referring to is that biotech companies participated, for 20 years, in the SBIR program, companies of all stripes, regardless of their capital structure. In 2003, the SBA made a rule change that effectively kicked out the vast majority of companies that might be eligible for the program, i.e. those that have majority venture backing.
David: And you said it’s the SBA itself that made the change. Was it instigated by anything that had happened in Congress? Or what was the impetus for the change?
Alan: It wasn’t a Congressional change; it was a change in rules that the SBA passed. It was based on a judgment made by an administrative law judge, first in 2001. And then in 2003, the SBA formalized it through a set of rule-making that defined that, if a company had a majority of its equity held by institutions, as many of our companies do–these institutions being venture capital firms–those companies were no longer eligible to participate in the program.
David: Now, I understand that there is a bill in Congress now, HR3567. Can you tell me a little bit about what that bill does and why BIO is supporting it?
Alan: That bill does a number of different things trying to help small business investment overall. There is a provision in that legislation that modernizes the definition of a small business, allowing companies to participate in the SBIR program again.
It also goes beyond that, because there are biotech companies that are unable to receive the PDUFA fee waivers, who have been categorized not as small businesses simply because of their capital structure and therefore unable to receive PDUFA fee waivers. So it corrects that sort of problem as well.
David: Can you just describe what the PDUFA fee waiver means?
Alan: Sure. Companies that are small, first-time filers, once they’ve completed their Phase III clinical trials, submit a new drug application to the FDA. And as part of that application, you are supposed to pay a fee. The fee goes to pay for reviewers at the Food and Drug Administration, to pay their salaries and so forth. This is the Prescription Drug User Fee Act, which has just been re-authorized by Congress this year.
As a part of that, though, to help small businesses, there is a waiver of that fee, which is about a million dollars. And simply put, some companies that are small, under 500 employees, nevertheless, because of how the SBA reviews them and looks at their capital structure, necessarily have begun to be denied that PDUFA fee waiver. The Food and Drug Administration has to, by law, use the definition of a small business over at the SBA.
David: I know that there’s been a letter that’s been submitted by 50-some groups representing various medical specialties and patient advocacy groups for a variety of diseases. Why would they be in support of this bill?
Alan: They would be in support of this legislation, and I believe they’re in support of any fix that will help biotech companies get back into the SBIR program.
And simply put, they understand that biotech companies represent the cutting edge of science, that they represent, really, the next great set of cures, especially for many unmet medical needs, and that by not having many biotech companies participate in the SBIR program, you are necessarily not pushing forward as many possible research programs as you might otherwise. And those research programs may lead to cures for patients, and that’s where I think those patient groups are probably coming from.
David: And where does the bill stand now in Congress?
Alan: Well, the House has passed HR3567, which does have a provision in it. I believe the Senate is going through its paces right now. And we’re hopeful that there will either be a conference on this particular legislation or that there will be other legislation that the Senate takes up that can then be conferenced with the legislation in the House and moved forward to something that is a compromise and acceptable to the President.
David: And how widespread is the support for it? Is this a bipartisan measure, or is it more from one side of the aisle or the other?
Alan: It’s a bipartisan measure. It was passed with the support of, in the House, over 300 votes. And it is supported by both the chairman of the Small Business Committee, the chairwoman, Nydia Velazquez of New York, and the ranking Republican on the committee, Steve Chabot of Cincinnati.
David: Now, it seems like there are a few that, despite the strong support in the House, there are some that have objections to it. I was wondering if you could just talk about your perspective on some of those.
I know that Representative Manzullo, who’d been involved in this legislation and related matters over time, has said that SBIR grants are already going to VC backed companies. Even under the 2003 interpretation, he said something like 17 percent of the grants and 18 percent of the funding are already going, so it’s not as though VC backed companies aren’t eligible in the first place.
Alan: I think you need to be careful with that specific statistic. It’s not a question of money going to VC backed companies. It is a problem going to majority venture backed companies.
For most biotech companies it takes a decade to get a product from bench to bedside. It takes a billion dollars in capital investment, including the cost of the failures that you have along the way. During that time, companies –because they don’t have revenue coming in the door from a product– can’t do what many small businesses do, which is go to a bank and get an average small business loan because they would be using the proceeds from that loan to pay the interest. The banks won’t lend money in that situation, so what you have to do is go to other avenues for financing. The vast majority of the time you’re going to venture capital firms.
When you go and get financed through venture capital firms, very often, after your first round –and if not your very first round then certainly after your second round– more than 50 percent of your equity is held by those venture capital firms. That’s one piece that I think is very important to be clear about.
The second point that’s important to be clear about is the interpretation by the Small Business Administration right now of what it calls its Affiliation Rule. Simply put, what it means is that even if your are minority venture backed, and therefore eligible to participate according to the eligibility standard, what kicks out many minority backed venture capital firms is that what the SBA defines as the number of employees. Again, I mentioned it earlier, that it was 500 or fewer.
The SBA will ask that not only do you count the number of employees that you have in your business, and your business will have an independent board of directors, but you count the number of employees that are employed of the venture capital firm that is invested in you, and you count as employees the employees of each of the portfolio companies of that VC’s portfolio.
So, it is not just your employees but the sum of the employees of each of the portfolio companies of each of the VCs who have invested in your company.
David: You talked about getting a bill together that the President would be in favor of, and I’m guessing from that that maybe the President is not in favor of the current bill. And I noticed that the OMB had a pretty strong statement where they said that “this redefinition strips the elements of independent ownership and control that identifies small business ownership under current law. Not only would this change be inequitable for actual small businesses, but it would be a step backward from our recent progress in addressing the misidentification of large firms as small businesses for Federal procurement purposes.”
I think they’re concerned about large businesses or big not for profits like universities that are already getting a lot of the Federal grants that are in that other 97 and a half percent to be able to control the small businesses and scoop up the remaining two and a half percent.
Alan: A couple points. The first is that we believe that statement was written prior to an amendment that was drafted and adopted on the floor of the House during floor consideration. That amendment prevented one specific company from owning the majority of the capital in a firm in terms of eligibility or having the majority of the board seats. So that’s one.
Two, it reinforced the prohibition on large companies participating in the program. The VCs can’t be corporate owned VCs and must be based in the United States. We think that the amendment that was adopted and is part of the bill that’s awaiting conference in the Senate does meet the test that the administration was putting forward.
David: And then maybe going on from that, there’s the National Small Business Association that’s also in opposition for some of the same reasons that were described in the OMB statement. They also put forward a scenario where they say that the bill would enable VCs that are jointly owned and operated or controlled, which isn’t so uncommon in the VC world, to collectively control more than half of a company and they’d still qualify for the SBIR funding.
They put a scenario out there: Intel and Microsoft executives and having funds that are backed by their companies. Is that a scenario that’s first of all realistic? And has it also been addressed by the change that you just described?
Alan: Sure. It’s not a terribly realistic scenario. The scenario that is put forward by those folks, frankly, there’s nothing in this legislation that changes the test for what is independently owned and controlled so as long as the investing VC is not owned by a large company and meets the other limitations that I mentioned earlier.
David: And then, I know the Small Business Technology Council has been talking about statistics about these SBA awards in general, and they’re saying there are five to seven companies that put in proposals for every one that’s funded and that at NIH in particular that’s true. The number of proposals has grown by about 1,000 in the last year.
I’m trying to understand whether, in fact, there’s a big pool of excellent proposals that are out there even with the current restrictions or if in fact the quality of proposals is a lot lower without more of these majority VC backed firms. Is there a shortage of high quality uses of the funds would you say? Or is it just a matter of fairness that some of the biotech companies are currently excluded?
Alan: David, I would point you rather to what the NIH has provided to Congress in terms of the number of new applicants over the last few years. And simply put, there has been a substantial decline: of 12 percent in 2005, of 15 percent in 2006; a decline in the number of applicants to the SBIR program.
So you are having fewer applicants rather than an increase. The SBTC doesn’t really have its data quite correct there. There has been a sizable decline in the number of applications for SBIR grants, at least at the National Institutes of Health.
The NIH director, Doctor Elias Zerhouni, has written to the Small Business Administration. In fact he wrote two years ago to the Small Business Administration that the rule change undermines the NIH’s ability to award SBIR funds to those applicants whom we believe are most likely to improve human health, which is the mission of the NIH.
So, I guess it’s not really my words you should listen to. It’s the agency’s. They’re the ones whose Congressionally-mandated mission is to further public health through scientific research. They’re the ones who argue that this rule change is really not helping them to proceed forward and accomplish their mission.
David: I’ve been speaking today with Alan Eisenberg from Bio. Alan, thanks very much for your time.
Alan: My pleasure.