[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]



                                                   S. Hrg. 102-000 

 
   THE IMPORTANCE OF THE BIOTECHNOLOGY INDUSTRY AND VENTURE CAPITAL 
                         SUPPORT IN INNOVATION

=======================================================================

                                HEARING

                               before the

      SUBCOMMITTEE ON RURAL ENTERPRISES, AGRICULTURE & TECHNOLOGY

                                 of the

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                     WASHINGTON, DC, JULY 27, 2005

                               __________

                           Serial No. 109-28

                               __________

         Printed for the use of the Committee on Small Business


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
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                      COMMITTEE ON SMALL BUSINESS

                 DONALD A. MANZULLO, Illinois, Chairman

ROSCOE BARTLETT, Maryland, Vice      NYDIA VELAZQUEZ, New York
Chairman                             JUANITA MILLENDER-McDONALD,
SUE KELLY, New York                    California
STEVE CHABOT, Ohio                   TOM UDALL, New Mexico
SAM GRAVES, Missouri                 DANIEL LIPINSKI, Illinois
TODD AKIN, Missouri                  ENI FALEOMAVAEGA, American Samoa
BILL SHUSTER, Pennsylvania           DONNA CHRISTENSEN, Virgin Islands
MARILYN MUSGRAVE, Colorado           DANNY DAVIS, Illinois
JEB BRADLEY, New Hampshire           ED CASE, Hawaii
STEVE KING, Iowa                     MADELEINE BORDALLO, Guam
THADDEUS McCOTTER, Michigan          RAUL GRIJALVA, Arizona
RIC KELLER, Florida                  MICHAEL MICHAUD, Maine
TED POE, Texas                       LINDA SANCHEZ, California
MICHAEL SODREL, Indiana              JOHN BARROW, Georgia
JEFF FORTENBERRY, Nebraska           MELISSA BEAN, Illinois
MICHAEL FITZPATRICK, Pennsylvania    GWEN MOORE, Wisconsin
LYNN WESTMORELAND, Georgia
LOUIE GOHMERT, Texas

                  J. Matthew Szymanski, Chief of Staff

          Phil Eskeland, Deputy Chief of Staff/Policy Director

                  Michael Day, Minority Staff Director

     SUBCOMMITTEE ON RURAL ENTERPRISES, AGRICULTURE AND TECHNOLOGY

SAM GRAVES, Missouri, Chairman       JOHN BARROW, Georgia
STEVE KING, Iowa                     TOM UDALL, New Mexico
ROSCOE BARTLETT, Maryland            MICHAEL MICHAUD, Maine
MICHAEL SODREL, Indiana              ED CASE, Hawaii
JEFF FORTENBERRY, Nebraska           RAUL GRIJALVA, Arizona
MARILYN MUSGRAVE, Colorado

                   Piper Largent, Professional Staff

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                               Witnesses

                                                                   Page
Doerfler, Mr. Douglas A., President & CEO, MaxCyte, Inc..........     4
Broderick, Mr. Daniel J., Managing Director, Mason Wells.........     7
Michael, Mr. Barry, President, B.A. Michael Consulting, Small 
  Business Technology Council....................................     9
Glover, Mr. Jere W., Executive Director, Small Business 
  Technology Council, Brand Law Group............................    11
Cruz, Mr. Anthony P., Senior Vice President, Finance & 
  Administration, AviGenics, Inc.................................    13

                                Appendix

Opening statements:
    Graves, Hon. Sam.............................................    28
Prepared statements:
    Broderick, Mr. Daniel J., Managing Director, Mason Wells.....    30
    Glover, Mr. Jere W., Executive Director, Small Business 
      Technology Council, Brand Law Group........................    41
    Cruz, Mr. Anthony P., Senior Vice President, Finance & 
      Administration, AviGenics, Inc.............................    60
Additional material:
    Biotechnology Industry Organization..........................    63

                                 (iii)
      


 
   THE IMPORTANCE OF THE BIOTECHNOLOGY INDUSTRY AND VENTURE CAPITAL 
                         SUPPORT IN INNOVATION

                              ----------                              


                        WEDNESDAY, JULY 27, 2005

                   House of Representatives
Subcommittee on Rural Enterprises, Agriculture and 
                                         Technology
                                Committee on Small Business
                                                     Washington, DC
    The Subcommittee met, pursuant to call, at 2:05 p.m. in 
Room 311, Cannon House Office Building, Hon. Sam Graves 
[Chairman of the Subcommittee] presiding.
    Present: Representatives Graves, Barrow, Bartlett, 
Velazquez 
    Chairman Graves. Good afternoon everybody, and welcome to 
this hearing of the Subcommittee on Rural Enterprises, 
Agriculture and Technology on the Small Business Committee. I 
apologize for being a little bit late. We have got a string of 
votes that could happen at any time now so I thought we would 
go ahead and get started and get some of the opening statements 
out of the way. Then we will take our votes, and we will come 
back as soon as those are over.
    Today, we are going to be discussing the importance of the 
biotechnology industry and venture capital support in 
innovation, and I appreciate everybody's support and 
participation, anyway, in today's hearing. We are going to have 
a good hearing. I think it is going to reflect both sides of 
this issue, and we are trying to find out as much as possibly 
about venture capital when it comes to the biotechnology field.
    The Small Business Innovation Research program [SBIR] was 
created by Congress in 1982 to increase the participation of 
small technology firms that participate in federal research and 
development activities. Federal agencies with R&D budgets of 
over $100 million or more are required to allocate 2.5 percent 
of all federal research and development grants to small 
business applicants.
    I take a particular interest in this issue since my 
undergraduate studies yielded me a degree in agronomy, 
particularly plant physiology. I understand the importance of 
and potential in biotechnology and the research these small 
companies do. In fact, the State of Missouri is slowly 
attracting more of these biotechnology firms from all across 
the country into our state. This means jobs for rural America 
and value-added products for farmers.
    Without question, the United States remains the global 
leader in the field of biotechnology. Part of this success can 
be attributed to the federal government's role in promoting 
critical research and development. This program allows for 
cutting-edge research that may not, in its earliest stages, 
attract funding from other sources.
    Venture capital funding is critical to the small biotech 
companies. They provide the initial seed money to help get some 
of these innovative ideas off the ground and running. Without 
this investment, given the nature of the biotech industry, it 
would be very difficult to finance this process. These small 
businesses are providing the country with the ideas and 
innovation that have become the identity of the United States.
    The biotechnology industry is unique in that it takes 
hundreds of millions of dollars to bring a product to market 
from its conception. Biotechnology companies must rely on 
venture investment as well as grants for sufficient funding.
    SBA regulations require that, to be eligible, a small 
company must be at least 51 percent owned by one or more 
individuals. The SBA recently clarified the definition of an 
``individual'' to include only actual human beings and not 
other forms of investment. This clarification now excludes many 
of the small biotech companies that participated in the SBIR 
program in the 20 years prior to this SBA clarification.
    Again, this hearing is going to examine this clarification 
and legislation that has been introduced, the Save America's 
Biotechnology Innovation Research Act. This legislation seeks 
to address the eligibility issue and restore the success of the 
SBIR program experienced prior to the 2002 SBA 
``clarification.'' The rule change resulted in the 
disqualification of many of the small biotech firms engaged in 
that research.
    It is now my pleasure to turn the mike over to Ranking 
Member Barrow for his opening statement.
    [Chairman Graves opening statement may be found in the 
appendix.]
    Mr. Barrow. Thank you, Mr. Chairman. Mr. Chairman, some of 
the nation's fastest-growing and most successful small 
businesses are responsible for introducing many of America's 
high-tech products, and the economic benefits of these small 
firms is undeniable. They employ almost 40 percent of the 
country's high-tech workers. In Georgia, over half a million 
working men and women currently are employed in the high-tech 
industry.
    The technology boon of the 1990's fueled the rise of these 
high-tech firms, an industry that has changed the face of the 
American economy. From biotechnology to information sciences, 
these industries have created good-paying jobs, and they have 
provided considerable benefits to Americans of all walks of 
life. We all recognize the significance of these firms, and I 
believe that Congress has to work together to keep 
technological innovation at the top of our agenda.
    For over 20 years, one of the keys to sustaining our 
nation's technology advantage has been the SBA's Small Business 
Innovation Research program, providing between one to $2 
billion a year in grants to start-ups and emerging firms. This 
program has invested over $14 million in Georgia companies. The 
SBIR program plays a critical role in technology development by 
providing small companies with the valuable seed funding they 
need to get their ventures off the ground. This has helped 
thousands of small businesses across the entire high-tech 
spectrum to grow, taking their product from an idea to an 
established technology.
    While the SBIR program provides an important source of seed 
capital, it alone cannot meet the financial needs of these 
emerging businesses. Research and development in the technology 
industry is incredibly expensive, often reaching millions upon 
millions of dollars. In order to fund new research and meet the 
goals of technology development and scientific advances, these 
businesses must have a healthy amount of venture capital. 
Without this vital source of financing, all of the great ideas 
that the SBIR program fosters will never have the opportunity 
to move from the drawing board to the board room.
    Today's hearing will give us an opportunity to look at the 
important role that venture capital plays in the SBIR program. 
It will also allow us to review a current SBA rule that is 
limiting this critical source of financing for America's small 
technology companies, a rule that needs to be revisited.
    In 2003, the SBA set an arbitrary cap on the type of 
investments that small businesses can receive, limiting the 
nation's emerging high-tech businesses' access to SBIR program. 
This rule runs contrary to the goal of the SBIR program, which 
is to assist in the development of technology that will have a 
place in the global marketplace.
    I am sure we can all agree that it is not the intention of 
the SBA to block small firms in the SBIR program form 
succeeding. Clearly, there is a need to ensure that legitimate 
small businesses have access to SBIR awards, but putting a rule 
in place that appears to protect small businesses on the 
surface but ends up only hurting them in the process is not 
good policy. There are no few industries that need the infusion 
of venture capital funding more than small business technology 
sector. If left unchanged, this current rule will have a 
chilling effect on the future of the venture capital and high-
tech industries.
    Today's hearing will give us the opportunity to learn more 
about the nuances of the SBIR program. Those testifying this 
afternoon will present a firsthand account of how important the 
SBIR program is to small businesses, and their testimony will 
show that without proper public/private partnerships, we will 
be denying American small businesses the tools they need to 
grow in today's economy.
    I have invited a fellow Georgian to come testify here 
today. His name is Tony Cruz, and he works for AviGenics, Inc., 
in Athens, Georgia. AviGenics is a biotechnology company that 
is developing therapeutic proteins for oncology infections and 
autoimmune diseases.
    Mr. Cruz, thank you for being here today, and I look 
forward to hearing your testimony.
    Thank you, Mr. Chairman.
    Chairman Graves. Mr. Bartlett?
    Mr. Bartlett. I am very pleased to be here today to welcome 
an old friend, Jere Glover. It is good to see you again after 
many years.
    In a former life, I was a small business person. I ran a 
company for 12 years and met a payroll every Wednesday morning, 
so I know the discipline that small business goes through. I am 
very pleased to be here in Congress today helping to look after 
the needs of small business, clearly the backbone of the 
economy in our country. Thank you, gentlemen, for being here.
    Chairman Graves. We are going to break now. We have 
probably about five, six, seven minutes left on this vote, and 
then there are three, five-minute votes. We will break and then 
come back here immediately, pick up immediately after those 
votes are over. Then we should be clear for the rest of the 
afternoon to have a good hearing. But we will recess for just a 
few minutes, and we will be back.
    [Whereupon, at 2:14 p.m., a recess was taken.]
    Chairman Graves. We will bring the hearing back to order. I 
apologize again for the interruption with votes. Neither I nor 
Mr. Barrow make the schedule, unfortunately, so we have to 
abide by it when votes do come up, and hopefully we are going 
to have plenty of time this afternoon now to work through our 
hearings.
    I want to point out that all of the statements made by 
Members and the witnesses will be placed in the record in their 
entirety, just so everybody knows, and we will start out with 
Mr. Douglas Doerfler, President and CEO of MaxCyte, Inc., and 
also you are here to represent the Biotechnology Industry 
Organization from Gaithersburg, Maryland.
    I appreciate you being here. I know you have come not quite 
as far as some others, but I appreciate it very much. I know 
you all are very busy, and I am glad that you did take the time 
to testify. This is a very important subject. I appreciate you 
being here. I look forward to hearing your testimony.

        STATEMENT OF DOUGLAS A. DOERFLER, MAXCYTE, INC.

    Mr. Doerfler. Thank you, Chairman Graves and Ranking Member 
Barrow. Thank you for the opportunity to testify today on the 
SBIR grant program.
    As you mentioned, I am Doug Doerfler. I am the president 
and CEO of MaxCyte. We are a biotechnology therapeutics company 
located in Gaithersburg, Maryland. I have led professionally 
the development of a number of successful biotechnology 
companies and products over the last 25 years.
    We founded MaxCyte in 1999. We have 20 employees and are 
developing novel therapeutics to treat serious diseases. We 
have one product in Phase I clinical human testing for the 
treatment of patients with leukemia and additional products in 
pre--clinical testing for the treatment of lymphoma, breast 
cancer, and ovarian cancer. These programs are in combination 
with a number of major universities, including Baylor College 
of Medicine, the University of Pennsylvania, and Harvard 
University. MaxCyte was a recipient of a Phase I SBIR grant in 
2003, but we are no longer eligible to participate based solely 
on our source of investment capital.
    Today, I am testifying on behalf of the Biotechnology 
Industry Organization, an organization representing over 1,100 
biotech companies, universities, research institutions, and 
state biotechnology associations, in all 50 states. I want to 
thank the Subcommittee for holding this hearing on the SBIR 
grant program and applaud the introduction of H.R. 2943, the 
Save America's Biotechnology Innovative Research Act, by 
Chairman Graves.
    I ask your permission to submit for the record a letter in 
support of Chairman Graves' legislation signed by 281 biotech 
CEOs from 37 states.
    B.I.O. represents many established companies in the 
industry. Over 85 percent of BIO members are small emerging 
companies with fewer than 500 employees and half with less than 
50 employees. Not surprisingly, the SBIR program has played a 
critical role in providing necessary financing for many of my 
fellow small biotechnology companies.
    Unfortunately, a recent interpretation by the SBA regarding 
eligibility requirements for the SBIR program has prevented the 
majority of BIO members from participating in the program. 
Specifically, beginning in 2003, the SBA Office of Hearings and 
Appeals ruled that companies that were venture capital backed 
in excess of 50 percent were no longer eligible for SBIR 
grants. Prior to this ruling, during the 21 years the SBIR 
program has been in existence, the majority of venture capital-
backed biotechnology companies fully participated in this 
program.
    H.R. 2943 would rectify this problem and allow venture-
backed, small biotech companies to once again pursue their 
innovative and cutting-edge research under the SBIR program.
    By way of background, I would like the Committee to 
understand the unique aspects of the biotechnology industry. 
The average development cycle for a successful biotechnology 
product is 15 years, and only one of five make it from the 
start of Phase I human testing until it is approved. Therefore, 
before most products can become commercially available, years 
of research and often hundreds of millions of dollars are 
required to complete testing, gain product approval, and build 
the necessary manufacturing infrastructure. While there are 
many different funding strategies, the typical form of 
investment in promising, early stage biotechnology companies is 
venture capital.
    In our industry, even the relatively small amount of money 
a company will raise in its first round,--this is called a 
``Series A''--between five and $8 million, generally results in 
new investors, usually a collection, a syndicate, if you will, 
of venture capital funds, owning more than 50 percent of the 
company.
    Therefore, both SBIR and VC funding is necessary to support 
the lengthy and costly clinical development process. Limiting 
government support for biotech R&D risks delaying the discovery 
and development of promising new therapies for cancer, 
diabetes, Parkinson's Disease, and, significantly, many 
diseases where there is less commercial focus, like 
tuberculosis or diseases that would qualify for orphan drug 
designation.
    In fact, according to a recent letter from Dr. Zerhouni, 
director of NIH, to the SBA, which I would also like to submit 
for the record, the SBA's current eligibility rule excluding 
majority venture capital-backed biotech companies, and let me 
quote this, ``undermines 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.'' That is a 
direct quote from his letter.
    While almost all BIO members will need to raise venture 
financing to advance their products toward the marketplace, 
many small biotechnology companies have come to rely upon the 
SBIR program to fund cutting-edge research in areas where 
venture capital and other sources of financing are difficult to 
obtain.
    For example, while a company is working on a lead research 
program, it often comes across a new application or new project 
opportunities that will need to be tested before attempting to 
raise additional funds. These new opportunities are precisely 
the type of research projects that should be eligible for SBIR 
grants. MaxCyte, my company's, project fell into this category.
    During our fund-raising process in 2003, we submitted a 
proposal to NIH to do basic research on our technology and 
expand its capabilities so that one day it may be used for 
biodefense or for pandemic influenza vaccine development. 
Venture funds were not interested in this particular project, 
as it was too early and risky. We received $95,000 in funding 
for our Phase I and subsequently, in 2004, closed a $10.7 
million venture round. We were able to satisfy the rigorous 
milestones of our project, including breakthrough science to 
prove general concept, but we are now not eligible to 
participate in any further funding for this project by the SBIR 
program. Due to this ineligibility, this project has been 
suspended. This is extremely frustrating for us since we 
believe that this project will have potentially a major impact 
on biodefense and in preventing potentially the pandemic flu 
crisis.
    The legislative history makes it abundantly clear that 
Congress intended for the SBIR program to assist small 
businesses in commercializing their creations and products and 
to stimulate small, U.S.-owned firms to produce innovative 
technologies. Congress viewed the SBIR program as providing the 
necessary ``proof of concept'' to encourage venture capital 
investment in promising small businesses seeking to bring 
products from the lab bench to the marketplace. Moreover, 
Congress even created an SBIR Phase II preference for companies 
that attracted venture capital investment by providing special 
consideration in the funding review of Phase II proposals.
    B.I.O. believes that this enormous promise of biotech R&D 
merits exploration and investment on a variety of fronts and by 
spectrum of creative, dynamic, and dedicated entities. 
Biotechnology is a fertile field, from which patients can reap 
huge benefits, if it is supported by both public and private 
investment. The rewards of biotech are limitless unless we 
choose to limit those who can participate in this effort. I 
urge the Subcommittee to favorably report H.R. 2943. I thank 
you, and I am pleased to take any questions you may have.
    Chairman Graves. Thank you very much, Mr. Doerfler.
    Next, we are going to hear from Daniel Broderick, who is 
the managing director of Mason Wells. You are representing the 
National Venture Capital Association from Milwaukee, Wisconsin. 
I appreciate you being here. I might point out to you that we 
generally do give minutes for statements, but I do not adhere 
to that very closely, so if you go over, it is no big deal. I 
am not going to crack any whips or anything. So I look forward 
to hearing your testimony, and thank you for coming today.

         STATEMENT OF DANIEL J. BRODERICK, MASON WELLS

    Mr. Broderick. It is my pleasure to be here. Again, my name 
is Dan Broderick. I am a founding managing director of Mason 
Wells Biomedical Fund, located in Milwaukee, Wisconsin. Mason 
Wells is a small, venture capital fund focused on seed and 
early stage investing in the life sciences in companies located 
in mid-America.
    Today, I respectfully submit testimony on behalf of the 
National Venture Capital Association and those venture-backed 
companies that are developing innovative technologies that 
improve the quality of our lives and raise our standard of 
living. For the last 20 years, the dual financing sources of 
the SBIR program and the venture capital community have allowed 
many of these promising companies to conduct ground-breaking, 
scientific research while simultaneously building viable 
businesses that will bring these innovative products to the 
marketplace.
    Venture capital is the investment of equity to support the 
creation and development of new, growth-oriented businesses. In 
terms of global competitiveness, the entrepreneurial segment of 
the economy is the true differentiator in America. U.S. 
companies originally funded with venture capital, like 
Genentech and Amgen, now represent 11 percent of our annual GDP 
and employ over 10 million Americans.
    There appears to be a misunderstanding that venture capital 
firms are large corporations that control the small start-up 
company by having a majority control over the company's board. 
It is important to understand the organizational structure of a 
venture capital firm, its limited partners, and the 
relationship between the VC firm and the portfolio company.
    Private venture capital funds are organized as limited 
partnerships and are managed by general partners. The general 
partners, like myself, are the individuals staffing the venture 
capital firm. They are responsible for and control all aspects 
of the fund's operations, including making the investment 
decisions. The venture capital funds are small organizations. 
In fact, the average number of general partners in any one firm 
in the United States is only 10. The investors in these limited 
partnerships are usually pension plans, foundations, trusts, 
and accredited investors, and they are called limited partners 
because they are limited from liability because they exert no 
control in the day-to-day operations of the VC fund, they do 
not participate in setting the strategic direction of the fund, 
and they take no role in making the investment decisions.
    The limited partners' investment in a venture capital fund 
is not a revenue stream for the fund; rather, the money that 
LPs invest in a venture fund are to make investments in 
portfolio companies and as loans to fund the day-to-day 
operation of the fund. These investment dollars and loans must 
be repaid by the venture capitalist before the firm can then 
profit.
    Based on my experience, the great number of companies that 
I see have established a board of three to seven members prior 
to any venture capital involvement. Members of these boards 
comprise founders, management, investors, and industry experts. 
Once a venture capital firm is involved, most boards slightly 
increase in size, with members representing the same groups of 
people. Each vote on the board is equal, and it is the 
fiduciary duty of each individual board member to act in good 
faith and in a manner to be in the best interest of the 
corporation. The groups involved generally do not vote as a 
bloc; rather, each member votes their own conscience.
    I would also like to briefly address the relationship 
between corporate venture capital and traditional venture 
capital firms, as outlined above. Typically, corporate venture 
capitalists play a different role than a traditional venture 
firm. They generally only co-invest alongside a traditional 
firm and usually do not take a board seat. They also generally 
own less than 20 percent of the portfolio company because of 
corporate-reporting rules. Furthermore, corporations manage 
only 4 percent of all venture capital under management.
    So why do venture capital firms care about SBIR grants? For 
the last two years, portfolio companies have continually 
alerted the NBCA to situations in which an SBIR grant has been 
denied because they have venture investors. Many of these firms 
were caught by surprise because this program has been working 
well for 20 years.
    It is paramount not to confuse the role of venture capital 
funding with the role of basic R&D funding. Both are critical 
to bringing innovation to the marketplace; however, basic 
research funding is targeted at discovery and invention. It is 
this type of activity that the SBIR program has historically 
supported. Venture capital dollars, even those labeled early 
stage, are used to build a strong and viable business so that 
promising discoveries can be brought to market.
    Some would argue that if a company receives venture 
capital, that it has hit the lottery and does not need 
government funding. Nothing could be further from the truth. In 
the life sciences sectors, the cost and time associated with 
bringing a discovery to market is colossal. Multiple rounds of 
financing at millions of dollars per round are required.
    The cost of bringing a new drug to market is about $800 
million. Young biotechnology companies cannot divert precious 
venture capital funds earmarked for business growth to embark 
on new research projects, although these projects may hold the 
next ground-breaking treatment for Alzheimer's, cancer, or 
other diseases.
    Another belief is that venture investment only impacts 
select regions of the country. To the contrary, venture capital 
is a national phenomenon. While Massachusetts and California 
are the leading regions for venture capital investment, VC 
dollars have been flowing to all 50 states over the last 20 
years and have directly benefitted regional economies across 
the country. Ironically, however, the SBIR program eligibility 
rule hurts the low-tech regions it is trying to support.
    Mid-America is one example where investing in early stage 
technology companies is difficult because of the smaller 
percentage of venture capital investment. From my experience as 
the founder of the Mid-America Health Care Investors Network, I 
know the inability of small businesses to compete for and 
receive SBIR funds is of particular concern to venture-backed 
companies in mid-America. The ruling that disqualified VC 
finance companies from competing for SBIR grants removed an 
essential source of financing, causing R&D at many technology 
companies located in mid-America to slow or stop altogether.
    A way to ensure the ongoing success of the SBIR program is 
to reopen it to the broadest and most qualified base of small 
businesses possible. This requires allowing venture finance 
companies to compete once again.
    Since SBIR's inception some 25 years ago, venture capital 
and SBIR funding have been proven to work together to research, 
commercialize, and distribute innovative products on an 
accelerated basis. Recently, Congressman Graves introduced 
legislation that clarifies SBIR eligibility requirements for 
venture-backed, start-up companies. NVCA applauds this effort 
and encourages quick action on this legislation, and we look 
forward to working with the Committee to address this spiraling 
problem, and I thank you all for the opportunity to express my 
views.
    [Mr. Broderick's testimony may be found in the appendix.]
    Chairman Graves. Thank you, Mr. Broderick.
    Next, we are going to hear from Barry Michael, who is 
President of B.A. Michael Consulting and here with the Small 
Business Technology Council from Clifton, Virginia. I 
appreciate you being here. Thank you very much.

      STATEMENT OF BARRY MICHAEL, B.A. MICHAEL CONSULTING

    Mr. Michael. Good afternoon. My name is Barry Michael, and 
I head a consulting company whose primary focus is life science 
start-up companies in the Mid-Atlantic region of the U.S.
    My business career began in 1972, after serving as a Naval 
Supply Corps officer during Vietnam. I have been part of the 
health care industry for the last 23 years. Many of these 
years, I worked for two major Fortune 100 health care 
companies. However, since 1993, I have worked primarily with 
start-up companies, with my focus including finance, strategy, 
tactics, and marketing. I have an engineering degree from Brown 
University and an M.B.A. from Wharton.
    I am here today to support the small start-up company. I 
believe that it would be bad policy to expand the current 
criteria for SBIRs to include large, venture capital, majority-
controlled start-ups.
    I have worked closely with four different organizations 
that have had SBIRs awarded by the NIH. I believe that it is 
important to note their collective stories. SBIRs were critical 
as they formulated start-up strategies, developed products, and 
matured as businesses. For the purposes of perspective, I have 
also played a key role in a majority-controlled, venture-
backed, biotech start-up. Therefore, I am at least somewhat 
aware of the fundamental differences, both financial and 
strategic, of these two types of start-up organizations.
    Venture capitalists usually think in terms of investing 
several millions of dollars. They represent very sophisticated 
investors who demand that the VCs hit their specific financial 
targets and have specific timelines for success. Early, small, 
science start-ups almost never meet these conditions and thus 
almost never qualify for VC funding in their early stages when 
it is most critical financially and strategically. Their risks 
are too great, their timelines too long, and their management 
teams are still too unproven. But this unproven group is still 
taking the personal risk, and they represent one of the crucial 
ways that important life science breakthroughs can start.
    When a person or a group of persons starts to develop their 
life science idea or invention, they are faced with daunting 
technology, market, and finance challenges. They will rely on 
their creativity and technical training to develop their idea, 
but usually they have to learn product development, business, 
and finance until their idea is proven.
    Most of these life science companies are so unproven or so 
clearly risky that established companies shy away from 
supporting them until the data show some glimmer of hope. SBIRs 
support the generation of that data. The NIH also provides 
valuable feedback to SBIR applicants, and if the proposal does 
not make it the first time, it may make the grade when 
resubmitted. Getting an SBIR Phase I contract award represents 
important validation. Getting a follow-on Phase II, like one of 
the companies that I have worked with, makes it possible to 
undertake follow-up studies, and theirs was a medical device 
clinical study.
    Many small start-ups plan to become competent enough to 
eventually be eligible to be financed by venture capitalists, 
both large and small. In the meantime, however, these start-ups 
have to rely on savings, spouse's income, friends and family, 
second mortgages on their homes, angels, and, most importantly, 
SBIRs to provide critically needed seed capital. SBIRs provide 
a significant percentage of this early financing effort. Small 
start-up companies typically generate several hundred thousands 
of dollars in funding. Funding for large, VC-controlled 
companies, when it is available, would be on the order of 
several million dollars.
    Currently, the 2.5 percent of the NIH budget allotted to 
SBIRs creates a zero-sum game. Adding more types of eligible 
organizations that could threaten the current environment that 
very properly benefits the early, small, life science start-up 
company is something I would not recommend. These life science, 
young, start-up organizations represent the ongoing start of 
our country's innovation process. Said another way, in three of 
the four start-up companies I have personally worked with, 
there would not have been a company and a development effort if 
it had not been for SBIRs. None of these organizations were 
even remotely mature enough to qualify for VC investment, but 
their creativity and entrepreneurial spirit needed a chance.
    Changing the current criteria to allow SBIR participation 
by large, venture capital-majority-controlled start-ups would 
be a major detriment to the life science start-up community. 
Bringing in new players with deep pockets will divert the 
current pool of money away from small start-up companies. These 
early stage companies will be faced with even greater 
challenges.
    Yesterday, the Small Business Technology Coalition released 
a survey of companies that received SBIR awards from the NIH. 
This survey is attached to Mr. Glover's statement for the 
record. Please note that nine out of 10 of these companies 
oppose giving large VCs greater access to the SBIR program 
funds. We are told that these companies are among the likely 
beneficiaries if large VCs are allowed to play a greater role. 
Yet these supposed beneficiary companies clearly oppose greater 
large VC involvement in the program.
    While preparing this talk, I had an interesting comment 
from an expert in the public financial markets. He said, ``I do 
not understand the issue. Venture-backed-capital companies 
already have their money.'' In fact, as noted in my attachment, 
they have $53 billion currently available to invest, and they 
cannot figure out how to invest it. Thank you.
    Chairman Graves. Thank you, Mr. Michael.
    Now we are going to hear from Jere Glover, who is the 
Executive Director of the Small Business Technology Council. 
Jere, thanks for being here today. I appreciate it.

STATEMENT OF JERE W. GLOVER, SMALL BUSINESS TECHNOLOGY COUNCIL, 
                        BRAND LAW GROUP

    Mr. Glover. Thanks for inviting me, Mr. Chairman, Ranking 
Member. Jere Glover, executive director of the Small Business 
Technology Coalition. I have over 27 years of experience in 
small business innovation. I served as chief counsel for 
advocacy under President Clinton.
    Let me start by saying that prior to enactment of the SBIR 
program, small business was virtually excluded from the federal 
R&D funding. This is true despite clear evidence that small 
businesses were more successful and more efficient at 
innovating than large firms.
    This program is a magnificent success, widely praised, 
yields thousands of patents and billions of dollars in 
technology since 1992. It has had nine favorable GAO studies. 
SBIR companies are successful in commercializing their 
technologies to the extent of 40 percent, much better than even 
venture capitalists have been. It has worked so well that in 
its 20-plus years of existence, there have been very few and 
minor changes made to this legislation. It is not broken, and 
this fix is not needed.
    The emphasis of the SBIR program is on early stage 
innovations and technologies, an area of little interest to the 
venture capital community. Less than 2 percent of venture 
capital investments last year went to early stage and seed 
investments.
    There are four facts that are lost in this debate. First, 
Phase III specifically is designed to encourage and facilitate 
VC partnerships and investment in SBIR companies. Two, small 
venture capital companies can today own a majority interest in 
an SBIR company and that company remain eligible. Three, large 
venture capital companies can own 49 percent of an SBIR company 
without it creating a problem. And, finally, SBA is currently 
involved in the regulatory process on this very specific issue.
    Where SBA has drawn the line is on allowing venture capital 
to own and control a majority interest in a small business SBIR 
company. This is based on Congress's core definition of a small 
business established more than half a century ago. A small 
business is one that is independently owned and controlled, 15 
U.S.C.  632. There are numerous laws and regulations 
that are driven by that phrase and that provision. It is a very 
important underpinning of the Small Business Act. To my 
knowledge, this is the first time in the history of the SBA 
that Congress has been asked to redefine ``small business'' to 
include large businesses and companies that are owned and 
operated by them.
    When this issue first came up, I surveyed the SBTC Board of 
Directors. They were unanimously and vehemently opposed to 
allowing venture capitalists to own and control SBIR companies. 
I later surveyed SBTC's membership, as well as SBIR 
participants, in a number of national SBIR meetings, always 
with the same results: Small businesses oppose the change in 
the definition to allow venture capital-owned and controlled 
companies to compete in the SBIR program.
    Recently, we surveyed the NIH awardees. We referred them to 
BIO, the industry association, Web site where their position 
paper was located as well as referred them to ours. We then 
asked them the questions. Ninety percent opposed. This was true 
even when we asked the question about whether it was owned by 
institutions and pension funds.
    In SBA's rule-making proceeding, there were a number of 
very interesting questions asked. Let me just mention those. 
Will the change in allowing venture capital-owned and 
controlled companies in the SBIR program shift the program 
emphasis to lower-risk technologies that are closer to the 
marketplace? Will it increase concentration in states like 
California and Massachusetts? Forty-six percent of venture 
capital money goes to California. Will it change the profile of 
successful and unsuccessful SBIR companies, and will it lead to 
calls for other changes to allow universities and large 
businesses in the SBIR program? I think the answer to all of 
those is yes.
    These questions are very important, and I think they must 
be answered before Congress goes forward with such a radical 
change to a very successful program.
    I wonder why SBA was not asked to present its views at this 
hearing. They certainly have the expertise, and with thousands 
of comments and dozens of field hearings, I think SBA should be 
heard.
    The SBIR program is extremely competitive. For every 
company that receives an SBIR award, there are five to seven 
companies that have put in proposals that are not funded. This 
is especially true at NIH, where last year they received a 
thousand more proposals than the year before. There were 5,000 
companies last year that submitted proposals to NIH that were 
not funded. Many ranked top, outstanding in science and 
technology, but there simply were not sufficient funds at the 
NIH to make the awards. Make no mistake: For every VC-owned 
company that receives an award, there will be a small business 
with outstanding technology that will go unfunded.
    I fear that if the Small Business Innovation program is 
opened to venture capital-controlled companies, universities 
and large firms will try to make the same arguments, thereby 
defeating the underlying purpose of the SBIR Act, which is to 
make sure that small business has access to federal R&D 
funding.
    The bill will result in increased geographic concentration 
of the SBIR program. As I mentioned, 46 percent of venture 
funds go to California. Ten states get 85 percent of venture 
funds. Having to compete with ventured-owned companies places 
small businesses and other states at a competitive 
disadvantage.
    We are not unsympathetic to the concerns raised by BIO and 
the National Venture Capital Association. We have supported 
programs, such as the ATP program and the MEP program, that are 
not targeted for small businesses. At the Science Committee, it 
was suggested that there needs to be a program for a large VC 
and even large businesses to use the remaining 97 and a half 
percent of federal R&D to help them commercialize new drugs and 
new technologies. We are open to such a proposal. Our objection 
is to having funds for large businesses and VC-owned firms come 
out of the very limited funds that are available exclusively 
for small business. Thank you for allowing me to testify.
    [Mr. Glover's testimony may be found in the appendix.]
    Chairman Graves. Thank you, Mr. Glover.
    I will turn it over to Mr. Barrow to introduce Mr. Cruz.
    Mr. Barrow. Thank you, Mr. Chairman. With me today is a 
fellow Georgian to testify in today's proceedings. His name is 
Tony Cruz. As indicated before, he works for AviGenics, a 
company in Athens, Georgia. AviGenics is a biotechnology 
company that is developing therapeutic proteins for the 
treatment of oncology infections and autoimmune diseases. Mr. 
Cruz, thank you for being with us. I look forward to hearing 
your testimony.

         STATEMENT OF ANTHONY P. CRUZ, AVIGENICS, INC.

    Mr. Cruz. Thank you. Chairman Graves, Ranking Member 
Velazquez, Ranking Member Barrow, and Committee members, Good 
afternoon. My name is Tony Cruz. I am the senior vice president 
of finance and administration at AviGenics. Before my 
involvement with the biotech industry, I served at active duty 
for five years as a captain in the U.S. Air Force, and I am 
thrilled to be a part of this democratic process.
    On behalf of AviGenics and the biotech industry, I wish to 
thank members of this Committee for this opportunity to present 
my comments on the recently imposed obstacles which prohibit 
small biotechnology companies like AviGenics from participating 
in the SBIR program.
    AviGenics is an up-and-coming biotechnology company located 
in Athens, a small town about 90 minutes from Atlanta. Our main 
offices and labs are located on the University of Georgia 
campus, and we are well integrated with the university's 
efforts to attract technology companies and to generate high-
skilled, high-paying jobs for that area. AviGenics employs 
about 50 very highly skilled scientists, technicians, and 
specialized farm workers. Currently, Athens is better known for 
the university's football program rather than its expanding 
base of high-technology companies. We hope that one day Athens, 
Georgia, will be recognized as much for its biotech excellence 
as the Georgia Bulldogs are for their football prowess.
    This is an urgent issue. The SBIR and access to the SBIR 
funding can determine the future of this and other companies 
within the Athens area, including whether or not we survive in 
the near term.
    AviGenics is not a subsidiary, nor is it a spinoff of a 
large pharmaceutical company. We are an independently owned and 
operated technology company dedicated to developing therapies 
for infectious diseases and cancer. The company's core 
technology is targeted specifically at producing protein-based 
therapies which are safer, more effective, and more affordable 
than those currently available on the market.
    AviGenics's approach is somewhat different from the 
majority of the biotechnology industry in that we utilize 
modern research tools as well as traditional agricultural 
expertise. Specifically, our technology combines state-of-the-
art molecular biology with Georgia's well-established poultry 
expertise to produce modern medicines at low cost in using 
chicken eggs as the core of our technology.
    The value-creation cycle as experienced by the company over 
the last few years is very similar to those experienced by 
other biotechnology start-ups. Financial support from a 
combination of federal grants, including the SBIR program, and 
venture capital funding has been critical for the survival and 
growth of AviGenics up to date.
    In the foreseeable future, SBIR funding will continue to be 
critical for technology development and preclinical testing of 
our products. SBIR funding and other federal grants make it 
possible for the company to establish a proof of concept for 
its base technology, and venture funding allows development of 
these specific products through very expensive clinical trials 
and the regulatory approval process.
    Only by demonstrating proof of concept of our technology 
were we able to attract VC investment and thus then were able 
to hire new employees, pursue activities required for 
development of a lead product, and complete human clinical 
trials. Future expansion of AviGenics relies heavily on SBIR 
and other federal monies being available to develop proof of 
concept for the next set of technologies and future product 
candidates. This next set of technology validation will 
hopefully lead to more VC funding, which, in turn, will further 
hiring and completion of other clinical studies.
    Early in the company's history, attempts were made to 
secure financial backing from industry to develop and validate 
the core technology. A cross-section of large pharmaceutical 
companies and established biotechnology companies were 
approached with an unproven concept of making low-cost and 
improved drugs through an unconventional technology, i.e., 
production of therapeutic proteins in chicken eggs.
    The message from industry to AviGenics at that time was 
loud and clear: Come back when you can show us your technology 
works. The industry declined to fund the basic research, even 
when the promise of making drugs cheaper, better, faster, and 
safer was there. Funding from government research and a few 
angel investors was then necessary to reach the initial proof 
of concept for our technology. Then and only then was the 
company able to attract significant funding from VC firms, 
eventually leading us to where we are now, a 50-person company 
about to enter Phase II clinical trials.
    In 2004, AviGenics completed a U.S. FDA-approved, Phase I 
human clinical trial for its lead compound to treat an 
insidious infectious disease. The data from the initial study 
suggests that our drug performs just as well or better and is 
safer than what is currently on the market. Furthermore, this 
drug will cost less than half of what it costs for a similar 
therapy today. Of course, more extensive human clinical trials 
are required for market authorization, but AviGenics's 
technology offers a significant promise to millions of patients 
who do not benefit from or cannot afford the currently 
available therapies.
    Advancing our innovative technology to the point where we 
were able to initiate clinical evaluation was a path fully 
loaded with technical risk. This initial technology development 
took over four years as several different technical approaches 
had to be utilized without the SBIR grants or other federal 
funding.
    It is important to note that even with the completion of a 
Phase I study for our lead compound, federal funding continues 
to be necessary for the company as we must continue to develop 
future products for other disease areas. Specifically, federal 
research grants are needed for technology-improvement projects, 
such as developing more effective and efficient ways to apply 
genetic engineering techniques.
    According to the recently imposed eligibility standards, a 
business must be at least 51 percent owned and controlled by 
individuals who are citizens of the U.S., and the company may 
not have more than 500 employees, including affiliates. The 
SBA's current interpretation of ``individuals'' excludes 
venture capital funds. As a result, AviGenics is ineligible for 
future SBIR funding.
    I believe AviGenics is a case study of what the SBIR 
program can do. Like I said, we currently employ close to 50 
full-time employees, most of whom are highly educated and 
skilled. With SBIR and federal grants early in its history, our 
company was able to secure VC funding and thus initiate human 
clinical trials. We look forward to the day that our technology 
and hard work will result in affordable, effective therapies 
for those stricken with hepatitis, AIDS, cancer, or other 
ailments.
    AviGenics strongly supports BIO's recommendation that the 
SBA adopt the rule that addresses the actual ownership 
structure of small biotech countries that are owned and 
controlled by venture capital companies. Since 1982, when the 
SBIR program was created, up until 2003, majority VC-owned, 
biotech companies were allowed to compete for SBIR grants. 
Specifically, we count on you to support this bill. Thank you.
    [Mr. Cruz's testimony may be found in the appendix.]
    Chairman Graves. Thank you, Mr. Cruz.
    I am now going to recognize Ms. Velazquez, who is the 
Ranking Member of the full Committee. It is a pleasure to have 
you here. Thank you for coming for a statement.
    Ms. Velazquez. Thank you, Mr. Chairman, and I would like to 
make an opening statement so that the record reflects my 
concerns about the SBIR program and the importance of venture 
capital and the role it plays in our economy. So I want to 
thank you for allowing me to make my opening remark.
    We rely heavily on this nation's technology sector to 
advance us forward and to create the next generation of 
innovations that will carry us into the next century. Over the 
past two decades, small businesses have become the dominant 
employer of high-tech innovators, producing 55 percent of all 
new technological developments. Clearly, if this nation is 
going to continue striving forward in the fields of science, 
engineering, and computers, then we must be investing in these 
businesses. This is where the SBIR program comes in.
    This program plays a critical role in enabling 
entrepreneurs with bright, innovative ideas in the technology 
field to receive the valuable seed funding they need to start 
and grow their businesses. The SBIR program is vital in 
empowering high-tech, small firms to obtain their end goal: to 
profit from its commercialization. However, the SBIR program 
needs some assistance when it comes to providing high-tech, 
small firms with the capital they need. That is why venture 
capital plays a vital role in turning innovative dreams into 
reality.
    There is no doubt that the applied research in the high-
tech industry is an expensive one. An example of this is in 
biotechnology and drug research where it is estimated to take 
$800 million and at least a decade for product development, 
testing, and movement to the market. Clearly, this is something 
that the SBIR program cannot finance alone. We need to ensure 
that there is a balance in getting venture capital to these 
aspiring technology firms. It is simply not a valuable option 
to limit the ability of small businesses to access one of their 
most significant resources: venture capital.
    These businesses represent the next wave of innovations, 
and placing an arbitrary cap of 49 percent, as SBA proposed, on 
the investment they can receive will only hinder their ability 
to grow and develop. SBA's proposal simply takes opportunity 
away from high-tech, small firms wanting to make their way in 
the global marketplace.
    There are many ways to ensure that this program truly 
maintains its focus on this nation's entrepreneurs without 
limiting their ability to access venture capital. These 
protections have already proven successful in other SBA 
programs. There is no reason why we cannot offer similar 
protections to the SBIR program. The issue here is that the 
need for venture capital within the technology sector is 
greater than ever.
    Our nation simply cannot afford to have a policy that 
withholds venture capital investment from high-tech, small 
firms. The SBIR program clearly plays a vital role in 
empowering this nation's small business technology sector. 
However, without an adequate public/private partnership, its 
capabilities will be severely hindered. That is why it is 
important that any change to this program is guaranteed to 
maximize technological developments. A proposal that would only 
hold small firms back and rob them of available venture capital 
investment is simply not a good policy.
    Without the resources offered through the SBIR program and 
adequate venture capital investment, small businesses will 
never have what they need to spur high-tech innovation and 
development in order to move this nation forward for 
generations to come. Thank you, Mr. Chairman.
    Chairman Graves. Thank you, Ms. Velazquez. I appreciate it 
very much.
    We are going to start with questions, and my questions, I 
guess, anyone could answer. I would be interested in hearing 
what all sides have to say about it, but one of the concerns 
with opening this back up is when a venture capitalist becomes 
a majority owner of a business, do they assume day-to-day 
control of the business, or--I might even rephrase that 
question--can they assume day-to-day control of your business? 
We will just start.
    Mr. Doerfler. We just completed our first venture capital 
financing round, so I am pretty intimately familiar with this 
one.
    First of all, there was no single venture capitalist that 
owned more than 15 percent of our company at any given time. We 
put a syndicate together, and I am not aware of any company in 
our industry, the biotech industry, that is owner controlled by 
a single entity. The VCs came in as a syndicate. We were very 
careful, I think as was just mentioned, that we created a board 
of directors that was majority controlled by non-VCs to ensure 
that the control of the company was not in any group's hands. 
Management controls day-to-day operations, the board controls 
the company itself, and the shareholders obviously can appoint 
the board members.
    Now, there is a shareholder agreement that most companies 
have--I believe virtually all companies have--that prevents any 
single VC from controlling the organization. The other members 
of the VC syndicate would not allow that to happen. So there is 
an inherent check and balance in our system to ensure that not 
one party will control the operations, certainly not control 
the day-to-day operations, of an organization.
    Mr. Broderick. I would like to respond as well. It 
certainly is not what the venture capitalist even wants to do, 
is to control the day-to-day operations of a corporation. What 
we try to do is we try to find talented management to take care 
of that responsibility. They have the skill sets to do that. 
They have the experience generally to run the day-to-day 
operations of the company. Were we to have to step in to run 
the company day to day, it would be a bad situation. It would 
be probably a distress situation, and we would probably even 
then hire experts to come in and take over the orderly 
dissolution of that corporation.
    As for controlling the company from the board of directors, 
it is our fiduciary responsibility as a member of the board of 
directors to act in the best interests of all of the 
shareholders involved for the purpose of increasing shareholder 
value. In all of the board memberships that I am aware of, each 
member has an independent vote. There are no side agreements: 
You vote my way. There are no club rules: I will vote for this 
if you will vote for that. Each member has a fiduciary 
responsibility to vote his own conscience on each issue as an 
individual.
    Chairman Graves. Mr. Michael?
    Mr. Michael. I think that there are times when a VC-
controlled or nearly controlled company is going to be 
frustrated about management's desire to take on new projects, 
and so although that is not possibly your definition of ``day-
to-day control,'' most energetic, creative scientists will 
often want to start new projects, and they will often be 
excluded from doing those projects unless they can get access 
to an SBIR grant. So that is a form of day-to-day control, and 
I think that happens fairly often.
    Chairman Graves. Mr. Glover?
    Mr. Glover. Most legal, underlying documents do provide the 
ability for the venture capitalist to take control if certain 
events do not happen or if certain things do not happen. To the 
extent the venture capitalist owns over 50 percent, 
collectively they have the option at any time to elect a new 
board, control that board, and make the decisions.
    The SBA's size-determination rules for this and all other 
small businesses have always looked at the potential to 
exercise that control, whether it has actually been exercised 
or not. Legally, they will have the right to exercise that 
control, and SBA, to protect small businesses from that 
eventuality and to make sure that companies are legitimately 
small businesses, do look at the control issue, and they do 
look at the underlying documents, and, in most cases, those 
documents do provide sufficient opportunities for the majority 
holders to exercise those controls.
    Chairman Graves. Mr. Cruz?
    Mr. Cruz. Just a short addition. In our case, at AviGenics, 
we are majority VC controlled; however, there are over 10 
different funds that own that majority, and it is very, very 
difficult for any one fund to actually exert control over the 
company. As was said before, there are underlying legal 
documents that provide the distribution of decision-making 
throughout all of the funds, as well as the management team and 
other common shareholders.
    Chairman Graves. Mr. Barrow? Ms. Velazquez?
    Ms. Velazquez. Thank you, Mr. Chairman. Thank you, Mr. 
Barrow.
    Mr. Broderick, I have a question, in particular, about how 
we can balance the need to allow increased venture investment 
versus protecting small businesses. If we had a structure in 
place that would allow venture capital companies to have an 
interest of up to 50 percent or more, if necessary, but made it 
clear that the day-to-day operations of the company rested with 
the small business owner and provided the investor the ability 
to step in and assume operations only if the company was in 
trouble, do you think this is something you could support?
    Mr. Broderick. Thank you for the question. I believe that 
that is generally how the companies are operated today. There 
is a board of directors that is responsible for the control of 
the company, if you will, and we would be happy to work with 
you on evaluating that possibility, and, I think, look forward 
to doing that.
    Ms. Velazquez. Thank you.
    Mr. Doerfler, if we limit the amount of venture capital 
small biotechs can receive, where will they turn for financing?
    Mr. Doerfler. The question is, if we limit the amount of 
money we can bring in from venture capital. Well, the venture 
capital industry is perfectly suited to support the kind of 
work that we are doing because it is very high risk.
    Ms. Velazquez. I am referring specifically, if we put a cap 
like SBA wants to do.
    Mr. Doerfler. Well, we will not be able to participate in 
SBIR. We, frankly, will not be able to do that, and investors 
will not come into the company unless they can invest as much 
as they want to and as much as the company needs to make it 
happen. If that cap continues, we will not participate in the 
program. It is that simple. It just is not worth our time to 
try to get around that.
    Ms. Velazquez. So will this cause small businesses to 
choose between the SBIR or venture capital?
    Mr. Doerfler. Well, it will definitely be venture capital, 
not SBIR. We have no alternative. We would have to go with 
venture capital because, in my particular instance, our funding 
is 98 percent VC funding, and a very small amount is SBIR 
funding, and that is what we are doing for additional projects.
    Ms. Velazquez. So what will that mean in terms of the 
biotech industry regarding development?
    Mr. Doerfler. I think that the biotech industry will walk 
away completely from the SBIR program. We are not able to 
participate.
    I think there is another consequence to this. If companies 
like ours, like mine, for instance, who have demonstrated the 
ability to develop technology, do not participate in the SBIR, 
that SBIR program will lose its competitiveness. It will not be 
worth what it was before. There is a competitive spirit there. 
It raises the level of play, and if you have got a number of 
players that cannot participate, it lowers the relevance of 
that program and the overall portfolio of companies and 
entities that can help NIH.
    So I think it is going to have a major effect. It will not 
have an effect on the industry as much as it is going to have 
an effect on the program and eventually NIH.
    Ms. Velazquez. Would you like to comment, Mr. Broderick?
    Mr. Broderick. Just one thing. Where would the 
biotechnology company go for money if they do not go to the 
venture capitalist? And I do not know. I do not think there is 
a choice. They would not be funded. They would go out of 
business, or they would continue to just get grant after grant 
after grant and never commercialize anything.
    Ms. Velazquez. Thank you, Mr. Chairman.
    Chairman Graves. Mr. Bartlett?
    Mr. Bartlett. Thank you very much. For the record, let me 
ask, if I am a small business company, and I get an SBIR, and 
if, in the process of the work on that, I come up with an 
innovation which is patentable, who owns the patent?
    Mr. Glover. You would, sir. The SBIR company retains patent 
rights under the Small Business Innovation Act.
    Mr. Bartlett. Okay. Thank you. If I am a small company, and 
I attract venture capital to a project, is that committed to 
the project or to my company? Can I separate the project from 
the company, or is it given to the company?
    Mr. Broderick. It is based on what is given to the company 
in general to have the company carry out the business plan, 
which includes a product development plan that the company has 
come up with, vetted, and otherwise had it reviewed by experts, 
and the venture capitalist will put the money inside the 
company to support that business plan--
    Mr. Bartlett. I understand that under the present rules, if 
I am that small business company, and I have an idea that 
attracts venture capital money, that if more than half of my 
resources are venture capital money, then I cannot now apply 
for an SBIR for another idea I have. That is correct?
    Mr. Doerfler. That is correct. That is my understanding.
    Mr. Bartlett. By the way, I would like to ask Mr. Doerfler, 
do you own and control over 50 percent? I think you answered 
that. You own and control about 2 percent of it.
    Mr. Doerfler. Do I personally?
    Mr. Bartlett. Yes.
    Mr. Doerfler. Less than 1 percent.
    Mr. Bartlett. Less than 1 percent. Okay. I just wanted to 
get that on the record.
    Mr. Glover, you indicated that there is not now anywhere 
near enough money to support the good proposals that come in to 
NIH for SBIR funding. Is that correct?
    Mr. Glover. That is correct, sir.
    Mr. Bartlett. Okay. So we have two things here which appear 
to be in tension. One is small companies that have one good 
idea or maybe two or three, and they acquire venture capital 
funding, which now disqualifies them for SBIR, but, you know, 
this engine of creativity is not going to be limited to one or 
two.
    I, in a former life, ended up with 20 patents, for 
instance. If I was pursuing one of those with venture capital 
money, then I could get no more SBIR money for one of those 
other ideas that I had. So that is on the one hand. We now have 
an idea that is going to add something of value to our economy. 
It is going to employ people. They cannot get any SBIR money, 
and the venture capital people, in spite of their name, are not 
really venturous, and they are not going to put any money out 
for this, and so now my idea goes begging because I cannot get 
any money.
    On the other hand, we have legitimate small businesses 
where the owner controls more than 51 percent of it, and there 
is not even enough money to go around to fund the good SBIR 
projects there. Is that correct?
    Mr. Glover. That is correct.
    Mr. Bartlett. Okay. Well, it seems to me that the solution 
to this problem is not to further dilute the effectiveness of 
that money by now spreading it over a broader field. It seems 
to me we need another program or an additional pot of money to 
fund those entrepreneurs who happen to have been successful 
enough to attract venture capital money and now have an 
additional idea that they want funded. You know, it just does 
not seem to me to be productive to go to the same well which 
already does not have anywhere near enough money in it to fund 
those for whom the program is currently specified. Is that 
correct?
    Mr. Glover. That is correct, sir.
    Mr. Bartlett. Okay. Help me understand why it makes any 
sense to try and dilute the effectiveness of that money by 
spreading it over a larger field.
    Mr. Glover. It does not, but I think, as I said, I 
sympathize with the Biotech and Venture Capital Association. 
There needs to be a program to take these companies, but it 
should not come out of the small business pot. We fought too 
hard to establish that small business preference.
    Mr. Bartlett. They may still be small businesses, if I 
might, but they should not come out of this pot--
    Mr. Glover. That is correct.
    Mr. Bartlett. --because this is the pot that is designated 
for small businesses, just start-up, more than 51 percent owned 
by the person. I agree that there needs to be another pot of 
money and another program somewhere for these others, but I 
cannot see the value of diluting unless we are going to pour a 
whole bunch more money into this, and then you could not be 
sure it is going to the right place because we have two very 
different entities here vying for the money, do we not?
    Mr. Glover. We do, indeed.
    Mr. Bartlett. Okay. One is an itty-bitty start-up company, 
and these other companies that could be not-so-itty-bitty 
start-up companies. Thank you very much.
    Mr. Doerfler. Dr. Bartlett, may I?
    Mr. Bartlett. Yes, sir.
    Mr. Doerfler. My company, before we received venture 
capital, was 17 employees. We are now 20 employees. So I think, 
by any measure, we are still a small company. I do not think it 
really made a difference how we got our financing, and the 
program worked fine for 21 years.
    This change that happened a few years ago changed the 
eligibility and forced companies like mine, who had a good 
idea, who actually invented something, based on SBIR, put in a 
patent application. We are very hopeful we are going to be able 
to get that patent, we are ready to go for a Phase II, and we 
think it is going to be important, but we cannot participate 
now because we have a different form of funding. And we are 
still, in my mind, at least my wife's mind, a very itty-bitty 
company.
    Mr. Bartlett. I am very sympathetic to your dilemma, and 
there ought to be a program there for you, and there ought to 
be money there for you, but if this present program does not 
have enough money for the people who are now in the program, I 
am having some trouble understanding how we make the situation 
better by making the field larger so that there is going to be 
now even a smaller percentage of worthy projects that get 
funded.
    I think that what our role ought to be, our goal ought to 
be, is trying to find more money in another program so that 
your second and third and fourth ideas can get the same kind of 
SBIR funding that your first one got.
    Thank you very much, Mr. Chairman.
    Chairman Graves. Mr. Barrow?
    Mr. Barrow. Thank you, Mr. Chairman. I want to pick up on 
Dr. Bartlett's comments by coming at it from a different route 
because, on the one hand, you have got a new definition that 
makes the field of eligible participants smaller than it has 
been over the last 20 years than commonly understood to be. So 
now, all of a sudden, we have got a new order of things in 
which a more expansive definition had a larger field of 
eligible participants based on their internal organization 
structure vying for a piece of the same pie.
    I certainly agree with Dr. Bartlett that to the extent we 
can provide more resources, we should do so, but unless and 
until we are prepared to do that, the question then becomes, 
how large should the field of eligible participants be? And the 
concern that I have got is that for 20 years we have had an 
accepted definition of ``eligible participants'' that has 
evolved and been applied consistently over the last 20 years 
while something else has been going on at the same time. 
Something else that has been going on at the same time has been 
the explosion of very capital-intensive ventures that can be 
very effectively started up by very small businesses that can 
grow into very big enterprises.
    I have in mind a growth profile in which an infusion of 
$100,000 might be adequate for Phase I, an additional infusion 
of $750,000 might be adequate for Phase II, and then the 
venture capital folks can get involved at Phase III. But here 
we have, over the last 20 years, an explosion in the 
biotechnology sector, for example, in which it is possible for 
folks to do great things in small companies, but at Phase II 
you need a whole lot more than $750,000 to get from Phase I to 
Phase III.
    So now what we have got, it seems to me, is a new 
definition which does not expand the resource pool at all, does 
not provide more money, but it does dramatically and all of a 
sudden alter the definition of ``eligible participants'' so as 
to shrink the pool of eligible people.
    Now, in terms of picking winners and losers, I have not got 
much to say about that. It is just that it seems to me, 
clearly, the burden of proof is on folks who are supporting 
this change in definition to say that it is good public policy 
to shrink the eligible pool of participants so as to exclude 
this very valuable sector of our economy that has grown up in 
the last 20 years. The text for my message comes from the Book 
of Exodus. There rose up in Egypt a king that knew not Joseph.
    Things change, and we have had two patterns going on 
simultaneously: this growth in the sector of our economy where 
we are going to have explosive growth in very small enterprises 
that do not fit the growth profile of the criteria, the amount 
of money you can get under this new definition. I sort of feel 
like we want to make sure that we continue to make it possible 
for folks under the old definition to compete for the same 
resources.
    Let me follow up on that. Mr. Glover, one of the 
explanations that you offered basically in defense of this new 
definition which excludes people who have been participating up 
until 2003 for Phase II money along with venture capital firms 
in their structure is that there is a place for venture capital 
firms in Phase III. Well, how do you answer the needs of start-
up firms that need a whole lot more than the $750,000 maximum 
you can get in Phase II in order to make the jump, make the 
move, from Phase I to Phase III? It is not enough to say that 
venture capital firms can come in at Phase III if you cannot 
get there from here. So help me understand why this definition 
serves that sector of our economy that we want to grow along 
with others that fit the more traditional growth profile.
    Mr. Glover. Let me first clarify the definition issue 
because I think it is important. The Small Business Act and the 
rules and regulations at SBA have used the word ``individual'' 
to mean, in fact, an individual forever, and it is specifically 
defined in things like the women's business program, the 
minority business program, the 8[a] program, and other 
programs.
    In 2000, for the first time, that issue came before an 
administrative judge at the Small Business Administration to 
say what is an individual. It was debated, it was discussed, 
and the decision came down in that case that said 
``individual'' means individual; it does not mean a corporation 
or a trust or anything else. So several people challenged that 
decision in subsequent years. Some looked at specifically, 
``Well, gee, I am a venture capitalist, and it should not apply 
to me,'' and the decision came down, yes, it does. It means 
what we said it did in 2000.
    So it is not like there was a rule that the SBA changed. 
There was an understanding. Now, certainly, some companies 
violated what the SBA ruling was in 2000 and 2003, but I am 
sure they were innocent and unknowing violations. But clearly, 
it is not like SBA suddenly changed something. It was the first 
time they were asked to interpret something.
    Mr. Barrow. Do not get me wrong on that. My point is that 
until that clarification came down, there were firms that fit 
that were competing along with those that meet the new 
definition who do not meet the new definition as it exists now. 
They were competing, and they were participating in the SBIR 
program, and they are no longer eligible to do so because of 
this clarification. I am not at all being critical or attacking 
the means that we got from here to there.
    My point is, up until that point, we had the different 
folks who qualified under either definition, either the earlier 
understanding or the new clarification, participating side by 
side and competing for SBIR participation. Now only one can, 
and my point is, how do you answer the needs of those folks who 
have now been rendered ineligible as a result of the new 
clarification?
    Mr. Glover. Well, the same way we rendered the needs of 
these same companies in whole bunch of areas outside of the 
biotech area. By and large, SBIR companies have not had access 
to venture capital, with the exception of some biotech areas. 
Half of the program goes to defense contracting. You have not 
heard any small businesses come in and complain about this rule 
from the defense sector. We do not hear noises outside of 
anything than really the biotech area.
    The challenge to find funding for your technology is the 
biggest challenge any small business has. There is no question 
that that has been there. It is well documented, and we have 
had some programs in the government that tried to work at that. 
The advanced technology program, the manufacturing exchange 
programs, to varying degrees, have worked at that. There is 
some help there. Obviously, getting good funding for your ideas 
has always be the biggest challenge in America, and that is 
what they have to work hard at, whether they are a venture-
backed fund or not. Some biotech companies actually have 
skipped the venture capitals altogether and gone public and 
done quite well.
    Mr. Barrow. Well, I hear what you are saying, and I want to 
work with you to try and make sure that there is enough help to 
go around. The concern I got is that we now have folks who are 
no longer eligible to participate who were in a sector of the 
economy that clearly is an American success story that they 
want to nurture and grow. I do not want to penalize other folks 
who can compete for opportunities to participate in this 
program alongside of folks like that.
    But it looks to me like the new clarification is what is 
doing the penalizing, and to the extent we can work it out in 
such a way that we address the legitimate concerns that big 
businesses not be masquerading as small businesses and the 
like, and we deal with the problems of effective management and 
control being in the hands of the people who are really the 
creative inspiration for these enterprises. I think that meets 
my concerns without penalizing this sector of the economy.
    That makes me want to turn, if I may, Mr. Chairman, to Mr. 
Cruz and ask him, but I know that Mr. Michael wants to say 
something.
    Mr. Michael. May I make a comment, please?
    Mr. Barrow. Sure. Go ahead.
    Mr. Michael. One thing that is probably helpful for the 
Committee to understand is that although we very often talk 
about the $800 million needed to develop a drug, the NIH SBIR 
programs also support diagnostic products, they support medical 
devices, both inside and outside of the body, and many 
businesses can get started on much less than the 20, $30 
million that might be needed to jump start, and it needs to be 
part of our focus.
    Mr. Barrow. No question about it.
    Mr. Chairman, if I am not trespassing on the Committee's 
time, I hear you on that.
    Mr. Cruz, you touched briefly, and others have as well, on 
the subject of internal management and control, and I think you 
just passed on it. Can you help us understand a little bit 
better what sorts of things are actually at work in order to 
make sure that large venture capital firms are really not able 
to control the management of companies such as yours?
    Mr. Cruz. There is, as was said, the legal documentation 
that determines sort of the voting of each of the classes of 
shareholders, and for anything large enough that would impact 
the direction of the company, there are votes necessary across 
the different classes of shareholders. So there are, as the 
company progresses, different shareholders, different venture 
capital that invest throughout the life of the company. So 
inherent in that is the check and balance of different 
shareholders or different funds having control or a portion of 
the control for changing the direction of the country. So that 
is one level.
    Another level, the board of directors is usually defined in 
the bylaws of the company, and that usually takes into account, 
again, the different classes of ownership,--preferred 
shareholders, common shareholders, and management--and that is 
usually negotiated between the VCs and the management team and 
the previous angel shareholders to make sure that there is not 
one single party, one person, controlling, you know, the 
direction of the company.
    Mr. Barrow. Thank you.
    Chairman Graves. Mr. Bartlett?
    Mr. Bartlett. Thank you very much. I just wanted to clarify 
for the record. We really never changed the rules, did we? 
Didn't we just interpret the rules?
    Mr. Glover. That is my review of the case law. That is 
correct. There is no change in the rule.
    Mr. Bartlett. It is still the same rule; it is just that 
before, the definition of ``individual'' was not clearly 
understood, and now that it has been defined, that precludes 
firms that have more than 51 percent venture capital funding 
from participating in this program. That is, in fact, where we 
are, isn't it?
    Mr. Glover. Yes, sir, with the exception that it can be a 
small venture capital firm and still be eligible at even over 
51 percent.
    Mr. Bartlett. Okay. For the record, I would just like to 
note again that there is now not enough SBIR money for the good 
SBIR proposals, as the participants are now determined by the 
interpretation of what an ``individual'' is. If NIH had more 
money, they could give it to more good proposals. Is that 
correct?
    Mr. Glover. Yes, sir.
    Mr. Bartlett. Okay. And it is primarily NIH money we are 
talking about.
    Mr. Glover. Yes, sir.
    Mr. Bartlett. Okay. If you are looking at these two 
different groups of companies,--one is the really small guy who 
started out, has no meaningful venture capital funding, and the 
other firm that has had a successful project, successful to the 
extent that they have now got venture capital funding--there 
are two of them now, and each one of them has a new proposal 
they are coming in with, this is not quite a level playing 
field because the firm that has already had enough success to 
get venture capital funding, they now have a group of investors 
who have confidence in them. They have already indicated that 
they have an idea good enough that they can fund.
    Now, if they cannot convince those people that this next 
idea is also good enough to fund, I do not think we have quite 
the level playing field with the new firm that has no prior 
history and no venture capital funding. And again, I am very 
sympathetic to that firm that has more than one good idea. What 
the heck are they going to do with the second and the third and 
the fourth good idea? They ought to be able to get funding for 
that.
    But I think, Mr. Glover, you are kind of where I am. They 
may need funding but not from this pot because this well is not 
even deep enough to fund the good proposals that come in. Is 
that correct?
    Mr. Glover. That is correct.
    Mr. Bartlett. Okay. So I think that what the Committee 
ought to be about is finding additional funds, perhaps under an 
additional program, so that you do not have these two not quite 
on the same playing field, so that you do not have these two 
groups of companies competing with each other. But I agree 
completely that if we are not able to fund small companies that 
have more than 51 percent of venture capital money and a 
second, a third, and a fourth good idea, that we are limiting 
the opportunities for entrepreneurship and creativity in this 
country. But I also agree that if we simply open up this 
program to that, that there is not enough money to go around 
now. So why would we want to spread this money thinner over a 
broader field?
    I think that we have a really great argument here for a 
specific program and additional funding, and this is the kind 
of thing that the Americans and the Congress can support 
because you can show a very good return for the taxpayer's 
dollar in these programs. Thank you, Mr. Chairman.
    Ms. Velazquez. Mr. Chairman, I just would like to work with 
you and the Committee and the people here, and maybe what we 
could do, expanding on what you were just talking about, the 
pot. What we could do is expand the amount of money, instead of 
going from 2.5 to 5 percent, that 2.5 is the ceiling. It is the 
base. It is the floor. It is not the ceiling. So why can't we 
expand the program and then have more people participating?
    Mr. Bartlett. My preference would be 2.5 for this program 
and 2.5 for another program because they are not quite the same 
population of companies. They are just not quite the same. You 
would reach the same goal you want to reach, but now you do not 
have these little guys competing with the company that is 
already bigger, with venture capital and maybe more consultants 
and so forth that puts them on a different playing field.
    Chairman Graves. Mr. Doerfler?
    Mr. Doerfler. I am not sure how long this would take, but I 
think there is a tremendous amount of urgency around this 
issue. I mentioned a letter that we put into the record by Dr. 
Zerhouni, who said that right now it ``undermines NIH's ability 
to award SBIR funds to those applicants whom we believe are 
most likely to improve human health....'' I think that there is 
a concern--at least, I have a concern--that the level of the 
applicants today--the applications are not what they were a 
year ago or two years ago or three years ago, and it is 
affecting public health, and that is something we have got to 
address immediately.
    I also believe that there will be more data coming in from 
analyses at NIH and NCI that we can put more empirical 
information around this issue so it is not something that is 
subject to opinion, but it is actually subject to someone who 
actually is looking at these applications to see if the level 
of the quality of the application is actually going up, staying 
the same, or going down. That is, I believe, a critical element 
of what we need to do with this program.
    Chairman Graves. Real quick, Mr. Glover.
    Mr. Glover. I have not seen this particular letter, but I 
can tell you, on 20 years' experience with the NIH on SBIR 
programs, they have been against it from the very beginning. 
They fought it. They have announced surveys and data which 
looked at universities and rated them on a five scale and rated 
small businesses on a four scale and announced we were lower. 
Only after we found out, did they have to apologize and say 
they were wrong.
    They have never been strongly supportive of small business 
at the National Institutes of Health, and I would look with 
interest at whatever they did based on this long-term history, 
not what the current people are doing. They may be doing a fine 
job, but I do know this long history, and it has been a very 
embarrassing situation, and they have not done their homework.
    Chairman Graves. Yes, real quick.
    Mr. Michael. One very quick comment. Public policy should 
not be based on just what is happening today, I think. Today, 
there are many, many people who cannot get venture capital 
funding. The flow of money, certainly in the Mid-Atlantic, is 
not supporting a lot of companies, so you are left without an 
option. It is very impressive to meet people who have those 
venture capital alliances, but that is not the norm certainly 
in the Mid-Atlantic right now. So SBIR has become increasingly 
important.
    Chairman Graves. I want to thank all of the witnesses for 
being here today. We do have another series of votes. But this 
is obviously a very important issue. I appreciate hearing both 
sides. We have exposed some very good ideas. You know, 
America's technology and innovation is world renowned, and we 
certainly want to do everything we can to promote that and push 
it forward and provide as much resources as we possibly can 
from all sectors. But I do appreciate all of the witnesses 
being here. This was a great hearing. Thank you very much.
    [Whereupon, at 4:20 p.m., the Subcommittee was adjourned.]

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