[Senate Hearing 110-739]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 110-739
 
REAUTHORIZATION OF THE SMALL BUSINESS INNOVATION RESEARCH PROGRAM: HOW 
 TO ADDRESS THE VALLEY OF DEATH, THE ROLE OF VENTURE CAPITAL, AND DATA 
                                 RIGHTS 

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

                               ROUNDTABLE

                               BEFORE THE

                      COMMITTEE ON SMALL BUSINESS
                          AND ENTREPRENEURSHIP



                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 18, 2007

                               __________

      Printed for the use of the Committee on Small Business and 
                            Entrepreneurship


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            COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                 JOHN F. KERRY, Massachusetts, Chairman
CARL LEVIN, Michigan                 OLYMPIA J. SNOWE, Maine
TOM HARKIN, Iowa                     CHRISTOPHER S. BOND, Missouri
JOSEPH I. LIEBERMAN, Connecticut     NORMAN COLEMAN, Minnesota
MARY LANDRIEU, Louisiana             DAVID VITTER, Louisiana
MARIA CANTWELL, Washington           ELIZABETH DOLE, North Carolina
EVAN BAYH, Indiana                   JOHN THUNE, South Dakota
MARK PRYOR, Arkansas                 BOB CORKER, Tennessee
BENJAMIN L. CARDIN, Maryland         MICHAEL B. ENZI, Wyoming
JON TESTER, Montana                  JOHNNY ISAKSON, Georgia

                 Naomi Baum, Democratic Staff Director
                Wallace Hsueh, Republican Staff Director




























                            C O N T E N T S

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                                                                   Page

                           Opening Statements

Kerry, Hon. John F., Chairman, Committee on Small Business and 
  Entrepreneurship, and United States Senator from Massachusetts.     1
Tester, Hon. Jon, a United States Senator from Montana...........     3

                        Roundtable Participants

Abramson, Fredric D., President and Chief Executive Officer, 
  AlphaGenics, Inc., Rockville, MD
Asmail, Clara, SBIR Program Manager, National Institute of 
  Standards and Technology, Gaithersburg, MD
Brown, Edsel W., Jr., Assistant Administrator, Office of Policy, 
  Planning and Liaison, Government Contracting and Business 
  Development, U.S. Small Business Administration, Washington, DC
Busch, Chris W., Consultant and SBIR Advocate, Missoula, MT
Caccuitto, Michael J., SBIR/STTR Program Administrator, Office of 
  Small Business Programs, U.S. Department of Defense, Arlington, 
  VA
Cooper, Ronald, Technology Policy Analyst, Office of Government 
  Contracting and Business Development, U.S. Small Business 
  Administration, Washington, DC
Doerfler, Douglas A., President and Chief Executive Officer, 
  MaxCyte, Incorporated, Gaithersburg, MD
Eisenberg, Alan, Executive Vice President for Emerging Companies 
  and Business Development, Biotechnology Industry Organization, 
  Washington, DC
Fanucci, Jerome P., President and Chief Executive Officer, Kazak 
  Composites, Incorporated, Woburn, MA
Glover, Jere W., Executive Director, Small Business Technology 
  Council, Washington,DC
Goodnight, Jo Anne, SBIR/STTR Program Coordinator, and Director, 
  Division of Special Programs, Office of Extramural Programs, 
  OER, NIH, DHHS, National Institutes of Health, Bethesda, MD
Haber, Stuart S., President and Chief Executive Officer, 
  Infoscitex Corporation, Waltham, MA
Jackson, Gary, Asistant Administrator, Office of Policy, Planning 
  and Liason, Government Contracting and Business Development, 
  U.S. Small Business Administration, Washington, DC
McGarrity, Gary J., Executive Vice President of Scientific and 
  Clinical Affairs, VIRxSYS Corporation, Gaithersburg, MD
Mehra, Kunal G., Head, Strategy and Market Development, 
  Scientific Systems Company, Woburn, MA
Necciai, Eric, Professional Staff Member for Senator Snowe
Rowe, C. Edward ``Tee'', III, Assistant Administrator, Office of 
  Congressional and Legislative Affairs, U.S. Small Business 
  Administration, Washington, DC
Sarich, Ace J., Founder and Vice President, Voxtec International, 
  Inc., Annapolis, MD
Wheeler, Kevin, Deputy Staff Director for Senator Kerry

          Alphabetical Listing and Appendix Material Submitted

Biotechnology Industry Organization, Washington, DC, charts......    58
Bond, Hon. Christopher S., a United States Senator from Missouri, 
  letter and questions to Steven C. Preston, Administrator, U.S. 
  Small Business Administration, and his response................    68
Busch, Chris W., Consultant and SBIR Advocate, statement.........    74
Kerry, Hon. John F., Chairman, Committee on Small Business and 
  Entrepreneurship, and United States Senator from Massachusetts, 
  opening statement..............................................     1
New England Innovation Alliance, response to Biotechnology 
  Industry Organization..........................................    84
Preston, Steven C., Adminstrator, U.S. Small Business 
  Administration, responses to Senator Bond's questions submitted 
  at March 9, 2007 hearing.......................................   106
Tester, Hon. Jon, a United States Senator from Montana, opening 
  statement......................................................     3
Various companies, foundations, and organizations in favor of 
  restoring SBIR eligibility for majority venture-backed 
  companies, letter..............................................   116
U.S. Small Business Administration, Washington, DC, statement....   119


REAUTHORIZATION OF THE SMALL BUSINESS INNOVATION RESEARCH PROGRAM: HOW 
 TO ADDRESS THE VALLEY OF DEATH, THE ROLE OF VENTURE CAPITAL, AND DATA 
                                 RIGHTS

                              ----------                              -
------


                       THURSDAY, OCTOBER 18, 2007

                               U.S. Senate,
                    Committee on Small Business and
                                          Entrepreneurship,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:10 a.m., in 
room 428-A, Russell Senate Office Building, Hon. John F. Kerry 
(Chairman of the Committee) presiding.
    Present: Senators Kerry and Tester.

OPENING STATEMENT OF HONORABLE JOHN F. KERRY, CHAIRMAN, SENATE 
 COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP, AND UNITED 
               STATES SENATOR FROM MASSACHUSETTS

    Chairman Kerry. Well, thank you all. We will come to order 
and I appreciate everybody's patience. I am sorry to be a 
little late, but I had an off-campus meeting this morning and 
Washington traffic seems to be getting worse, not better. I 
think every road is under repair and every detour is closed, so 
it is fun.
    Let me just say up front that we are going to run this as 
we have in the past, and the staff will principally drive the 
discussion. This is not because of our lack of interest or 
anything, but I have a competing transportation hearing down in 
the Commerce Committee which I need to be at because of 
Massachusetts interests, and also we have a new Congresswoman 
being sworn in in about 40 minutes, so I need to attend to 
that.
    However, let me try to focus this conversation, if I can. I 
want to start by thanking Kevin Wheeler for her terrific 
efforts with these roundtables, which I think are enormously 
productive. I can't tell you how helpful they are to the 
committee because they allow for a back and forth discussion. 
There are a lot of faces around the table that have been here 
many times, and as I have said before roundtables are just so 
much more effective than the hearings in many ways, and the 
discussions are really helpful to us and provide a very strong 
record in the process.
    For those who aren't here who wanted to participate, we 
will accept their thoughts and comments in writing, and the 
record will remain open for a couple of weeks in order to 
adequately do that and to help us build our base of knowledge 
as we move forward with the reauthorization process.
    As you all know, the SBIR program, the Small Business 
Innovation Research Program, for those new to it, expires next 
year on September 30, and this is now the second roundtable in 
this Congress that we have held to think about its 
reauthorization. The first was held during the summer, in 
August, and it focused on the National Academy of the Sciences 
study, and I am pleased to say that the conclusion of the 
National Academy of the Sciences was that the SBIR program is 
working well and should be reauthorized, which is an important 
contribution to our discussions.
    Senator Tester, welcome.
    If you will forgive me for singling him out, I would 
particularly like to welcome Dr. Fanucci of Kazak Composites, 
Mr. Mehra of Scientific Systems, and Mr. Haber of the 
Infocitex. Kazak Composites and Scientific Systems are both 
based in Woburn, Massachusetts, and Inofcitex is located in 
Waltham. I am proud that they are here and pleased that they 
will share their experiences. Their firms are examples. They 
are conducting very exiting research in defense and health and 
alternative energy, and I know it is going to help the 
committee to understand the real world dynamics to be able to 
hear what they have to say, particularly about venture capital 
and the whole venture capital issue.
    The venture capital issue is probably the most 
controversial, but it is not, I don't think, the most 
difficult. The more difficult issue is this ``valley of death'' 
issue and how you work through it, and we want to hear people's 
thoughts, descriptions of exactly what the valley of death is, 
how it works, and how we can move through it.
    But, obviously, over 25 years, this program has built a 
pretty impressive track record of small businesses that have 
grown, of small high-tech firms with very important 
technologies, but we are still struggling with this issue of 
commercialization and where and how you make that seamless 
transition, which we want to be seamless but it doesn't always 
prove to be so, hence the valley of death issue.
    So we must really look at this question of whether or not 
it is reasonable, or where is the reasonableness of expectation 
with respect to Phase II, the end of Phase II and the beginning 
of freestanding commercial enterprise.
    We are also going to have an opportunity to talk about the 
issue of small firms that are owned and controlled by venture 
capital firms and their access to the SBIR program. That will 
be the second portion of today's roundtable.
    However, let me start out by saying that there is a lot of 
frustration on some of our parts with some of the misleading 
statements that have so often guided this debate, and I think 
it is important that the debate at least operate on the basis 
of fact. I am referring to the myth that venture capital firms 
are not allowed to participate and that this is a choice where 
you take VC and lose SBIR eligibility or you don't and remain 
eligible. It isn't. That isn't nor has it ever been true.
    In fact, GAO did a study of the awards at DOD and NIH, the 
two largest SBIR agencies, looking at a 2-year span before the 
SBA clarification of who was eligible to receive an SBIR award 
and then the 2 years after that clarification. They found that 
the number of awards and the number of dollars going to firms 
with venture capital actually increased in the two years after 
the clarification. So there are firms with venture capital 
participating in SBIR, and they can participate so long as VC 
ownership does not exceed 49 percent. Now, can you improve? Can 
you do a better job and still maintain SBIR in a small business 
program? Obviously, we need to look at that. GAO is here, I 
think, and we can draw on GAO to clarify their study if people 
need that clarification as we have this discussion.
    Let me also emphasize, and I really want to emphasize this, 
that this is not a question of whether some members of the 
committee are pro venture capital or con venture capital. I 
want to make that very clear. I think everybody on this 
committee is 100 percent supportive of venture capital efforts, 
and that is evidenced in our own efforts on the committee in a 
number of different areas to facilitate venture capital and 
capital movement into small business and small business 
endeavors. Futher, in the full Senate we have created tax 
incentives to help those firms and others to conduct R&D and to 
attract capital. We have supported stem cell research and so 
forth. So there have been a lot of examples of the members of 
the committee embracing venture capital.
    The final issue is the question of data rights. SBIR firms 
are often pressured by the agencies as well as by prime 
contractors to relinquish their intellectual property, and that 
struggle often results in a duplication of effort. It is a 
waste of money as well as time for people to spend thousands 
and thousands of dollars on attorneys to fight to keep data 
rights when they enter into a contract, and in many cases, 
other people spend the time just duplicating the work. So there 
ought to be a way to try to resolve this and that is something 
that I hope will be discussed here today.
    So let me ask, Senator Tester, do you have any opening 
comment you would like to make?

STATEMENT OF HONORABLE JON TESTER, A UNITED STATES SENATOR FROM 
                            MONTANA

    Senator Tester. I do. Thank you, Senator Kerry. I want to 
welcome Dr. Busch from Missoula, Montana, to the roundtable 
today. Welcome. You have had a lot of experience in SBIR and I 
appreciate you making the long trek from Montana out, as well 
as everybody else. Thank you for coming to this roundtable.
    I think Senator Kerry has laid out the landscape pretty 
well and I look forward to the discussion around the table 
about the valley of death and how venture capital and expanding 
that may or may not be good. I have my own thoughts on that. 
And then, of course, the data rights issue.
    So with that, I will apologize ahead of time. I am probably 
going to have to leave early, but I look forward to the 
discussion and I look forward to reading what is discussed here 
in the end, because I think the SBIR program in a small 
business State like Montana is critically important to us so we 
need to make sure it is viable and it does the job it needs to 
do and allows for a reasonable level of success.
    Thank you very much for being here.
    Chairman Kerry. Thank you very much, Senator Tester.
    So, Kevin Wheeler, go for it.
    Ms. Wheeler Thank you, Senator. I think that we will go 
ahead and open up the roundtable with the valley of death 
issue, having each of the firms that would like to make a 
comment discuss their perspective with the committee so we can 
build a record about what is happening. What is this so-called 
valley of death? How do we get from Phase II to Phase III? And 
is it actually reasonable to expect a firm to be ready to 
commercialize after Phase II? The committee often hears 
comments that Phase I and Phase II awards do not allow enough 
time and that it is not enough money to move a technology to 
the point of being able to commercialize it. So if you would 
like to explain, using your company as an example, please turn 
your nameplate on its side and I will call on you, or the 
Senators will call on you so that you can explain to us.
    Chairman Kerry. Who wants to lead off on that? Go ahead.
    Ms. Wheeler Jerry? And Jerry, can you remind us of your 
company and where you are located and what industry you are in?
    Dr. Fanucci. Sure. My name is Jerry Fanucci. I am with 
Kazak Composites and we are, I would say, an engineering design 
firm specializing in advanced materials and automated 
manufacturing to support cost reduction.
    Chairman Kerry. How big are you?
    Dr. Fanucci. Thirty-five people plus probably another 15 to 
20 part-time consultants, temps, things like that.
    Chairman Kerry. Do you have venture capital?
    Dr. Fanucci. We have no VC, no debt. The company's sales 
are about $18 million this year.
    Chairman Kerry. How long have you been in business?
    Dr. Fanucci. We were founded, basically me sitting on a 
couch writing an SBIR proposal in 1992 and grown largely with 
SBIR funding since then to be quite successful at Phase III 
commercialization. So we are very happy with the SBIR program 
and owe, in fact, our existence to it in this current state, at 
least. So----
    Ms. Wheeler Jerry, can I ask for one clarification? Can you 
give us an example of one of your products? I know you 
described it, but just something in layman terms?
    Dr. Fanucci. Yes. Well, our largest Phase III SBIR success 
is a piece of a new Navy ship called T-AKE, which is a cargo 
ship the Navy is building, and through SBIR and the Navy TAP 
Show, which is the commercialization show, we managed to 
interest General Dynamics. NASSCO is the company in San Diego 
that is building this ship, and working with us, actually 
bringing us into a competition that they had been running for 
several years to try to supply this particular product and we 
eventually won it, partly with SBIR technology. So we were able 
to do that and it is a very large Phase III, two to three 
ships' worth of 30,000 to 40,000 parts a year. To us, it is 
many millions of dollars of sales, so it is quite important to 
us and it is a big commercial success.
    Ms. Wheeler And what is the value to the DOD?
    Dr. Fanucci. Well, the value to DOD is the fact that they 
had no other solution, first of all. They had a ship that 
needed these things and couldn't do it. These keep the cargo 
from rolling around inside the hull. That is a bad thing if the 
ship is moving and the cargo is going with it.
    The cost savings, we have learned in the process of working 
on this that the current cost that we are charging is about 
one-third the previous cost. So over the run of the ship, we 
probably saved them maybe about $140 million in cost avoidance, 
so that is, I think, quite significant. So we get the benefit 
of the sale and they are not paying $140 million for the next 
alternative solution, which actually didn't work too well, and 
which we replaced.
    So it is quite a good success story for the SBIR program. 
It is partly SBIR and partly just the right place at the right 
time and luck, you know, and lots of things contribute. You 
can't point just to any one thing, but certainly SBIR allowed 
us to be at a point where we could even compete, and then to 
carry the research along to the point where we could win that 
contract.
    Ms. Wheeler And the valley of death?
    Dr. Fanucci. That one actually is the one example we have 
that didn't have a valley of death because it was so far into 
the ship design phase that they needed something then and we 
went straight from SBIR, actually Phase I, to production.
    Chairman Kerry. In your case, when you talk about the 
valley of death, do you refer to it in terms of a specific 
technology or with respect to the company as a whole?
    Dr. Fanucci. Well, that is a good question and I think that 
applies both to the valley of death question and the VC 
question, in a sense. It applies in our case, and I am not 
familiar with how the health industry works, but certainly in 
ours, each SBIR is like a little product development project. 
We do different things for different applications. If you are 
familiar with DOD's solicitations, they ask for specific things 
and the winner develops that thing.
    A case, for example, where we are in the midst of a big 
valley of death right now is a very successful Phase I-Phase II 
SBIR that everyone loves the outcome. It was an end 1999 topic, 
so it was initiated in 1999. Parts have been on sea trials on 
carriers and they want to put them on ships, but there is no 
mechanism that we can find and that even the people in the Navy 
can easily identify to take that thing that has been tested now 
on aircraft carriers and they want to put on all the carriers 
and put it into production and put it on not only carriers, but 
other ships, as well, so----
    Chairman Kerry. Well, are there particular features that 
can be standardized, or is it completely ad hoc as to when a 
particular technology actually deserves to be sustained to go 
into commercialization? Or is there an effort sometimes because 
it is bread and butter to the company to fit a round peg in a 
square hole kind of deal sometimes, and so we are sustaining 
something that may not ultimately succeed. Is there a pressure 
to do that?
    Dr. Fanucci. Yes. Well, there is a lot of pressure to 
commercialize because it is becoming the thing to do these days 
with SBIR and it is important to do that. But I think if you 
study the topics, at least the kinds that we bid on and 
materials and engineering high-performance structures, you can 
tell right away some of these are going somewhere quickly and 
some of them are just the next step along a long path to moving 
technology forward.
    You know, nano materials would be one. We work in nano 
materials topics sometimes, along with many other companies. 
That is not something that at the end of a Phase I-Phase II in 
SBIR you are likely to now have a big commercial product, but 
you might have discovered something that would fit into the 
next product.
    Another case is like this aircraft carrier part. Just 
reading the topic, you know they have so specifically defined 
the problem and the solution they need that if you find the 
solution, they have a use. Now, in this case, we did find the 
solution and everyone likes the answer and it is very easy, but 
there is no transition from the R&D guys to the ship 
maintenance guys, basically in this case.
    So I don't know that you can, at least in our kind of 
products, circle a small specific area and say, that is the 
problem. That is what we have to address. Each thing that we 
develop is its own little story like that. We do some UAV work, 
for example. That is very different than things that keep you 
from falling down holes in aircraft carriers, which the other 
thing is. It is a whole different group of people, a whole 
different technology, so----
    Ms. Wheeler Did I hear you say you were financing the 
testing and evaluation?
    Dr. Fanucci. Well, actually, that is a different--we have 
talked about this in the past, and yes, that is often a 
problem. You come to the end. You have something that looks 
good. It has been through some preliminary tests, but now, in 
the example that Kevin is mentioning, we need to throw this out 
of airplanes. That is not covered by the costs and fees to 
SBIR. You need millions of dollars for that. The Navy--most of 
our work is Navy, it turns out--is attempting to address that 
with transition programs, but so far, we haven't benefited from 
that, at least.
    Mr. Necciai. Did the communication that you had between 
your personnel and the contracting officer, in relation to the 
valley of death, did that ever falter or decrease during that 
period of time, or did you think it had any influence on----
    Dr. Fanucci. No. No. The contracting officer is interested 
in the Phase I-Phase II SBIR contract----
    Mr. Necciai. Right.
    Dr. Fanucci [continuing]. Which doesn't address what 
happens after the Phase II contract ends. As long are you are 
performing, they are doing their job and you are doing your 
job, everyone is happy. But, you know, with the technical 
people on the program, they realize the cliff is coming up and 
it depends on who you get. If you have a very involved program 
person on the Government side, they are very active in trying 
to move this forward. On the carrier application, that is the 
case. We have a very involved couple of guys in the Navy who 
see the value and are, on their own initiative, really, pushing 
this thing as hard as they can. But it is not the contracting 
officer.
    Mr. Necciai. The project manager who saw the value, how to 
move forward, but in other instances where the project manager 
didn't either see the value, you didn't feel like that 
connection was still there?
    Dr. Fanucci. You know, you can run the range of program 
managers from very interested to guys who got handed this thing 
and it is just another thing they have to do. That is one of 
the facts of SBIR life. You deal with who you are dealt with on 
the Government side. Sometimes they are interested, sometimes 
they are not. Sometimes there is such a long period of time, I 
think in some cases, between writing the topic and getting an 
award that the person who wrote it is gone. That person's 
interests are not there anymore and someone else is in the 
position with different interests, but they have a Phase I to 
deal with. So you can tell almost right away that it is not 
going anywhere.
    Mr. Necciai. Thank you.
    Ms. Wheeler Stu, would you like to explain how the valley 
of death affects your company?
    Mr. Haber. Sure. Can people hear me? First, a little 
background. My name is Stu Haber. I am co-founder, President 
and CEO of Infoscitex Corporation. We are headquartered in 
Waltham, Massachusetts. We were funded internally by the co-
founders. We have no debt. We had some cash, and we have been 
profitable since the first year. Next month, we are celebrating 
our seventh anniversary.
    We did not participate in the SBIR program until about two-
and-a-half years ago, and since then, we have developed a 
number of products--I should say, we are developing a number of 
products--and I might talk about two particular products to 
give you an idea about how it relates to the valley of death.
    One in particular is waste energy conversion systems. What 
we are doing that is novel is we are, to make a long story 
short, we are gassifying, essentially shredding, pelletizing, 
and gassifying trash, and trash being paper, plastic, food, and 
wood. The gassification connects directly to an institution's 
grid, a power grid, and creates electricity and heat.
    Now, the reason I mention this is that we have received 
funding from the Army because they have a very specific need to 
dispose of--to find a less expensive and more environmentally 
friendly way of disposing of their field waste. In this 
particular case, we are the point, I would say we are about a 
year away from actually having a product that we can 
manufacture and sell, not only to the Army but the real sizable 
market beyond that is our institutions--hospitals, 
universities, it could be supermarkets, prisons, I think you 
get the idea. There is a pretty good market there.
    Now, what we require is two things. One is that we require 
some money to actually build a field demonstrable unit, an 
implementation pilot program, and we are actually right now 
working with the University of Massachusetts-Lowell to do just 
that. And that would require about a million dollars.
    Now, down the road, we are expecting we can get the cost 
down on these systems to $200,000, but the first one doesn't 
cost $200,000. It is about a million dollars to install and to 
operate. The payback is 2 years. In order to get the company 
off the ground, not only do we need the million dollars for the 
pilot, but we need another $3.5 million to fund the company for 
working capital, investment, and so forth, and unless we 
receive the CPP or Commercialization Pilot Program money, we 
have to go to other sources. We don't have the capital to 
invest there.
    And we have a lot of interest, but it is a major effort, 
and that is--there is a situation where the Government cannot 
really--is not in a position right now to fund that value, or 
as we call it, crossing the chasm.
    The other example, a little bit different, where the 
Government actually has helped us is with a CPP program. We had 
a Phase I-Phase II contract with the Air Force to develop a 
novel cover glass for satellites to protect the satellites 
against radiation hardening, extend the life. The Air Force 
felt it was important enough that they issued--it was a little 
over 1 year ago, 1 year ago August, they awarded us a sizable 
CPP program and we are working very closely with Schott Glass 
of Germany, which the Air Force more or less instructed us to 
work with, who is a big player in the creation of glass, and 
they are our partner. Two years from now, and everything is on 
schedule, we will be able to--Schott Glass will be able to go 
to production and we will receive a licensing fee.
    Now, I will tell you that the additional CPP money we 
received was $5 million over a 3-year period, which is huge. We 
did not actually market this. The customer came to us and said 
that this was important enough that they wanted to fund this. 
Without that money, I suspect nothing really would have 
occurred. But with that additional sizable amount of money, we 
are going to be able to go to production in 2 years. In this 
case, the Government actually did fund.
    I think the CPP program is outstanding. It is the only one 
we have, the only CPP funding we have at this time. But I think 
it is an extraordinary way to take people across that chasm, 
through the valley of death, and it can't be done for 
everything. It has to be selective. But I think it is a great 
thing to do.
    I wanted to ask Kevin, at what point do you want me or 
others to suggest--make suggestions about what specifically to 
do about the valley of death in the program?
    Ms. Wheeler If you would like to offer a suggestion now, 
feel free.
    Mr. Haber. OK. I would say that I know that there is a lot 
of discussion about increasing the budget for SBIRs in the 
future. Whatever that increase would be, I would suggest that I 
guess really almost all of that, if not all of that additional 
money go toward CPP. Whether you call it Phase II-B or Phase II 
enhancements or Phase III or Fred, I think it is important to 
put the money in there. I think that I would also probably 
increase the minimum amount of money, the canonical $100,000 to 
maybe $150,000 on Phase Is. The Phase IIs, perhaps increasing 
them maybe from $750,000 to $1 million.
    But that is not all that critical. What is really critical, 
I think, is taking the successful Phase I and Phase II 
programs, I should say successful Phase II programs, and making 
sure there is money there to meet the Government's needs, to 
meet the global economy's needs, and I think any increase 
really should be substantially put toward what I call the CPP.
    Ms. Wheeler Thank you. Did anyone else have a comment? 
Usually people turn their cards on their sides and I haven't 
seen anyone, so I am not sure if we are missing someone. Kunal, 
do you want to go ahead?
    Mr. Mehra. Sure. My name is Kunal Mehra. I am with 
Scientific Systems. We are a small business based in Woburn, 
Massachusetts. We are about a 50-person company and we focus on 
developing advanced technologies and solutions, primarily for 
the aerospace and defense markets. The SBIR program has been 
critical to our growth and success over the last 15 or so years 
and I just want to highlight a number of success stories that 
we have had in terms of transitioning technology, in our case, 
into the Department of Defense.
    Today, software that we developed, that Scientific Systems 
developed, is used by troops in Afghanistan on hand-held mine 
detectors to detect mines that may be underneath the soil. We 
also have a very large program underway right now to develop a 
collaborative network of about 50 robots to lower the cost of a 
DOD operation by probably about 5 percent, so another great 
success story that draws on a number of our SBIR-funded 
technologies over the last ten or 15 years.
    Third, we have a program underway right now. A major 
concern within the DOD is that all of their air vehicles, 
manned airplanes, UAVs, or missiles, are reliant on GPS for 
navigation, and at the beginning of Operation Iraqi Freedom, we 
saw that Saddam Hussein had actually bought jammers for $50,000 
that he had set up around a lot of the targets, and there is a 
major concern that in the next war, we could be in an 
environment where somebody is able to disable the GPS network 
either by jamming it or by shooting down some of the 
satellites, as the Chinese did earlier this year. If that were 
the case, virtually all of our air vehicles would be irrelevant 
in that type of war.
    So we have developed a technology under the SBIR program 
that enables a missile or an air vehicle to navigate without 
GPS. Let me just say that this technology would have never been 
funded, the development of it would have never been possible 
were it not for the SBIR program and for the incredible support 
and advocacy that we got from some real thought leaders in the 
Navy. The technology we developed is software only. It can be 
implemented onto an existing missile or vehicle that is already 
in production within 3 years, if we are able to get the funds 
in place to continue the development. By comparison, the 
alternative technology is about seven or eight times more 
expensive.
    The weapon that we are focused on right now is the Tomahawk 
cruise missile. Our technology could be on the platform across 
2,500 or 3,000 missiles for $40 million from today. The 
alternative technology will cost about $300 million and will 
take another five or 6 years, because it requires some 
substantial hardware modifications to the platform.
    I think in talking about the valley of death, I think one 
has to consider a number of things. The first is that not all 
SBIR technologies are the same. There are some technologies 
that are very narrowly defined. They might be software-only and 
therefore you can take them to a higher level of maturity with 
the $750,000 that you would ordinarily get in a Phase II.
    We have seen other technologies, and the program that I 
mentioned that we have, it is actually with DARPA to develop 
these robots. This is an accumulation of SBIRs that we have 
done over the last ten or 15 years, and it has taken a very 
long time to get that technology to maturity just because of 
the breadth of the capability that we are developing.
    So there is really no one-size-fits-all over here. It is 
possible to take some technologies to a TRL of five or six. 
Other ones, you can't get beyond a readiness of three or four.
    But I think one of the big challenges we face is: who the 
program manager is. We have the GPS navigation example I gave 
you. We are lucky enough that we are working with a person who 
is responsible for engineering within the Tomahawk acquisition 
program at NAVAIR, so he is very well plugged into the needs of 
the program. He is able to help us shape the direction of the 
technology development in a way that nobody else could.
    In other examples, I have had technical monitors who are in 
labs and they are as disconnected from the acquisition program 
and the user as we are. In many cases, they have told me, oh, 
you are too worried about commercialization. Don't worry about 
that right now. Let us develop some cool technology and we will 
think about that later on.
    So I think education and fostering better collaboration 
between the labs and the acquisition programs is just 
absolutely critical, and it won't only help SBIR technology, it 
will help every single other form of technology development 
that is sponsored by these labs. I think that is really 
critical and it is just very important to get a higher return 
on investments that are to be made in technology development.
    Ms. Wheeler Michael from DOD, did you want to comment on 
any of this about the valley of death, since many of the 
examples have been from DOD?
    Mr. Caccuitto. Sure. I would be happy to say a few words. I 
first want to second what was just said. I mean, one of our 
biggest challenges in DOD is that collaboration. We are 
institutionalized--we tend to be institutionalized in such a 
way where our technologists, our real experts, generally reside 
in laboratory functions and where most of the procurement, and 
indeed, most of the R&D money resides are in our buying 
activities, or developing and buying activities, or acquiring 
functions. And they tend to be very separate institutions--tend 
to be--and it differs from service to service how much they 
collaborate, the degree to which they are either collocated or 
not, how they are set up to operate.
    So that is indeed one of the challenges that CPP is 
supposed to address, is to find new ways to effectively connect 
our technologists with our weapons developers and buyers, or 
weapons systems support systems and logistics and maintainers. 
That challenge, I see as perhaps the biggest, and indeed, if we 
crack that nut, then we bring value to the broader institution, 
not just to SBIR. We can help ourselves do a better job across 
the board.
    I want to make a couple of other comments, too. I think it 
is important that we recognize that we want some amount of 
failure in the program. Failure in a sense is a measure of 
success, and we need as we are thinking about this to recognize 
that we can't expect every technology we invest in to be a huge 
success in the marketplace. That is just not the nature of 
scientific exploration and technology development. Some are 
going to rise to the occasion via circumstances, or good 
forward thinking by the part of the Government, or excellent 
execution on the part of companies, and some will not and that 
is good.
    So in a sense, what we need to get comfortable with is what 
is the right balance, what is the right expectation to have for 
the program as a whole, if we are looking at it as a whole. 
What is the right transition rate, if you will. What is a 
reasonable expectation.
    And then we need to look at what we can control in the 
context of what is that proper way of viewing transition, and 
what we can control on the Government side is how we 
institutionalize, how we govern the program, the processes that 
govern the program, and CPP is another one of the governance 
mechanisms that we are looking at now. And I think that is 
where we need to focus our effort, is to continually evaluate 
how the program governance mechanisms are operating, how 
effective they are being, and at the same time not--we need to 
be very careful not to, I guess the term is throw the baby out 
with the bathwater.
    We need to be careful we don't turn the program into what 
amounts to a procurement program. We need to be sure that we 
are taking risks and accepting a certain amount of failure in 
the context of a smart institutional design. From where I sit, 
that is our biggest challenge, is balancing that risk spectrum, 
if you will, in the institutionalization of the program.
    Ms. Wheeler Senator Kerry feels the same way. He has always 
said that this is not an acquisition program and that there 
needs to be a balance, that we shouldn't expect every project 
to commercialize and that we want an element of risk because 
there are certain technologies that the private sector simply 
will not take on. And so I am sorry he is not here to hear you 
say that because, for the 9 years I have worked for him, that 
has been his goal for the program. Thank you.
    Jo Anne--oh, wait a minute. Senator Tester, did you want to 
hear Dr. Busch's----
    Senator Tester. That would be fine, either way. I will be 
here.
    Ms. Wheeler OK. Jo Anne, did you want to go ahead, since 
your card was up first?
    Ms. Goodnight. Sure. I kind of wanted to give a perspective 
from another Federal agency, but one where we are typically not 
the Phase III customer. It may happen that our intramural 
scientists are buying, and it does, in fact, happen that the 
intramural scientists are buying some of the products being 
developed, but by and large, the NIH SBIR, and STTR awardees 
are looking externally for that Phase III partner.
    And so we have thought long and hard, how can we help 
companies over this proverbial commercialization valley of 
death, recognizing, A, that this is not a linear process. When 
Roland Tibbitts conceived of this program as Phase I, Phase II, 
and Phase III, it was laid out linearally, but in fact, at 
least in the biosciences area, it is anything but.
    And so we offer Phase I, Phase II, Phase II competing 
renewals for those projects that need to go through the FDA 
regulatory process, and then we go further to offer a 
Commercialization Assistance Program to our Phase II awardees 
whereby this program is focused on attracting third-party 
financing, be it licensing partners, strategic partners, 
venture capital. There is a mix of exit strategies for our 
companies.
    So this program, the CAP, is now in its fourth year. It is 
very much individualized entrepreneurial training, because just 
as you just mentioned, this is not one-size-fits-all. Different 
companies are going to need different things to help them cross 
that valley.
    We bring them through a 10-month fairly rigorous process, 
and we actually lose some companies in the beginning because 
there is a little bit of attrition, that they are not ready to 
go through that rigor. But for those who go through and for the 
more than 300 Phase II awardees who have participated, we are 
starting to see some positive outcomes.
    And so part of my comment here is: is there something that 
is broken? Because, given what we have been doing and will 
continue to do, based on using the currently allowable SBIR 
funds, as well as some of our own administrative funding, we 
have got that nice mix within the current set-aside. For 
example, 50 companies in our 2004 and 2005 through 2006 
participants have received $136 million in equity investments. 
Sixteen companies received $73 million in strategic partner 
investments. These are now just the value of a program that 
provides that very important early stage funding for really 
high-risk projects and seeing that leveraged into some very 
real dollars for getting drugs and devices to the marketplace.
    One other thing. We also offer a Pipeline to Partnerships, 
because after the venture forum is over, everybody goes home 
and deals are definitely not made overnight. So we offer this 
Pipeline to Partnerships, or P-to-P opportunity, which is a 
virtual space for Phase I and II SBIR and STTR awardees to 
showcase their technologies to an audience of potential 
investors--again, licensing partners, VCs, and strategic 
partners. We offer that, as well, to our NIH licensees, and 
that is starting to gain some real momentum. We just launched 
it in July, and we have already heard from Genzyme, and from 
some other companies, that this is exactly what they are 
looking for--a one place stop where we can look at who is 
working in cancer diagnostics, who is working in autoimmune 
diseases, and what phase are they in with regard to clinical 
studies. Is it Phase II? Is it Phase III? So we are going to 
continue that endeavor, as well.
    Ms. Wheeler Erik, did you have a question?
    Mr. Necciai. It sounds like the partnership was very 
successful and I wonder if there are any other agencies--I know 
that we have got the pilot program that has had success at the 
DOD, and I know that NIST has a program that they are working 
on, and I imagine that that is going to be a success, as well. 
But are there any problems with the program? There is always 
success, and that is fantastic, but what things can we do to 
make them better?
    [No response.]
    Mr. Necciai. No comment, OK.
    Ms. Wheeler Erik, I think both Jo Anne and Kunal wanted to 
respond.
    Mr. Mehra. Well, I think in the Department of Defense, I 
think one has to realize there is a big difference between the 
Department of Defense and the NIH in that products developed 
for the NIH, by and large, have a very large commercial market 
you can go after. Most of the--I don't want to say most, but 
many of the products developed under the DOD SBIR program have 
a very narrow niche market which is pretty much the Department 
of Defense. Outside investors are often not interested in that.
    I am a member of the Small Business Technology Council and 
last week we had a large conference where a venture capitalist 
said, if you can't show me a commercial application for your 
technology, I am not interested in funding it because the 
Federal Government market is so narrow and it is so hard to 
navigate that we don't want to invest in it.
    So for companies like mine that are developing products to 
really enhance the Nation's security, CPP is the only 
alternative, and I just want to echo Mr. Caccuitto's points, 
which are I think the CPP program is excellent. The legislation 
is exactly the right direction. I think if there is a problem 
with it, the only problem is that there is not enough funding 
there.
    The funding required to go from a promising technology out 
of the end of the Phase II to where we are all trying to get, 
which is being credible enough that the technology is approved, 
that a program officer will put you into their budget, what 
they call the POM, the Program Operating Memorandum, where the 
technology is proven. That can be ten to 15 times the amount of 
money that you got in the Phase I or Phase II. So you are 
talking about going from needing $100,000 to $750,000 to $10 to 
$15 million and there is just not enough money in the CPP 
program to support that.
    So I agree with Mr. Haber's points also, I think we should 
look--any increases in the SBIR program should be directly 
channeled to enhancing the transition of technologies through 
programs like CPP.
    Ms. Wheeler Jo Anne, did you want to answer?
    Ms. Goodnight. I guess the only other point I would offer, 
because, again, we are a very different agency, I think getting 
that involvement very early on. It is not looking for these 
avenues to cross the valley at the end of Phase II. All of 
these concepts need to be thought of even prior to submitting 
the Phase I.
    And to the extent that States can help--I mean, there are a 
lot of, again, for our agency, the State assistance can help 
companies address some of their manufacturing issues and scale-
up issues, to the extent that Federal agencies want to model 
after Pipeline to Partnership. We have had a couple of agencies 
talk to us. There is no need for them to reinvent the wheel and 
maybe there is an opportunity for us to partner on this just 
like we did for the I-Edison System, where it is a multi-agency 
system for companies to report their inventions.
    And then for the companies also to take on some of this, as 
well, not that you are not, but it has got to be a shared 
activity for really getting across that valley.
    Senator Tester. Dr. Busch?
    Dr. Busch. Thank you. Thank you for being here, Senator 
Tester. I appreciate it.
    Just a short, brief background. I had a small business a 
long time ago. I started in 1975, before the SBIR program. When 
the SBIR program came into being in 1982, we focused on it as a 
target of opportunity and it was very good to us, benefited our 
company a lot. I personally benefited a lot from it.
    We sold the business in 1986 and in 1993 moved back to my 
roots, which are in the Northern Rocky Mountain States. I now 
live in Missoula, Montana. And when we got there, I became 
involved in this so-called SBIR outreach activity, basically 
working with small businesses in Montana, mostly the Northern 
Rocky Mountain States, but other regions, as well, helping them 
compete in the SBIR program. So that is a quick summary of my 
background.
    On this valley of death issue, what I wanted to say is that 
I think the agencies have done a wonderful job in supporting 
transition to Phase III and commercialization. The programs 
that Jo Anne has, NSF, DOD, perhaps all of them, are laudable 
and have been very helpful. I do think, though, sometimes 
perhaps too much help is offered to the small businesses to try 
to guarantee a successful transition through the valley of 
death. I think the true entrepreneur needs to, in some cases, 
at least, fend for himself and weave his own way through the 
hurdles and through the valley of death and shouldn't depend 
too much on the SBIR program, should seek other sources of 
funding, from industrial partners, other agencies, non-SBIR R&D 
funds, venture capitalists, and angel investors and so forth.
    As far as SBIR assistance and getting through the valley of 
death, I think what Jo Anne said is certainly true. It is not a 
linear process. I know of very few cases, if any, actually, 
where there has been a linear process where you go from Phase I 
to Phase II to a successful Phase III program. It is a parallel 
process in virtually--certainly it was true in my case, and 
virtually all the companies I work with, it is a parallel case. 
Multiple programs are underway. They dovetail with sources of 
funding from other sources, other R&D sources, other commercial 
sources. So I just wanted to underscore what Jo Anne said about 
the parallel process.
    Senator Kerry mentioned the distinction between the valley 
of death for a specific technology and the valley of death for 
the business as a whole, and I think that is an important 
distinction to make. The SBIR program is set up so that some 
technologies don't get through the valley of death. If every 
technology funded by SBIR gets through the valley of death, 
there is a question of whether enough risk is being funded. 
Some technologies should fail, should stay in the valley of 
death. So that distinction, I think, is important.
    I appreciated the comments about the CPP program at the 
DOD. I think that is a great opportunity. We didn't have that 
when I was in the program, obviously. But again, what Jo Anne 
said, not all agencies are set up to have a CPP-type program. 
In fact, probably most of them are not. So other opportunities 
are needed there.
    Again, I am kind of echoing all the things Jo Anne said, 
but I think the cases that I have been involved with since I 
have been involved in this outreach effort where businesses get 
into trouble is where the business personnel and resources are 
top-heavy on the technology side and low on the business savvy 
side. You know, it is all about doing research, it is all about 
solving this technical problem or that technical problem, and 
by the time it comes to commercialization, they are just not 
either mentally or culturally or in other ways, financially, 
prepared to cope with the rigors that come with 
commercialization. So early access and early provision of 
mentoring, commercialization mentoring by the agencies, I 
think, and encouraging small businesses to begin thinking about 
it, is really vital.
    Ms. Wheeler Because we are running to the end of the one 
hour I had allotted for this topic I want to give everyone a 
chance. Could we just go through and maybe give everybody 2 
minutes to weigh in here. Dr. McGarrity, I see your card has 
been up.
    Dr. McGarrity. Thank you. I am with a biotech company in 
Maryland known as VIRxSYS, and I just wanted to give a 
different perspective of the real life of a biotech company.
    We started in 1998. It was technology that came out of 
Johns Hopkins University, and so the company was started. It 
got initial funding and we went into our first clinical trial 
in 2003. Presently, VIRxSYS has about 65 employees. We have 
raised about $85 million from investors, very little of it, 
frankly, from VCs. We have had a couple of SBIRs and probably 
more SBIRs from a company that we just acquired recently, and I 
will talk about some of those experiences in the VC section.
    But to give you a snapshot, in our Phase I trial, it is for 
AIDS, and you say, what is the new approach in AIDS? We are 
doing gene therapy in AIDS so hopefully those patients can take 
one treatment and then do not have to take daily pills for six 
or 8 months and you circumvent the problem of drug resistance 
in these patients.
    So the trials have been going reasonably well. We had a 
Phase I at the University of Pennsylvania. Our Phase II trials 
are occurring in Connecticut, Kentucky, Florida, New York, and 
we will start a clinical trial in Harvard before the end of the 
year. So to date, we have treated about 52 patients.
    However, if you look forward as to where we are going, we 
are in a Phase II clinical trial. We hope to start a Phase III 
clinical trial next year and that is going to require about $50 
million to do. Also, the requirement on us is that we have to 
meet the same standards in our Phase III trial as a Genentech 
or a Merck or anything else like that. So the anticipation, if 
all of this goes successfully, we will go to market in 2010, 
2011.
    So I wanted to contrast the experience of a biotech company 
that started in 1998 and it will take 13, 14 years before we 
have any sort of reasonable revenues, and it is an enormous 
amount of money. The SBIRs that have been helpful have been not 
so much in the AIDS program but in smaller programs and smaller 
disease states, like cystic fibrosis and in hemophilia. So that 
is where that attraction of SBIR's grants is concerned.
    But it is a stark contrast between the biotech and the 
emerging biotech companies and what I have been hearing around 
the table today. In fact, sitting here this morning, I have 
realized that I have been living in the valley of death for the 
past ten or 15 years and didn't know it.
    [Laughter.]
    Dr. McGarrity. Thank you.
    Ms. Wheeler And your valley of death was on an SBIR grant?
    Dr. McGarrity. No. No.
    Ms. Wheeler No?
    Dr. McGarrity. The SBIR grant is now when we are finishing 
our Phase II clinical trials and now we are going to a Phase 
III that we are going to have to have 250 to 300 patients and 
either--will our original investors stay with us and invest 
more money, or can we find a partner in the form of a large 
pharmaceutical company to share that burden and provide money 
and expertise to get us to commercialization.
    Mr. Necciai. Dr. McGarrity, just to distinguish, you are 
talking about Phase I, Phase II, Phase III in a medical trial--
--
    Dr. McGarrity. In a medical setting.
    Mr. Necciai [continuing]. Not in SBIR phases.
    Dr. McGarrity. That is right. That is right. And as I said, 
we have used the SBIRs, but not in our main program of AIDS but 
in programs with smaller capital markets like cystic fibrosis.
    Ms. Wheeler Kunal, did you want to go ahead?
    Mr. Mehra. I just want to summarize. I mean, I think we all 
agree on two points. One is that not every technology should be 
transitioned. It is probably a low percentage. I think we all 
agree that the yield right now is lower than it ought to be.
    I think the second thing is that all the programs are quite 
different. The NIH is different than the DOD and a one-size-
fits-all approach will not fit.
    But I think the improvements that we seem to all agree on 
are kind of three-fold. The first is certainly there needs to 
be more education of the entrepreneurs themselves so that they 
understand how to cross the valley of death and how to market 
to the acquisition programs or to the drug companies in the 
case of a former organization.
    The second thing is I think more collaboration between the 
technical monitors and the labs and those on the acquisition 
side of the house will only help to kind of foster the kind of 
information transfer that we need.
    And then third, once those two things are done, you have 
got people who understand how to cross the valley of death, you 
have got advocates who can help them cross the valley of death. 
The thing that is missing is the funding in place to be able to 
support a company through that process. So that is kind of my 
summary of what I have heard and what I agree with.
    Ms. Wheeler Thank you. Mr. Sarich?
    Mr. Sarich. Hello. My name is Ace Sarich. I am the founder 
and Vice President of Voxtec. We do research, development, 
manufacturing, sales, software, after-market support, and 
training of a hand-held one-way translation device. It started 
off as an SBIR program back in Phase I in 2000. Phase II, 2001, 
the first prototypes September 10, 2001. And then from that 
time on, it went from an R&D prototype to now we have about 25 
employees and are doing $12 to $15 million in revenue this 
year.
    The program, first of all--our company would not exist if 
it wasn't for the SBIR program. But a couple comments I just 
want to make. We were talking about some of the challenges. 
First of all, there is no free lunch, but the SBIR program 
certainly does help out a lot. We still--we have three owners. 
The company has been all bootstrapped. It is our three owners 
of the company have mortgaged our houses to the hilt to be able 
to make this work, but at the same time, if we didn't have the 
Government revenues, it wouldn't exist.
    Regarding the incubation period or the valley of death, I 
call it the incubation period. It took longer than I expected. 
We had a working prototype, but it took a while before it was 
what I would consider good enough. So this has been aided quite 
a bit through the Phase III program. We have had a number of 
our military customers using, customers around the world, 
Afghanistan, Iraq, are using our products to communicate with 
the indigenous population and we have been using the SBIR 
grants.
    But the challenge has been in the past working through 
various contracting agencies. They just don't understand what 
the Phase III is, and we weren't smart enough to be able to a 
lot of times tell them how to do this. We just recently got a 
Phase III IDIQ with NAVAIR for $45 million over 5 years, so 
that should help us quite a bit over the next few years.
    I would also like to say that a lot of times, our biggest 
challenge has--one of our biggest challenges has been working 
through contract officers. If you get the wrong one, it can be 
the kiss of death. It has taken like 6 months to get paid on 
some, and for a company that lives from hand to mouth, you 
can't wait 6 months to get paid because of the slowness of the 
contracting process.
    Ms. Wheeler Thank you. Dr. Abramson?
    Dr. Abramson. Hi. I am Fredric Abramson, founder and CEO of 
AlphaGenics. Our business is to commercialize genetics into the 
consumer world for everyday life with a series of products 
dealing with weight control, physical performance, and 
influenza prevention.
    But I come here really with a different background. In 
addition to being a scientist, I have got 40 years in the 
computer IT field, 20 years in the retail segment, as well, and 
I teach in the Master's Program of Biotechnology at Johns 
Hopkins and I teach three courses, Financial Management, 
Creating the Biotech Enterprise, and the Economics of 
Biotechnology.
    We have heard three comments here about the difference 
between bio or a life science from the DOD kinds of 
technologies. I want to reiterate this. There is a structural 
problem in the life sciences which is deeper than SBIR. Very 
few people who are scientists have any business background. In 
fact, their ability to get an SBIR depends upon their 
qualifications and their knowledge of science, not business. 
And as Ms. Goodnight said, many of these people come into the 
program unprepared even to think commercialization.
    I have many conversations with companies in the incubator 
in Rockville. We are in the Maryland Technology Development 
Center. And frankly, very few of them can even understand what 
it means to define a market in concrete terms. So it is 
difficult for them to think of commercialization when they 
can't think through the steps of even who it is they are going 
to sell to.
    There is a tendency in the field to live as in the film 
``The Field of Dreams.'' If you build it, they will come. But 
the fact of the matter is, they do need a great deal of 
expertise and insight on the business side. Dr. Busch pointed 
this out. Whether that is in the purview of an SBIR program, or 
as Ms. Goodnight said, maybe it is something they need to get 
in advance as they are coming to the table, and maybe that 
needs to be something that is put into the system as part of 
their development through Phase I and Phase II so they can 
better understand what they need to do to begin moving through 
the long process, as Dr. McGarrity said, eight to 12, 13 years. 
So it is not just, I think, an issue that SBIR can solve at the 
NIH level, for example. Thank you.
    Ms. Wheeler Thank you. Edsel?
    Mr. Brown. He stole my thunder.
    [Laughter.]
    Mr. Brown. Again, on behalf of SBA and looking out for the 
best interests of small business, he hit the nail right on the 
head in addition to what some of the other commentors have 
already said, CPP, enhancements to Phase II. But again, we are 
making these as to highly technical, organic companies, but 
again, we need to look at the ability of these companies from a 
business standpoint. They are so focused on moving this 
technology forward, they may not have the necessary 
infrastructure in looking long-term to commercialize it. So 
even if they had the technical expertise to move it forward, 
just how much do we know about the actual management skills, et 
cetera, that the principals of the firm have?
    And again, one of the other issues facing us as we move 
toward reauthorization, we talk about administrative costs for 
the agencies. They get the funding, but we are looking at 
administrative costs for the agencies to move the funding to 
the firms, and the same could be said for the small businesses. 
Yes, they get an award, but be careful what you ask for. They 
may not be able to handle it.
    Ms. Wheeler Thank you. Erik? I am sorry. Ron, did you want 
to go ahead?
    Mr. Cooper. Ron Cooper with SBA. First of all, I would like 
to thank the committee. We find these hearings and these 
roundtables extremely helpful in trying to understand the 
aspects of the program.
    Just stepping back a bit, the valley of death is 
essentially a market failure that we are addressing in 
financing early stage and innovative activity. As such, that is 
the rationale or a key rationale for having the SBIR program in 
the first place. My work has shown that there are five 
dimensions to this market failure and it is quite complex, 
including information gaps as well as the size of financing 
that the private market is able to or willing to invest, and 
the degree of risk, and also the geographic areas that are--
there is a gap there or a valley of death geographically.
    So our task with SBIR is to focus the program, to target 
the program to this valley of death, trying to address the 
market failure, and so we are very interested in how this gap 
is changing over time and developing.
    I just wanted to mention the way that we target. The 
targeting mechanism for the program is the eligibility 
requirements and that is, I suppose, a segway to our next 
section, so we can talk about that more. But that is the way 
that I view this, is that we have to continually reevaluate the 
nature of that gap and use our eligibility requirements to 
target it effectively.
    I wanted to just also echo what has been said before about 
the fact that this valley of death has a very different shape 
for different industries. The best example of one that is quite 
different is the biotech firm that has this long lead time and 
has, in essence, not just a valley of death, but at the end of 
that, a long canyon of thirst or starvation or whatever you 
want to call it, but it has got an additional issue. So there 
are unique profiles to this funding gap. Thanks.
    Ms. Wheeler Thank you. Jerry, and then Stu, and then we 
will go on to the venture capital piece of this.
    Dr. Fanucci. Something I guess a little different that 
hasn't been said. I have been told by some of our technical 
managers on the Government side that the SBIR management 
process is basically out of their own time and hide. They are 
not funded to support a SBIR company. When we look at the 
projects of our company that have been the best commercial 
successes or have at least a possibility of commercial success, 
one of the things that is always true is we have had an 
involved program manager on the Government side.
    Maybe some of the money that we are talking about giving to 
the small business should be directed to support the Government 
program manager so that he can be more actively engaged in the 
program from the beginning, you know, trips to the company, 
trips to the customer, who is not usually the program manager 
but someone on the ship side of the Navy, for example.
    Ms. Wheeler But you are saying program manager that is in 
the field, not program managers of SBIR, like Jo Anne or Mike?
    Dr. Fanucci. I am talking about we interact on each SBIR 
with a different technical person in the Government who either 
wrote the topic or has been handed this topic to deal with in 
some way, and if that guy is interested in the result of that 
program, you find that that correlates highly with eventual 
commercialization of that part. He knows--he is actively 
involved enough to tell us where we are going wrong, to talk to 
people who would eventually use it, who isn't the person who is 
the technical person but someone else in the Navy, and really 
help to guide us along this two-and-a-half-year SBIR path to 
something that at the end looks useful to someone else in the 
Navy, which is hard for a company on its own to do.
    So maybe some of the money--I don't know if it is true or 
not, but I get the impression that those guys don't have 
funding really to support real active participation in the SBIR 
process.
    Ms. Wheeler Thank you. Stu, do you want to make a comment 
quickly?
    Mr. Haber. Yes. Thanks, Kevin. I wanted to respond to 
something that Jo Anne said earlier, and I think, Jo Anne, you 
were making the case for not needing a CPP because NIH has been 
successful in seeing some of the companies who have received 
SBIRs gain a fair amount of venture capital and what not. I 
want to argue that I think NIH actually has a built-in CPP 
program, because often, the awards made by NIH are two-and-a-
half to three times the size of those that are made by DOD.
    Ms. Goodnight. Do I get to have one final----
    Ms. Wheeler Sure. Go ahead.
    Ms. Goodnight. I am sorry. That will make the second hour 
go more rapidly.
    Ms. Wheeler Yes.
    Ms. Goodnight. Right. And I think that we have some type of 
CPP-like program built in. We have multiple programs built in.
    But I just want to come back also to a comment that Chris 
highlighted and I just think that it is very, very important 
that we think about--I need to even articulate this right--
small companies to succeed are going to need to have the right 
team in place. It is going to be management. It is going to be 
market development. It is going to be the commercial guy. It is 
going to be the PR gal or guy. You are going to have to have 
that team, and it doesn't matter how much money the Federal 
Government puts into this program. If that team is not there to 
see those products move across that valley, it won't ever 
happen, OK.
    Ms. Wheeler OK. Go ahead.
    Mr. Mehra. Just a very quick closing point. I could not 
agree more with the importance of having business skills in the 
company. I think that is something that most people overlook. 
But unfortunately, the way that the program is structured right 
now, I think it is not companies with great business and 
technical skills who are necessarily being rewarded. It is 
companies with great political skills, because most of the 
Phase III success stories that I am aware of involved a 
congressional plus-up at some point, and I just think that that 
is not the process that we want in place right now, where you 
have to go get a congressional plus-up to be successful to 
cross through the valley of death.
    Ms. Wheeler Well, that is an excellent point and we have 
been concerned about that, that plus-ups, as you said have 
often been relied upon. Then can we get around this inefficient 
process of requiring people and the money that it involves for 
them to chase those plus-ups?
    One final question before we go on. Well, I will turn to 
Erik, but my final question is to DOD and to NIH. On your Phase 
II-B-pluses or your CPP, where does the money for these extra 
grants come from? Is it coming from the 2.5 percent? Where does 
it come from? Michael?
    [Laughter.]
    Mr. Caccuitto. Not by much. You have Phase II enhancement, 
we call it. It otherwise sometimes manifests itself as Phase 
II-plus or Phase II-B at NSF and other places. The matching 
funds for those programs tend to be matching fund programs 
where we require the companies to secure external funds to 
match our additional money. That additional money that we 
provide does, in fact, come from the set-aside, and what you 
are seeing happening right now at CPP is the same way. It is 
Phase II enhancement with a new governance mechanism attached 
to it. It is really the same old program that has been around 
for 8 years, just being used in a more aggressive way, in a 
different way. But it does limit our ability to influence 
outcomes because we are drawing that money from the same pool, 
that same set-aside pool.
    Ms. Wheeler OK. Thank you. Jo Anne?
    Ms. Goodnight. Our Phase II competing renewal awards are 
made using the SBIR or STTR set-aside. But I should also 
mention that sometimes actually the companies are bringing 
State funds to that project, as well. For example, Kentucky 
offers Phase I and Phase II match funds, and there are 
certainly other States who provide some match funds, so that if 
they see we are funding a Phase II or Phase II competing 
renewal, they can bolster that a little bit.
    Ms. Wheeler Thank you. Erik, did you want to add anything 
before we go on to the VC portion?
    Mr. Necciai. My questions will lead into that, especially 
considering the various forms of funds either increasing the 
percentages or outside VC funding or State funding, et cetera. 
So I will reserve my questions for that time.
    Ms. Wheeler You are OK? Michael, your card.
    Mr. Caccuitto. Just an addendum. Often, the contracts are 
modified with non-SBIR money, even unilaterally. We will call 
it mission funds, DOD funding that is not set aside for SBIR 
and apply that to SBIR contracts if there is interest to do so. 
So that does happen quite frequently----
    Ms. Wheeler OK, but----
    Mr. Caccuitto [continuing]. In addition to----
    Ms. Wheeler [continuing]. For both of you, it is coming 
from the 2.5 percent right now? OK. Thank you.
    Well, with that, if Senator Snowe's staff is OK, we will 
move on to the second portion of the panel and discuss the role 
of venture capital. The easiest way to lead into this is to 
just start with the firms and get them to explain to us how 
they feel about the possibility of changing the eligibility 
rules to allow firms majority-owned and controlled by venture 
capital firms to participate in the program.
    You know what? Someone just asked if we could take a break. 
Could we take a break and then we will come right back, let us 
say in a couple of minutes. Is that all right? OK.
    [Recess.]
    Ms. Wheeler I am sorry to interrupt, but could we ask 
everyone to take their seats and we will start the second panel 
on the role of venture capital. Thank you.
    At least one of our participants has to leave within 30 
minutes, and so I would like to get started and we will open up 
with the SBA. An important part of this is to try to get the 
facts straight. As Senator Kerry has said, we continue to see 
articles and documents that suggest, for some reason, that 
firms with venture capital are not allowed at all to 
participate in the SBIR program, and that is not accurate. So 
we will start this with SBA giving us the definition of 
eligibility for SBIR and answering whether firms with venture 
capitals are allowed, and then I am going to turn to Stu Haber 
before he runs out to an airplane, and then, after that, it 
will be first come, first served. SBA?
    Mr. Brown. OK. I don't want to bore everybody, but to make 
sure I get right on point in terms of the development of the 
eligibility criteria, especially as it relates to potential 
venture capital participation, I have a prepared statement.
    Ms. Wheeler OK. Two minutes?
    Mr. Brown. Well, I will tell you what. I will wind it down 
to the basic criteria and I will pass it on and then we can get 
reaction to that.
    Ms. Wheeler OK. Can everyone hear? Do you want to pull your 
microphone a bit closer?
    Mr. Brown. OK. This definition is basically right out of 
our amended SBIR policy directive, and I am probably going to 
get on a roll anyway. It was most recently amended back in 
December 2004 and it became effective in January 2005 with the 
latest amendment.
    The basic definition is that the firm must be for profit, 
it must be at least 51 percent owned and controlled by one or 
more individuals who are citizens of or permanent resident 
aliens in the United States, and have, including affiliates, 
not more than 500 employees.
    The latest amendment added an additional provision on the 
51 percent. It added, or 51 percent owned by another concern 
that is also 51 percent owned by individuals that are U.S. 
citizens or permanent resident aliens, and that was expanded to 
allow for subsidiaries of a small business.
    And, of course, where we stand at now is are we going to 
expand upon that definition that is already out there, so I 
will just leave that there.
    Ms. Wheeler OK, but before I turn to Stu, I want to make 
clear that firms with venture capital investment are eligible 
to participate in the SBIR program.
    Mr. Brown. Yes. Under that definition, and again, that is 
what comes up time and time again at SBA, is an understanding 
of exactly what that definition that I just outlined means, and 
it means--I don't want to say it this way, but it means exactly 
what it says. And the fact that the firm happens to be a 
venture capital firm as opposed to any other type of business, 
the criteria is the same. So the venture capital firm can have 
49 percent ownership in the company as we speak. So there is no 
prohibition against venture capital participating in our 
program as we speak.
    Of course, the issue is where do we go from here? Is 
additional ownership going to be allowed? Could you have a 
minority interest, say two or three venture capital firms 
owning 20 percent, participating in the program? But what we 
have to also look at, and I am glad that we have Gary Jackson 
here from our Office of Size, is it is not just ownership, it 
is control. It is potential control of a firm. So I will just 
leave it out there with that broad stroke.
    Ms. Wheeler And tell us what the affiliation rule is.
    Mr. Brown. The affiliation rule is if a firm has an 
interest in a small business, that control could be inferred, 
that that would be lapped into the firm that is under 
consideration and the firm may possibly not be considered 
small.
    Ms. Wheeler But I think my question is, are the employees 
of affiliates counted in the 500?
    Mr. Brown. Right. Right. That is what would put them over 
the 500. So if you had two or three companies that are 
considered affiliated with one another, even though they have 
less than 500 employees individually, the total would be 
included for the firm that is being considered for eligibility, 
the SBIR firm, and they, in turn, would not be considered 
small.
    Ms. Wheeler OK. Let us turn to Stu and then we will go to 
Gary on size standards.
    Mr. Haber. Thanks, Kevin. I would like to make four points, 
and one is to quasi-quote the regulations, which says that the 
SBIR program protects small businesses and enables them to 
compete on the same level as large businesses. If you think 
about what that means, what do large businesses have that small 
businesses don't have, I would say it is resources. I would 
argue that a company, a small business that has millions of 
dollars invested in it has resources. And so I think to change 
the regulations to include--to modify the regulations to give 
VC-backed companies more opportunity, I think would be contrary 
to really what the program was designed for.
    My second point is I have heard it mentioned a few times 
that, you know, why would VC-backed companies ever be 
interested in $100,000 Phase Is and $750,000 Phase IIs, and I 
don't believe they are. I think DOD is--my opinion is DOD is 
out of the picture from a VC perspective for two reasons. No. 1 
is DOD issues topics and companies have to respond to those 
topics, and I don't imagine that a VC-backed company is going 
to operate that way. I would imagine that a VC-backed company 
is going to submit their own topics, and to my knowledge, NIH 
is the only agency where that can be done.
    So No. 1 is I don't think it fits for VCs to go after DOD 
SBIR, and I don't think they will. The second thing is I think 
they are really focused on NIH because they can submit their 
own topics, plus the size of the awards, as I mentioned before, 
are much larger, two-and-a-half to three times the size.
    The third point I want to mention, and I guess I will--this 
is from speaking with many VCs, trying to raise funds from them 
for our own products, and also something Jo Anne said earlier, 
and that is VCs really are focused on betting on the horse. 
They are focused on investing in management, not really 
technology. Sure, there has to be a market there, but I think 
they are really focused on bidding on management, and it would 
seem to me that if they have already made an investment and 
they believe in a company and that company has one more product 
that they want to move forward, I don't understand why they 
wouldn't invest if they really do believe in the management, 
why they wouldn't invest some additional money at the early 
seed stage level.
    And the fourth point I wanted to make was actually to 
respond to the slides that Mr. Eisenberg sent to us. Slide No. 
8, depicts four companies. One is a public company with 300 
employees who would be eligible. Another one is 475 employees 
that has $150 million in revenue. It is also eligible. Company 
C, a $200 million company with 400 employees, eligible. And 
then the fourth case of an ineligible company with only 20 
employees, very small, $50,000 in revenue, very tiny, but yet 
$8 million in VC funding.
    I think this is a good chart, but I don't think it argues 
for company A, B, and C to receive SBIR funding. I think what 
it argues is that perhaps the 500-employee threshold is too 
high. So I think a company that has received $8 million in 
capital, I think has resources and I think that would--I think 
it would place small businesses without those resources in a 
competitively disadvantaged situation.
    But even though that is not your point, I would go along 
and argue that maybe the 500 is too large. I have always 
thought of a company with 500 employees as not being small. 
Maybe it should be half that. That is open for discussion. But 
it seems to me by the time a company gets to that size, I think 
they do have the resources and they really don't need--just 
like VC-backed companies, I don't think companies with 300 or 
400 or 500 employees need to be nor should they be entitled to 
go after SBIR funding.
    Ms. Wheeler We have here Gary Jackson from the SBA, who is 
an expert in size standards, and I wonder if you could speak to 
that 500-employee number. Can you tell us the history, why we 
have that number?
    Mr. Jackson. There is a relatively simple history of it. 
Basically, for R&D activities under the North American Industry 
Classification System, we set a small business standard. We 
look at the characteristics of R&D firms in that industry to 
come up with that level. And since the SBIR program is focused 
on R&D-type companies, or at least R&D activities, SBA 
historically has just applied that size standard for the SBIR 
program.
    There have been some discussions saying that there is some 
legislative history that supports that. I can't cite anything 
to say that, but it is mainly to be consistent with our other 
size standard that we apply for R&D activities.
    Ms. Wheeler SBA several years ago put out a rule on this 
issue. In fact, SBA is still in the middle of that rulemaking. 
You can give the dates of when you did this, but SBA went all 
around the country and solicited comments. Did the 500-employee 
number come up?
    Mr. Jackson. It did come up in a few instances, not very 
often. It wasn't raised by either members of the public that 
testified at our hearings, which were in June of 2005, or 
during the public comment period on our December 2004 Advanced 
Notice of Proposed Rulemaking. So a few people have raised that 
issue, as Mr. Haber has, but not--again, it has been few in 
number.
    Ms. Wheeler And what is SBA's position on changing the 
eligibility rules relative to venture capital firms?
    Mr. Jackson. OK. At the moment, we have looked at a lot of 
information on comments that we have received. There are a 
variety of issues. One thing that I think I have learned from 
working in size standards for many years is there is rarely a 
consensus on these issues, and within the question about how to 
address the question of VC companies that are majority owned by 
VCs, we have the same situation. We have some very good 
arguments on both sides of the question.
    So when we are looking at that issue, we are very concerned 
about a number of things. One, what does the public feel about 
this? That is a consideration. Again, we have mixed views on 
the appropriateness of allowing companies that are majority 
owned by VCs to participate in the SBIR program as small 
businesses. Mr. Haber has reflected some of those concerns on 
reasons against that. I am sure we will hear reasons that we 
ought to do that or allow those companies to also qualify.
    I wanted to just follow up briefly with Edsel's remarks and 
just point out that when we look at small business status and 
what is a small business, there are really two aspects of it, 
and this is driven from the Small Business Act. One, there is a 
size dimension, and that is where the numerical size standards 
come into play in terms of some type of measure of what is a 
small business.
    But there is also the aspect of one that is independently 
owned and operated, and that is more of a qualitative 
assessment. What that provision is trying to focus on is 
whether a business is controlled by another organization, 
especially large businesses, and Mr. Haber kind of stole my 
point, too, that part of the concern there is that you do have 
access to different resources. If you are part of a much larger 
organization or you have overcome some of the disadvantages of 
being a small business, you have access to resources. You have 
access to managerial advice and other forms of assistance. That 
is a consideration, not just the numerical aspect of size.
    So I think that is something to keep in mind as we look at 
that whole issue. How does that play into it? How does that 
change the nature of a firm and how does that VC backing give 
more competitive advantage to one firm over another that is in 
a similar situation.
    Mr. Necciai. You mentioned the VC's competitiveness. What 
benefits do VCs bring to small businesses?
    Mr. Jackson. Well, first of all, quite obviously is the use 
of capital to pursue investments. We have already talked about 
that during the discussion of the valley of death. But also VCs 
quite often bring in very knowledgeable and experienced 
management talent. We have already talked about that, too, and 
the need that it is not just getting the capital, but it is 
also having the business expertise to be able to follow through 
and market a product.
    Ms. Wheeler Mr. Doerfler, do you want to comment?
    Mr. Doerfler. I would like to tell the story about our 
company. I would also like to talk, maybe at another time, 
about how important this industry is, the biotechnology 
industry, but let me tell the story of MaxCyte.
    I formed the company in 1999. It is a biotechnology 
company. I financed the company through, I like to say now, 
unfortunately, ex-friends and family----
    [Laughter.]
    Mr. Doerfler [continuing]. Over the course of the first 
four or 5 years, and we raised about $10 million through that 
group.
    We are working in an area that is really exciting. It is 
technology that uses a patient's own cells to treat disease, 
and our major product right now is in clinical development and 
it is for treating people who have severe lung issues, where we 
are actually regenerating lung tissue. So it is the only 
treatment of its type that is available. It is truly a really 
fascinating product.
    When we started to see some progress on that--I have a very 
unique situation. I am still under 49 percent from the venture 
capital perspective because I have an angel that has been 
investing in the company who has a personal interest in the 
work that we are doing.
    As we began to raise more money, we got around $10 million 
and he said to me, he said, ``Doug, this is a really 
complicated area you are in and I think you need help. You need 
to bring in some people to,'' he called it smart money, because 
he is smart money himself, but he doesn't understand the work 
that we are doing.
    So we went out and we met with scores of potential 
investors. In these investors we had to find their interest in 
the product that we are developing, which is a cell-based 
product, very unusual, and we wanted to find people who had 
expertise, to Mr. Jackson's point, because they had networks of 
physicians and they had been through this a number of times and 
they could give us more discipline in terms of how we should be 
thinking about developing these products because they are so 
risky.
    In biotech, there is a valley of death and the valley of 
death is perhaps hundreds of millions of dollars. And then you 
get to a cliff at the end of that point and the FDA can turn 
your drug down or put it back up just like that, and all that 
investment goes down the drain.
    There is also a number of instances where clinical trials 
have been stopped because of a single patient having adverse 
effect that you can't prove that your drug wasn't the culprit. 
It is hard to prove a negative, but sometimes you are forced to 
do that. And again, those trials can completely go upside down 
on you.
    So this is a very risky business and you have to find 
people who understand the business and who have the financial 
ability to do so. So we are under 49 percent. We have been the 
recipient of a Phase I SBIR for about $90,000 through NIH and 
it was for a completely different use of our technology in an 
area that I didn't feel we had enough understanding of before 
we wanted to make any investment in, so we went to NIH and we 
went into a large study section. I believe there were 18 
people. These are just top-notch scientists that really took us 
through the wringer to make sure that we had the right science 
behind what we were trying to do.
    We got the Phase I and we are about to move into a Phase II 
submission for about $800,000, which we hope to get sometime in 
the near future. So that is a sideline of our business. It is 
very exciting. It opened up a new area for us, which is in 
actually a vaccine for treating these same kind of diseases.
    The issue here is that when we are successful in this 
clinical trial, I have to raise a lot more money, probably 
around $35 to $40 million to take this product through the next 
phase, and that money is going to go to nursing staff. It is 
going to go to paying for the hospital for the patients that 
are on this drug, paying for the drugs that the patient takes, 
as well, because the insurance companies won't pay those. So 
these are very expensive trials.
    I need to raise that money. I am not going to have those 
resources. I need to raise money for the next two or 3 years 
that is going to be dedicated to those kind of operations. I am 
not going to be flush with cash. Although I have cash, it will 
be very well committed to the hospitals that we are going to be 
using.
    I talked to my lead investor, my angel, if you will. It 
just so happens that my angel has more capital at his disposal 
than all the venture capitalists that I have invested in my 
company combined. He said to me, he said, ``I want to go this 
next step, but I need help. I need more smart money into your 
company to make this work.'' So I will be faced very soon with 
a situation where I will undoubtedly have to go above 49 
percent and in the 51 percent range in order to go after the 
product that the company has been focused on.
    It is interesting, though. If I become a public company and 
I am very successful, I can go back into the program. But under 
the existing SBA rules, I can't participate during that time 
when my capital structure is more than 51 percent, but I can 
when I go back to being a public company and have even more 
resources than I would in the future.
    The size of my company, we are 14 people. I expect when we 
raise the next major round we will balloon to about 25 people. 
I don't expect it to be any larger than that. So we are a small 
company. We absolutely are a small company.
    We are in a very high-risk business and we are in a 
business that is unique, and I think we have heard that today, 
that perhaps this is an industry that is really different than 
most industries in the U.S., and perhaps this is the only 
industry of its type where the venture capital community plays 
a major part in its success.
    And biotech, we are still the leaders in the world in 
biotech, I think in large part because of the role that SBIR 
played in some of the early formations of companies with 
venture capital and with public financing.
    Ms. Wheeler We have a question for SBA. Mr. Doerfler is 
saying that if he were to go public, he would still be 
eligible. What would be the rationale for them being eligible 
if they are public as opposed to if they are majority-owned by 
entities? You are saying that these will be entities, they will 
not be individuals?
    Mr. Doerfler. It could be individuals. They could be--it 
depends on----
    Ms. Wheeler Well, then you would be eligible. But if they 
are entities, then you would not be.
    Mr. Doerfler. Right.
    Ms. Wheeler So let us just say that they are majority-owned 
and controlled by entities.
    Mr. Jackson. Right. That is correct. Within the SBIR 
current regulations, that publicly traded company still would 
have to satisfy the requirement that 51 percent of the stock 
was owned by U.S. citizens or permanent residents of the United 
States. It comes back to an issue of control, that if you have 
a certain amount of ownership, there is control that you can 
exercise. But when you distribute ownership widely or by 
various institutions, the question of control comes up. It is 
somewhat of an anomaly, this situation that you bring up, 
because it does say that in some cases, a very small company 
may not qualify but a very large one may relative to the other. 
But I think the issue becomes one of control, where that public 
company is still under the control of the individuals.
    Ms. Wheeler Who would control your company?
    Mr. Doerfler. This is my third company. The first two were 
venture majority-owned companies, investor companies. We have 
an independent board of directors. In each of the three 
companies I have been involved in, we have an individual board 
of directors, and the board is made up of a majority of non-
investors, which isn't unusual in this business.
    We went out and we found the venture capital investors. 
They did not put together their own group. We find these people 
based on our interests and their capability to invest in us. So 
it is not like we are going to a club or it is not like we are 
going to a group that is investing in our companies. We are 
responsible for bringing in these investors.
    Frankly, I don't want to have an investor that has more 
than maybe 20 or 25 percent in it for any influence whatsoever, 
but they don't have control. We have an independent board. We 
vote on all matters concerning the management of the company. I 
have complete control of that company on a day-to-day basis. So 
I don't see the connection, frankly, from my experience in my 
third company that your ownership structure infers some sense 
of control by a group or a number of investors.
    Ms. Wheeler So if they have the majority, they do not 
control your company? They don't exert control?
    Mr. Doerfler. They don't, no. I mean, I can't--I don't want 
to be glib about this, but it is hard enough to get them to 
agree on lunch and location. It is very difficult for them to 
agree on a business strategy. It is very uncommon for there to 
be unanimity around what their interests are because they are 
all in different aspects of their funds. They have different 
portfolio pressures. Their need to invest in the company is 
based on their return, but they also have their own internal 
payback requirements and time lines that are different from 
investor to investor.
    Ms. Wheeler Dr. McGarrity, your name plate was up.
    Dr. McGarrity. Thank you. I also wanted to add my 
experiences from biotechnology, and I told you about my present 
company. I want to talk to you about a company that I was 
formerly CEO with until about a year ago and that company was 
ENTRON. It was very similar to the beginning that Dr. Fanucci 
mentioned. The basic technology was invented in the scientist's 
living room. They started out with one to two employees. The 
first grant that this company had was from the Cystic Fibrosis 
Foundation, so it was taking a highly innovative technology, 
trying to apply it to this disease setting.
    The company applied to NIH for a Phase I SBIR grant and it 
was approved. In fact, the same kind of review committee that 
Doug had mentioned, 18 to 20 national scientists actually gave 
the company more money than we requested, and when is the last 
time you heard a Government budget grouping doing something 
like that? We fulfilled the objectives of that Phase I.
    We went into a Phase II application. A different expert 
committee of 18 to 20 scientists approved that and they said, 
quote, ``This is one of the most innovative, thoughtful, and 
exciting applications'' they ever read. So that really psyched 
us. We thought we were highly valid, we had something to 
contribute.
    We then got an addition, an extension of that SBIR grant 
that was awarded in June of 2003. In August of 2003, NIH 
contacted us and said there is a new interpretation of the 
eligibility rules. We want to look at your funding. And on the 
basis of our Phase II grant, that highly innovative 
application, we went out and raised venture capital funds, and 
that was--the SBIR award was our credibility and our 
credentials.
    So suddenly, 3 months into this grant, the grant was 
rescinded and we had three people working on cystic fibrosis. 
We had to terminate those people. We canceled that program and 
we could never restart that. So on the one hand, NIH invested 
probably $3 million, $3.5 million in all of these studies and 
we will never really know whether that would have any potential 
to help or cure cystic fibrosis.
    And so I am sitting in my office and I am saying, you know, 
I have 20 employees and I am told I am not a small business and 
there is just something wrong with this picture, because I read 
the legislation of the SBIRs and it was to stimulate and help 
small companies and it was to stimulate innovation in American 
companies. So, I thought, we are really doing that, and as an 
entrepreneur, as a manager, as a scientist, I am perfectly 
willing to compete with anyone in the country on the quality of 
my science and the quality of my program, and if I don't get 
the award, it tells me I have to go back and work harder, and 
that is really the American way. That is what competition is 
all about in this country.
    So I see there is a disconnect there, and I think if I 
apply this even to this setting, if you allow me to be 
McGarrity Venture Capital this morning just for the sake of 
illustration, and let us say all of the people around this 
table are biotech companies, and let us assume that the 
ownership requirements are fair and the total number of 
employees around the table total 450 employees total in 
affiliated companies, well, that means we are all fine, we are 
all eligible for SBIR.
    But let us assume Mr. Jackson's company hits a breakthrough 
and there are great things going on in the country and he has 
to hire 50, 60, 70 employees. Well, then suddenly we are over 
the 500-employee limit and his success means you are ineligible 
for SBIRs. There is just something wrong with that equation for 
me.
    And when I look at that, and I have recently in the past 6 
months been to Europe and to Japan and then to Australia and I 
am meeting with other biotech companies around the world. I 
want to point out, and I think you are well aware of this, but 
I want to say it for the record. What happens here really has a 
direct impact on biotechnology in the United States and in 
international competition. I would say, please let these 
companies, especially these early stage biotech companies, 
compete for the most innovative idea, the most innovative 
science, and allow them to prosper, to create jobs, create 
economies, and also to bring cures to patients, especially 
those that are in those markets that are perhaps underserved or 
where there is no alternate therapy available.
    I would just close by saying if you are developing a 
therapeutic, if you are developing a drug, it is basically 
going to be the same cost of development whether your market is 
$10 million, $100 million, or $1 billion. So where is the 
emphasis going to go? It is generally going to go, all things 
equal, to the larger markets.
    And one final point. I read that if this goes through, 
well, large pharma is going to get in and have access to SBIR 
funds. I was with a small biotech that was purchased by 
Novartis about 12 years ago and I can tell you, that just 
doesn't happen. When I am inside Novartis and a scientist comes 
to me with a new and innovative idea, do you think I am going 
to take two people and tell them to work 2 months to write a 
grant application to NIH and then wait 9 months to get an 
answer back? If it is worth doing, we are going to do it today 
and I am not going to wait ten or 12 months to do it. So I 
think that type of argument just doesn't reflect the reality. 
Thank you.
    Ms. Wheeler May I ask you a question?
    Dr. McGarrity. Sure.
    Ms. Wheeler When you had that Phase II that had so much 
promise and the company attracted the venture capital that then 
made you ineligible, why would a round one of investment eat a 
majority ownership of a company?
    Dr. McGarrity. Because they were approximately 60 percent 
ownership.
    Ms. Wheeler But isn't that highly unusual? I was under the 
impression that first rounds are usually a smaller amount, and 
then as you go on, you receive more investment and VCs take 
control of a larger percentage of your business.
    Dr. McGarrity. No. I think there is a tremendous variation 
there, and typically in an early stage biotech company, you 
will reserve a certain amount of stock for the owners and the 
founders, the scientific founders of the original team. You 
will set a certain amount of stock aside for stock options. And 
it is not atypical at all for the VCs or a VC to end up with 
more than 49 percent.
    Ms. Wheeler And so why did the company still need the SBIR 
money if they had just attracted all of that venture capital?
    Dr. McGarrity. That is a great question, and it goes to 
what I had said. The VC money that came in, there was a 
cardiovascular program, a large, large market, a lot of 
potential. There was a cancer program, again, large market, a 
lot of potential. Cystic fibrosis, and I have done the clinical 
trials in cystic fibrosis, they are really tough clinical 
trials to do. I mean, kids are sick, they are mucousy, and even 
to get the medicine in, it is very difficult. And the markets 
are much more modest.
    And that was my point, that for all of these so-called 
orphan diseases or the diseases that do not have large and 
attractive markets, that is where you need the help of a thing 
like this to get it off the ground and to go through the early 
stages. As I say, large markets, the capitalist system works 
very well. If you say, I have great data, great technology, and 
I am going into atherosclerosis, you get a lot of attention on 
that.
    Ms. Wheeler But I don't understand. I thought that project, 
the one for multiple sclerosis, had attracted the VC. So you 
had the money.
    Dr. McGarrity. No. The--well, the actual technology was 
what attracted the VC. I mean, getting down into the detail, we 
had a cystic fibrosis program and it was the innovative 
technology that was being applied to cystic fibrosis. So how we 
pitched the VCs was, look, this is working and we have proof in 
animal models that it is working in cystic fibrosis. We want to 
take the same technology now and apply it to cardiovascular and 
cancer, and so they liked the combination that it was this 
highly innovative technology applied to a major market disease.
    Mr. Necciai. You mentioned cystic fibrosis. And that it 
unfortunately got cutoff at that time. Are you familiar with 
any other programs that got cut? It seems like every time the 
funding is taken away, that these programs just get dropped and 
that there are potential cures for, you know, X-number of 
different things that unfortunately don't come to fruition.
    Dr. McGarrity. Yes, and the unfortunate thing is, as I 
said, we will never know whether this could have been 
effective. As I said, we had to terminate the three people that 
were doing this program and scale back and drop that program. 
And then you asked, well, could you go back and try to restart 
that? You could, but it is very difficult to do on a day-to-day 
basis because the team and the cohesiveness and everything else 
has left. It is very hard to restart something like that.
    Ms. Wheeler So those venture capitalists who said they were 
interested in cystic fibrosis, once they found out you weren't 
eligible for SBIR, they decided not to give the company money?
    Dr. McGarrity. No, no, no, no. No. We had data on cystic 
fibrosis using this innovative, I call it smart technology. So 
they said, hey, this is really slick, and we always got high 
marks from people on the technology. They said, this is really 
nice, but gee, you are applying it to cystic fibrosis. That is 
a long clinical path, it is a modest market, and they are tough 
clinical trials to do. We said, it will also apply to 
atherosclerosis, which are much easier trials to get through 
and you could potentially attract the interest of large 
pharmaceutical companies.
    So they said, all right. We will pay you for this--we will 
invest in you for this innovative technology if you are 
applying this into atherosclerosis or into cancer. But to 
cystic fibrosis, they said that is such a challenging disease, 
a difficult disease, and a small market. We don't want to fund 
that aspect of it.
    And I think that is what is happening with a lot of biotech 
companies, that they are using SBIR grants as a model or as a 
proof of concept into often diseases that are underserved by 
the markets, and often these orphan diseases, or you look at 
the list of people who have signed this letter, the patient 
advocacy groups, and we would get a lot of questions, can you 
use your technology for spinal muscular atrophy? Can you use 
them for Duchenne muscular dystrophy? So that is more typical 
than not.
    Mr. Necciai. Dr. McGarrity, how was the business model for 
biotech firms different pre-SBIR than it is with the 
restrictions currently in the SBIR program?
    Dr. McGarrity. Well, I think if you look over the past 10 
years, a number of things have happened because it is difficult 
to try to put a stereotype around venture capitalists because 
that model is changing for a long time. When I went to my first 
biotechnology company in the early 1990s, it was high risk, 
high reward, and they were willing to take much more risk. If 
you look what has happened over the past five to 8 years, 
venture capital firms want less and less risk, and that is why 
I think the vacuum created by not having access to these SBIRs 
is really starving early stage biotechnology companies.
    I mean, I want to point out, right now, my present company, 
VIRxSYS is eligible for SBIR, so I don't have an axe to grind. 
And you could say, well, why don't you keep your mouth shut and 
you will have a better chance at competition, but I think that 
is not what the country is about and I don't think that is what 
the spirit of the SBIR legislation is about.
    Ms. Wheeler Did you have another question? If not, we will 
move on to Kunal.
    Mr. Necciai. Sure.
    Mr. Mehra. My comments are kind of over three different 
parts, but I would just say, I mean, I think one thing we 
really need to talk about are the unintended consequences of 
any form of legislation, and there are a lot of, I believe, 
unintended consequences from the proposed legislative changes 
to the small business size standards.
    The first is the two examples that Mr. Doerfler and Dr. 
McGarrity just gave are, I think, riveting examples of 
companies that are clearly doing things to save lives, but 
these are companies that are also clearly in the development 
and testing phase. They are not in the early stage innovation 
phase, which is what programs like SBIR and other things are 
intended for.
    And I understand there is this kind of disparity. On the 
one hand, they are developing a drug that is for a particular 
set of applications, and then they see a separate application 
on the side that they might want to apply it to and maybe that 
is innovative.
    We need to figure out a way to distinguish between those 
two different types of companies, and one way that you can do 
that is you can actually spin out the application of the 
technology for this new market, have a different capital 
structure with it, and then you don't worry about the company 
that is further down the road in the development and testing 
from being--as not eligible for SBIR because you have got this 
new small entity that just has that license, has a different 
capital structure, and could take advantage of an SBIR if it 
has the technology.
    So I think there is an element of kind of robbing Peter to 
pay Paul in this, which to me is kind of concerning.
    The second thing I want to talk about was the control 
issue, because I think this is an extremely complex issue. 
Quite frankly, I think boiling it down to something black and 
white, like if 51 percent of the equity sits with one entity, 
then it is no longer controlled by the entrepreneur, I just 
don't think it is that black and white.
    I was a strategy consultant with McKinsey and Company and 
then I actually worked in a venture-backed company, so I think 
I have some unique insight into this, and I have seen examples 
where the venture capitalist will give $5 or $10 million to a 
small business in the form of debt that is equitable at some 
point in the future, OK. They basically control that company. 
The entrepreneur literally has a gun to his head. If he does 
not perform, his equity will be wiped out because in some kind 
of liquidity event, all the money is going to first go to the 
VC who is holding debt before the entrepreneur is allowed to 
benefit at all. So that would not show up on any of the control 
standards that have been suggested by the SBA, but I think 
clearly is in direct opposition to what people intended under 
SBIR. So there needs to be a very careful study of this.
    Second, you know, venture capitalists can structure their 
investment in preferred stock, so again, even if they only own 
20 percent of the equity, if that is a preferred type of equity 
vehicle, they can still have control over the company.
    Third, the question of independent versus non-independent 
boards, well, that only matters depending on how rigorous your 
governance structure is. I have seen companies that have 
entirely independent boards, but guess what? Their board has 
really no control over the company because of the way the 
governance is set up. It is a particular set of shareholders 
that control, again, preferred equity or control a convertible 
debt note that might be exercised at some point in the future.
    So I just think this requires very careful study. There is 
no easy demarcation to make here, and what I worry about is 
every one of these companies are going to have to be a unique 
case and then the SBA is going to be overloaded in terms of 
studying these examples.
    And when I talk about unintended consequences, let me give 
you the extreme example. The way that the legislation has been 
reworded by the House, the Carlyle Group, which is a private 
equity firm that I am sure most of us in this room are aware 
of, which owns several multi-billion-dollar defense companies, 
could go out and hire Phil Condit, who used to be the CEO of 
Boeing. They could go put $100 million into a new small 
business. They could compete for SBIRs. They could go out and 
get small business set-asides.
    And why would they want that? Well, because of the sole 
source authority that you are given in SBIR and other types of 
awards. And they could go out and they could use that as a 
front to sell products from some of their other portfolio 
companies. That would be allowed underneath the current 
regulation. It just seems completely ridiculous that we would 
allow a loophole like that to compete with a company like what 
Mr. Sarich has talked about, which is bootstrapped by three 
guys who mortgaged their houses and are clearly disadvantaged 
and don't have access to those kinds of resources.
    Ms. Wheeler Thank you very much.
    Erik, did you have a question on any of that? No?
    Mr. Necciai. No.
    Ms. Wheeler It sounds to me that what this argues for is 
what SBA has said all along, which is that there is no easy way 
to get at this structure when you look at venture capital 
firms, and that is why they have stayed with the basic 
definition of independently owned and controlled, because it is 
so hard to get at these individual cases. Is that accurate?
    Mr. Jackson. Unfortunately, yes, that quite often we have 
to look at these situations on a case-by-case basis. The 
overriding principle is the power to control, who really 
controls, who benefits, and that can vary under the 
circumstances. We have seen situations where a small share of 
ownership coupled with other types of assistance leads to 
control, and again, it is very difficult to give general 
guidance on what is acceptable and not. We try to keep our size 
ranks simple, but again, this is an area that you do have a lot 
of complexity.
    Ms. Wheeler OK, thank you. Dr. Abramson, did you want to 
make some comments?
    Dr. Abramson. Yes. Thank you. I think the points being made 
here revolve around business decisionmaking. The bottom line 
for me is, there is no need to change the current rule. So make 
that clear right up front.
    I think we just heard Dr. McGarrity discuss a business 
decision not to pursue a particular line of research by his 
investment group. That is a legitimate business decision. Doug 
Doerfler gave a similar discussion, that his investors don't 
want to pursue a certain line of research or development in 
contrast with other more valuable or opportune opportunities.
    For an individual business--by the way, we have no SBIR 
funding. We have applied three times and were turned down. But 
fundamentally, on an individual business basis, any funding 
program that is available should be sought. So there is no 
question that if I had an opportunity to get funding, I would 
go after it. But what is good for an individual business 
doesn't make good public policy. We can find individual 
examples where a particularly meritorious type of research 
would have, could have, should have been funded, but that 
doesn't mean as a general rule that we should change the basic 
structure of the rule system.
    Very few early stage life science companies have any 
funding at all from the outside. It is very difficult even to 
get angel funding, let alone VC funding. As Dr. McGarrity 
pointed out, they have to prove some success, some traction 
somewhere to attract the kind of investment to move forward.
    For many SBIR companies, many small bio companies that I 
know personally, the SBIR funding is their lifeblood. Without 
it, they die. If the rules are changed and other companies who 
are not now eligible enter the game, it will eliminate the 
opportunity for these smaller companies to prove themselves.
    Another point that needs to made is that the SBIR 
community, the representatives of SBIR, say quite candidly to 
the small business community, apply, get turned down, then you 
can improve your proposal until you can be approved. But the 
science isn't changing. So what that says is that there is a 
part of the SBIR process is the quality of the writing of the 
proposals, and we already heard the comment that resources that 
can be dedicated to writing a proposal can provide a better 
quality proposal.
    Now, we can argue about whether that should or shouldn't be 
the way it is done, but the fact is that is how it is done. So 
the small person who struggled for 2 months, who is a 
scientist, who is facing the valley of death, doesn't have the 
business background, isn't a very good writer, will get turned 
down. If they can't compete for that, where they could get a 
good enough score, the chances of them surviving to even 
demonstrate that what they want to do could have a benefit to 
society disappears. That means, ultimately, in my view, the 
pipeline begins to dry up, and in fact, we will lose the 
opportunity to sustain our world leadership in biotech if we 
change the rules.
    Ms. Wheeler Thank you. Chris, did you want to make a 
comment, or did you have a question?
    Dr. Busch. Yes. The discussion we are having largely deals 
with why certain entities should be excluded. Exclusion was the 
name of the game from the very beginning of the SBIR program. 
When it started in 1982, it excluded not-for-profit entities. 
It excluded universities. It excluded large businesses, big 
businesses. And they all screamed and hollered when this 
program was being put into place. What it was restricted to is 
a very small part of the R&D pie of 2.5 percent today. It 
started smaller, but 2.5 percent today that is dedicated and 
established just for for-profit small businesses. So there is 
nothing new or unusual about excluding entities.
    The second point is, ownership and control matters. Several 
folks have talked about situations where VCs or angels own a 
majority of the company, but they don't have control of the 
board. Well, that might be true today, but I have been involved 
in a number of these situations where that transitions to the 
situation where the outside owners take control of the board. 
So ownership and control really does matter.
    And in the H.R. 3567, in principle, takes that away from 
the SBIR program. It limits, if I have it correctly, any 
individual venture capital company can own up to 50 percent, 
but there can be multiple VC firms owning a company so that the 
small business people, the entrepreneurs, could own less than 
50 percent and the company could still compete for SBIR.
    It is hard for me to understand, especially being from 
Montana, how one can view that as a small business. If the big 
companies own and control the entity, it is just common sense 
to me that it is no longer a small business, and outside the 
original intent of the SBIR program and the intent of the rules 
and regulations that are promulgated by the SBA policy 
directive. So that was that point.
    The third, if the H.R. 3567 goes forward, it seems to me 
that it really lends the SBIR program to folks gaming the 
program, just exploiting the program, which I think would not 
be in the best interests of either small businesses or the 
technologies that they look to bring forward.
    As I indicated in my previous comment, I grew up in and now 
reside in a rural State region where the SBIR program provided 
and provides the fertile bed for high-technology companies to 
take root. I think I may have mentioned before that before 
SBIR, there were virtually no high-tech companies in the rural 
States like Montana. Today, there are not as many as some of 
the States that you are from, but there is a fairly healthy 
high-tech community that has evolved, not due exclusively to 
SBIR but enabled in large part by SBIR.
    So I really worry about the impact of changing the rules 
and the impact that that will have on the competitiveness of 
small high-tech businesses in the rural States, because there 
are virtually no venture capital resources available in the 
rural States and I think the GAO study of DOD and NIH awards, 
the one that came out about a year ago, pointed that out. If 
you look at the State-by-State information that GAO compiled, 
in the rural States, there is virtually no venture capital-
funded SBIR projects, either on a minority or a majority scale. 
So the rural State impact, I think, is a big time concern for 
myself, and Senator Tester mentioned that this morning.
    Ms. Wheeler Thank you, Chris.
    Edsel, did you want to make a comment? I see your card up.
    Mr. Brown. Yes. A couple of quick points. First of all, for 
purposes of clarification from my earlier statement about our 
definition, as most of you around this table probably already 
know the facts, but our definition really hasn't changed much 
since 1980. The change I spoke of in 2004 broadened our 
definition and it was basically a follow-up for a clarification 
of individuals that came out from the Cognetix case back in, I 
believe, 2003. So I just want to point that out there, that the 
program really hasn't changed and the definition and 
consideration of individuals really hasn't changed and the 2004 
change, which was effective in 2005. We wanted to provide a 
little bit more latitude to firms because of concerns like 
those expressed here at the table.
    Now, having said that, I would like to elaborate on a few 
things. First of all, from my perspective at the Small Business 
Administration, having been there for 3 years, and I can tell 
you that in my brief tenure there, I can see how this program 
is really maturing. Now, 3 years may not sound like much, but I 
can look at that back to 2004 and see the type of issues we 
were entertaining versus where we are today, and we are really 
moving forward.
    One concern that I have is we are talking about possibly 
changing the eligibility criteria, not just for SBIR, as 
outlined by Dr. Busch for H.R. 3567, we are talking about 
changing the standards for all of SBA. And again, there are 
pros and cons on this issue, obviously. But I think we really 
need to look at what the implications of this change will be, 
not just on our program, but for all small business programs.
    And the question that I ask is, where do we draw the line? 
If we change it now, and there are some very good arguments 
here, let me say that now. I know Jo Anne is probably going to 
speak on a lot of the issues from the NIH and through the 
proposed rulemaking process that we went through a couple of 
years ago when we got hundreds of comments in the Federal 
Register, there are a lot of very good arguments. But again, I 
ask, where do we move the line as we move down a continuum? And 
as we move down that continuum, more firms are going to be 
coming into focus as we move upstream. What happens to those 
firms that were downstream in terms of what the program was 
originally put together for? So I think we need to look at 
that.
    The other thing is, and this is beating a dead horse, but 
if we do change it, what are we doing in terms of looking at 
the risk and the creative technologies that we are looking to 
fund? Are we looking to fund less creative technologies by 
changing our eligibility standards? Again, I think that needs 
to be looked at.
    This is a key point, again, from the SBA's standpoint, is 
as there has been greater concern about whether my firm is 
small or not, because that is what is happening. A lot of 
firms, they have heard there was a change, and that is why I 
made the point earlier that SBA is changing standards, and a 
lot of people--we have received hundreds of calls. We heard you 
changed the eligibility standard, and, of course, we have to 
explain to them that the standard did not change, that there 
has been feedback relative to that Cognetix case and we just 
provide clarification.
    But if there is a change, there will definitely be an 
impact on SBA, as Gary has touched upon already. We will be an 
eligibility office, because once you get into the more 
sophisticated organizational structures, we are really going to 
have to look at these. I don't want to put out there the 
lessons learned from other SBA programs, but we have programs 
like the 8(a) program, where you have an eligibility office 
that they actually look at things. I am not saying we are going 
down that road, but that would also have to be considered.
    The other thing I want to point out is, again, there are 
some very good arguments for venture capital participation. As 
we have already said, that participation can be up to 49 
percent in terms of pure ownership without getting to the 
control issues. But what impact will the potential exit 
strategies of the firms have on the program, because there are 
a little bit different interests involved when you are looking 
at someone looking to get a return on their investment versus 
to develop a cutting-edge technology, and as we are saying 
here, we shouldn't just be focused on commercialization. It is 
very important and we want to keep our commercialization rates 
up, but it is a balance. It is not all or nothing.
    And last but not least, I want to touch upon what Dr. Busch 
said, as well, that we need to keep this out front and in 
focus. We are talking about 2.5 percent, not 97.5 percent. 
Thank you.
    Ms. Wheeler Thank you, Edsel.
    Ron, did you want to make a comment? And, I am sorry, we 
are just going to have to keep everyone a little briefer here 
so we can explore this a little more.
    Mr. Cooper. Yes. I was just going to--I won't repeat what 
Edsel said, but with the--I just wanted to clarify that the 
rule, the last rule change that we did make, which was in 2004, 
and it took effect in January 2005, that I call the subsidiary 
rule because it is allowing a subsidiary, a firm to set up a 
subsidiary to receive the SBIR. We had been approached by SBIR 
firms that wanted to just set up an R&D subsidiary to pursue 
their SBIR work and we were not thinking of venture capital 
when we were making this rule change. It has implications, of 
course now, for venture capital. A small venture capital 
company that qualifies as 51 percent owner controlled by 
individuals can own and control a SBIR awardee so long as, 
looking at the affiliation web, it does not include--does not 
go over the 500-employee mark.
    Now, the comments that we received during that rulemaking 
procedure led us to the Advanced Notice of Proposed Rulemaking 
which went out in 2004, and this is our process for making 
adjustments to the SBIR eligibility requirements, is we go 
through this rulemaking procedure. We received a significant 
amount of public comment during this advanced rulemaking.
    We did not overall receive a clear, compelling argument or 
rationale to change the program eligibility requirements for 
the entire program. It was clearly demonstrated that there are 
unique innovation financing problems for small biotechs, which 
we are very concerned about and are very interested in trying 
to address. We also did not receive a clear quantitative 
measure of the extent of the problem that existed or that was 
being claimed.
    So I just wanted to emphasize that this is, as we have been 
hearing, an extremely complex issue. We are still analyzing 
this and we would request your input.
    A couple of issues that I think Edsel touched on, when we 
are looking at eligibility requirements, we need to be sure to 
maintain the transparency of the applicant, and that is for 
identifying the control issue. This can easily get very 
complicated as we try to address some of the specific cases, 
say, that we have heard today in a rulemaking. For a small 
business program, it is important to keep the eligibility 
requirements simple and easy to self-certify. We don't want the 
Rube Goldberg solution, even though that is what may be 
necessary to--we could all point to cases that we think should 
be allowed. We need to keep these rules simple.
    And then my last point is that we want to avoid shifting 
the program down toward--out of our focus of this market 
failure gap toward activities that the private market would 
probably fund anyway. Thank you.
    Ms. Wheeler Thank you, Ron. Those are very good points.
    Mr. Eisenberg, did you want to go ahead and make some 
comments?
    Mr. Eisenberg. Sure. Thank you. I wanted to make a couple 
points that I think are important to make here. The first is 
much of the concern from the biotech industry is not about 
venture backing, it is about majority venture backing, and 
there is a difference here and it is important. Most of our 
companies have majority venture backing. There are about 1,400 
biotech companies in the U.S. and 75 percent of them are 
private. Of those that are private, the vast majority have more 
than--have 50 percent or greater, are majority venture backed.
    The average company that is out there right now today, be 
it in Maryland, be it in Massachusetts, be it in North 
Carolina, be it in Texas, be it in California, all over the 
country, the average company has five products in development, 
one in Phase II, not Phase II SBIR-speak, Phase II being FDA-
speak, that is efficacy testing, small-scale efficacy testing. 
They have another product that is in small-scale safety 
testing. And they have three products that are somewhere in 
pre-clinical.
    And the value of SBIR is, as has been discussed, really in 
helping to move products that are otherwise sitting on the 
shelf down the road through some proof of concept, early proof 
of concept testing that would not otherwise generate venture 
backing. When a company receives venture capital backing, those 
funds are generally dedicated toward the achievement of certain 
milestones with a particular product, and normally it is going 
to be the product that has the least risk, that is the product 
that is furthest along.
    And so it is important that the SBIR provides the 
opportunity to take products, or applications of products, or 
new products that you otherwise have on the shelf and move them 
out into--down the road for proof of concept testing sooner 
than you otherwise would have. That is good from a public 
health standpoint. That is good from a patient standpoint. And 
it is good from a public policy advantage.
    The basic fact is that biotech companies participated in 
the SBIR program for 20 years, and there are many of the 
success stories that SBA publishes on its own website, that we 
are happy to publicize, as well, about the biotech industry. 
Many of the companies that participated have had SBIR backing. 
Synagis, a product from Medimmune that takes care of--Medimmune 
out here in Maryland that takes care of kids that--premature 
infants that have lung infection, that is an SBIR success 
story. There are wonderful success stories from this, and the 
basic fact is, for 20 years, companies participated regardless 
of capital structure.
    Ms. Wheeler But I think the point is there that they 
weren't supposed to.
    Mr. Eisenberg. Well, the SBA clearly knew who it was going 
to, and what is further, Congress reauthorized the program 
twice during that period, and if they weren't supposed to, 
Congress could have, but clearly didn't, make a change to the 
rules.
    Ms. Wheeler But we did not know that firms majority-backed 
by multiple VCs were participating until there was a ruling 
from the SBA when the issue of size standards came up. I would 
prefer that you would focus on why we should change the rules 
rather than on whether it was a change because we disagree on 
that.
    Mr. Eisenberg. So we can turn then to why should companies 
be able to participate.
    Ms. Wheeler OK.
    Mr. Eisenberg. Take a look at the decline--what has 
happened since the rule change has occurred? Slide 5 of the 
slides I provided to the committee shows what has happened to 
the applications at NIH in terms of SBIR grants.
    OK. What is more, our companies are not taking--don't take 
advantage, it is not a question of taking advantage of the 
other 97.5 percent. The NIH grant structure is intended--the 
vast majority of them are intended toward hypothesis-driven, 
research-oriented grants. Those are intended to further science 
and do wonderful things for public health, but are not oriented 
toward commercializing technology.
    And as a result, what is appropriate are the SBIR grants. 
And so you see the fall-off in the application. The companies--
so what you have is a reduction by 12 percent in 2005, another 
15 percent in 2006. So there is a fall-off and that doesn't 
help produce the best science. The best science helps when you 
have as many applications as possible, reviewed by world-class 
scientists organized by the NIH to review that science, and 
then awarded to the best science to produce the best outcomes 
that we can find.
    Mr. Necciai. Could you repeat those statistics again you 
mentioned in 2005 and 2006?
    Mr. Eisenberg. Sure. In 2005, you had a fall-off in SBIR 
base application rate of 12 percent, 11.9 percent, and 15 
percent, 14.6 percent. Meanwhile, there is an increase, a 
continued increase in the R01. That is the largest program at 
the NIH, which is for hypothesis-driven research that really is 
not oriented toward commercializing technologies. So you have 
had a fall-off in scientific applications.
    Mr. Necciai. And do you think that these fall-offs are 
attributed to the lack of venture capital funding?
    Mr. Eisenberg. Sure, and that is why you see, if you take a 
look at the next slide, the letter that was sent by Dr. 
Zerhouni, the head of the NIH, specifically making the point 
that it is not receiving the best possible scientific 
applications, that the NIH believes, and you can read this to 
yourself, the NIH believes that the current rule undermines the 
statutory purpose of the SBIR program to stimulate 
technological innovation and to increase private sector 
commercialization of innovations derived from Federal research 
and development, thereby increasing competition, productivity, 
and economic growth. Furthermore, it 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 NIH.
    So that is why there should be--you have lost some of the 
scientific competition and you have lost the opportunity to 
more quickly advance products out to patients sooner.
    Ms. Wheeler May I ask you a question? Why is it that you 
think that this drop in applications correlates to the rule 
change?
    Mr. Eisenberg. Because you have fewer companies that are 
able to participate, and therefore those companies that would 
otherwise participate are not submitting applications. When you 
ask our companies, would they participate in the program if 
they were eligible, over 80 percent of them say, yes, we would 
submit applications. We want to be able to compete for these 
grants because we have products that may work.
    Ms. Wheeler But that is assuming that this entire 12 
percent and almost 15 percent is only made up of companies 
majority-owned and controlled by VC firms, and do we know that? 
It is impossible to know that. Furthermore, I had more than 20 
meetings this summer with the SBIR program managers and we have 
pulled the data from SBA also, and there are at least four 
other agencies that have seen a drop. I don't think you can say 
at the Department of Agriculture that they have seen a drop 
because of venture capital owned and controlled firms suddenly 
realize they can't compete in the Department of Agriculture.
    So I think for the purposes of the committee, in looking at 
legislative solutions, it would be better to focus on how we 
could identify those firms which require a lot of venture 
capital backing but that legitimately are still small 
businesses. We could make them eligible, but I think the 
blanket approach is not working, and I think that some of these 
arguments that suddenly science has stopped or that there is a 
correlation to the drop in applications or that VCs get no 
money, are very hard to substantiate.
    So I think a more constructive conversation would be for 
all of us here to say, is there some agreement that there is a 
sliver of these firms that legitimately should be participating 
in this program, how do we define eligibility and how do we 
stay within these terms that Ron identified? We must keep it 
simple. The firms must be able to self-certify. Also, how do we 
keep SBIR dollars going toward the early stage projects instead 
of those that are further along.
    So can you speak to us in those terms?
    Mr. Eisenberg. Sure, and as far--I guess a couple points on 
that. Point No. 1, as far as keeping it simple, one of the 
things that needs to be addressed are the affiliation rules as 
they presently stand, because as Dr. McGarrity pointed out, not 
only is that information not public, a venture capital firm 
could be investing in companies in California, Boston, 
Michigan, Florida, Texas. Those companies don't know each 
other, don't have any interaction with one another, but yet if 
they are supposed to apply for an SBIR grant, they are supposed 
to ask their venture capitalist non-public information.
    How many employees do these other firms have? And then if 
one of them happens to all of a sudden be successful, that 
knocks me out of the program, even though I am in a totally 
different field and have never even met those companies? That 
doesn't make much sense. So that certainly gets away from, as 
you just pointed out, the intent of keeping it simple and 
making it straightforward. That certainly gets away from that 
sort of stated intent.
    So in terms of addressing it, and we would be more than 
happy to come back and talk with you about potential ways to 
look at this, but that certainly strikes me as not in the 
spirit of keep it simple.
    Ms. Wheeler I think you are right. This 500-employee number 
is not really applicable to the biotech industry because, in 
general, most of the firms are fewer than 50 employees anyhow. 
And so do you think that there should be a consideration of 
looking at the biotech industry and the actual numbers--you 
seem to know what that market looks like--and saying, OK, we 
are going to say that a small biotech firm is 20 employees. 
Would that be fair?
    Mr. Eisenberg. I don't know that it makes sense to 
speculate on numbers. The average is 50 or fewer. We can 
certainly have discussion about that. But to suppose that a 
company is able to ask its investor, well, how many employees 
do all of your other portfolio companies have, and that is not 
public information, and then ask several of the venture capital 
firms that have invested in it, and how many do all of yours 
have, doesn't get at it. What is more, investors in venture 
capital firms, some venture capital firms invest across 
multiple industries. Some invest exclusively in health, but 
some invest across multiple industries where the average size 
may be larger than that.
    So again, if you are trying to stay within what the spirit 
of the SBA is saying, which is that affiliation is important, 
that still gets you sort of--it can get you off in a couple of 
different areas that don't make sense relative to, I think, the 
public policy that the committee is trying to get at.
    Ms. Wheeler But my point is, if the industry is seeking to 
be exempt from the affiliation rules, what would be the 
alternate suggestion that you are bringing to us to help 
identify what would be a small firm?
    Mr. Eisenberg. As I said, we would be more than happy to 
talk with you and have a conversation with the committee staff 
and Chairman Kerry and so forth about possible outcomes and 
possible constructs in terms of how we would move that forward. 
I think we would welcome the opportunity to have that 
discussion with you. I didn't come in here today with a 
proposal to put down about what makes sense, and we are 
obviously very pleased that the committee is holding this 
roundtable to have a good discussion about these issues and 
certainly appreciate Chairman Kerry and Senator Snowe's 
interest in moving this issue forward. But there are--we wanted 
to have the discussion on the broader issue, and if there are 
specific areas that the committee would like to discuss in 
terms of different constructs, we would welcome that 
conversation.
    Mr. Necciai. And Alan, we appreciate you taking the time to 
come today and discuss these issues. That goes for everyone 
here. It is very important to have this conversation to get all 
aspects, a nice balance of varying different views.
    Mr. Eisenberg. Sure.
    Mr. Necciai. I wanted to ask you a quick question just for 
a moment and then we can move on about the graph that you 
provided here. You have this zone where the 2003 case was 
illustrated, and then later 2004 and 2005 where the SBA 
regulation changed, and then the grants drop-off here, and we 
were talking about the lack of venture capital and how that 
could have a great effect in the lack of NIH grants, et cetera. 
And then Kevin pointed out that there was a lack in other 
agencies at the same time. Since we don't for sure know what 
caused the lack of awards, couldn't it be possible that the 
lack of NIH, SBIR awards in addition to the lack from other 
agencies, are directly related to the lack of venture capital?
    Mr. Eisenberg. I am not sure I fully followed you.
    Mr. Necciai. The same association of the lack of having 
these NIH grants dropping and that other agencies who also 
receive venture capital firms, that the lack of those awards is 
also attributed to the lack of venture capital.
    Mr. Eisenberg. It is reasonable. What we have received from 
our companies, our membership, is that many of them stopped 
making application to the program because they were under the--
they were told that they were no longer eligible to 
participate, and as a result, many of them said, we would have 
otherwise applied or we would be happy to apply in the future 
if we are again eligible. That suggests to us that that is the 
sort of--the correlation is that companies that were otherwise 
eligible and no longer were have stopped making application to 
the program. So that is where our impression has been from our 
company feedback.
    Mr. Necciai. So in other words, there is potentially a 
direct correlation between the lack of NIH awards and the lack 
of venture capital funding?
    Mr. Eisenberg. Potentially.
    Mr. Necciai. OK. Thank you.
    Ms. Wheeler But then I think we would need to look further. 
That is why I think it is hard to look at these graphs, because 
then we have something that contradicts that when we look at 
the GAO study, which found that 2 years after the 
clarification, actually the number of awards to firms with VC 
went up and also the dollars.
    Mr. Eisenberg. The GAO study, though, the GAO study, just 
to be clear, didn't do a terribly good job in terms of looking 
at majority venture-backed companies as opposed to venture-
backed companies, I think.
    Ms. Wheeler Those are two separate issues. We are talking 
about venture investment, not majority owned. In fact, we 
invited the GAO here for this purpose because we know that in 
this discussion, some people have tried to undermine the only 
unbiased study that there is. We requested the GAO study 
because we really felt like we needed to get data.
    And so, again, I think that the constructive conversation 
here is not to argue over everyone's interpretation but for us 
to really try to identify if there is a way to get these 
legitimately small firms into the program or if there should be 
a change at all.
    Mr. Mehra. Could I make a suggestion for how we could do 
that?
    Ms. Wheeler Yes.
    Mr. Mehra. I think the mechanism exists currently, which is 
if you are a small business and you are developing some 
revolutionary technology in the biotech space, you want to go 
into these Phase II clinical trials, you need to raise a whole 
slug of venture capital money to do it, which will dilute you, 
what you could do, which is the same approach that PSI, who is 
in this document, has done is you spin that out into a separate 
entity. You let venture capitalists invest in that entity, 
which is solely focused on the clinical trial, and you keep the 
core technology in the parent company which is still majority 
owned by the entrepreneurs and you can continue to apply for 
SBIR grants.
    If you have already gone down the road of being diluted by 
your VCs, then you could say to them, hey, let me carve out 
this technology and put it in a separate entity that I will 
capitalize and fund myself. But that seems to me like a good 
mechanism that doesn't create any more administrative burdens 
for the SBA, stays on the existing rules, and achieves all the 
objectives that Mr. Eisenberg just talked about.
    Ms. Wheeler Mr. Doerfler or Dr. McGarrity, does that model 
work for you?
    Mr. Doerfler. The amount of SBIR funding that we would go 
after is relatively low. I look at Slide 7 where there are 
companies in here that receive tens of millions of dollars a 
year in SBIR funding. This isn't the biotech way in any way. I 
mean, the companies--we need to provide the data, but the 
averages are quite small. They may have two or three SBIRs 
going at one time. It is a very small part of our business, but 
it is important because it allows us to try out new science. I 
was trained as an engineer. Engineering is very different than 
basic science. You cannot predict what is going to happen, so 
you have to give it a shot and maybe a one in 20 chance of 
being successful. You have got to give it a shot, and that is 
what these SBIRs are.
    So I personally wouldn't set up a separate company to go 
after half-a-million dollars or a million dollars of funding. 
It is more complicated. There are governance issues. It just 
would be--if I had to do that, I wouldn't go after--in our 
industry, bio sciences, I would not go after SBIR if the only 
way I could do it was to set up a separate subsidiary or 
separate company for that sole purpose. I just wouldn't do it. 
That is my opinion.
    Ms. Wheeler Which, as Dr. Abramson would say, is a business 
decision, no? That would be a business decision.
    Mr. Doerfler. So my business decision would be to not 
pursue the creation of any innovative new science, which is an 
interesting business decision but one that I think many in the 
bio science would completely disagree with, because again, we 
get up in the morning to create new medicines and we want to 
have as many chances as we possibly can to do that.
    So again, the question was posed, would we do it? I 
wouldn't do it, and therefore I wouldn't participate in the 
SBIR program.
    Ms. Wheeler OK. Thank you. I am sorry. I know that Jerry 
and Jo Anne are waiting to talk, but go ahead, Dr. McGarrity.
    Dr. McGarrity. My comments would really reflect what Doug 
just said, because, one, it is an awful lot of work to set up a 
managerial structure to handle a relatively modest type of 
investment. On the other side, while you can say it makes sense 
from a managerial standpoint, you are asking your present 
investors to say, look, we are going to take some stuff that we 
kind of took out of the mainstream of the company and that you 
invested something in and we are going to spin this out and you 
are not going to be in the control that you have now. You are 
going to have to give up something. The investment market just 
doesn't work that way. Investors are not going to say, yes, I 
would be happy to spin this out into a free-standing entity and 
I will take less for my investment.
    Ms. Wheeler But what I don't understand about that argument 
is that, on one hand, they say that they are not going to put 
money in the SBIR technology because it is too nascent, but 
then when you say you are going to take it out, they say, hey, 
wait a minute. You are taking something that I have interest 
in. Did I understand that?
    Dr. McGarrity. Well, because we are paying for the 
superstructure. We are paying for all of this. And to say, let 
us take this and just go off and either not give you anything 
for all of the years of support that you have given or to give 
you less than what you think may be fair market value. And I 
think that this whole point comes back to what we were saying 
about the VCs are going to control the entity or they are going 
to be--you know, I could make an equal scenario that if you 
have a sole investor that is going to be putting up $5 million, 
an individual can be just as demanding as a VC. There is 
nothing in the VC criteria that says they are going to be 
controlling and an individual investor is not going to be as 
controlling.
    Mr. Mehra. I think that is a key point behind the SBIR 
program, though. It is intended to support entrepreneurs, 
entrepreneurially controlled companies to do innovative 
activities. It is not intended to support VC-controlled 
companies to go after these really innovative ideas. And so 
exactly the issues that were just brought up, I think that is a 
great argument for why they should not be participating in 
SBIR.
    Mr. Doerfler. I am not a policy person, but I did read a 
little bit of this and I didn't think that venture capital was 
included in the original SBA law. It was around, I think, 
creating innovative science, and that is what we are talking 
about here. And the issue is, is the bio science business a 
different business than perhaps the other ones around this 
table, and what might work for the concern that you have, Mr. 
Mehra, around unintended consequence of someone raising $100 
million. That is not the bear in the woods that we see in the 
bio science area. There is no evidence of support that that has 
ever happened. I think when we have worked on this bill, we 
tried to prevent that from happening by ensuring that someone 
who owned 51 percent of the company and controlled the company 
wouldn't be participating in this program.
    So again, I am going back to the business decision of would 
I set up a separate company, create a rather complicated 
licensing agreement between A and B in order to get--which is 
another complicated issue and probably would also have some 
control tests around that licensing agreement--would I set that 
up to go after SBIR in a bio science company? I would say, 
absolutely not because of the size of the awards.
    Ms. Wheeler Thank you. Dr. Fanucci, and I am really 
serious, 2 minutes. I am sorry but we have to move on to the 
next topic very soon.
    Dr. Fanucci. Well, I guess one question I have, it seems 
that there is a, unless we have a skewed sampling of people 
here, that biotech people all would like to see VC participate 
and everybody else wouldn't. Can't you split the rule so NIH 
has a different set of rules? That is just a question.
    The other, I think it would be an extraordinarily bad idea 
to allow VC to participate in the DOD, maybe NASA, other 
hardware-oriented SBIRs. In our experience, DOD primes now 
create a lot of the SBIR DOD topics. They write them. This is 
research they would like to be doing and often participate with 
the small business, in our case always actively in the program. 
If they could do it themselves, I am sure they would. So if the 
rules were changed in some way that created a possibility for 
them to position themselves as a small business-eligible 
program participant, they would do that and exclude companies 
like Kazak because they wouldn't need to have us involved.
    An unstated benefit here of the rules right now is that 
those guys, the GE or Boeing and the large companies, are 
motivated to work with the small businesses, which even when 
you don't get the award, you have now made contacts in that 
company that remember what you talked about and it is a great 
marketing benefit for other things not related to SBIR that 
really wouldn't be easy to match without the program and the 
motivations and the big companies to work with us.
    Ms. Wheeler Thank you, Jerry.
    Jo Anne?
    Ms. Goodnight. The fun of going last.
    Ms. Wheeler And Joan is running the timer here, if that is 
helpful to anybody, with the green and red lights.
    Ms. Goodnight. Great. I just want to start by emphasizing 
that NIH shares SBA's commitment, it shares all of these small 
companies around this table and other small business advocates 
around the table's commitment to ensuring that only small 
businesses receive SBIR and STTR support. It is a very 
important point for me to get across this preface.
    I also want to say we absolutely appreciate the rule change 
that SBA put into effect in January of 2005 that did, in fact, 
open the door ever so slightly for subsidiary firms to 
participate.
    When you look at the reality and the profile, the real 
profiles of companies who are being determined ineligible, the 
data show, in fact, that most companies are not just owned by 
another, a single other business concern. When they get to the 
stage of getting through their Phase II clinical studies, when 
they get to the stage, and I am speaking more specifically to 
drug development and medical devices, of needing that 
additional financing, which often will come from VCs, not 
solely, it may be coming from strategic partners. It may be 
coming from others. So we can't just totally focus on that.
    When they get to that stage, then the small business is 
often owned by multiple VCs. We have data to show that, happy 
to share it, because every time a firm is determined to be 
ineligible, I ask them, tell me what your ownership structure 
is. When GAO did their study, as much as the information was 
useful in there, some very important points. It went from 2001 
to 2004. Well, our downward spiral of the applications has been 
since 2004.
    Ms. Wheeler Right, but the study ended in 2005.
    Ms. Goodnight. There is data----
    Ms. Wheeler If you would like us to ask them to update it, 
we will.
    Ms. Goodnight. Their data ended with the 2004, so it is 
since 2004 we have seen an overall 25 percent reduction. Is it 
solely because of VC? Absolutely not. I won't sit at this table 
and say that.
    We do have another unbiased study and that is the National 
Academy of Sciences study. You know, they found that 25 percent 
of the 200 NIH Phase II award winners between 1995 and 2005 
received the highest number of SBIR awards, also obtained VC 
funding. They also found that new lines of research that are, 
indeed, high risk that VCs cannot or will not fund are 
perfectly ripe for SBIR and STTR funding. Hence, there is a 
synergy there that nobody here is really talking about, where--
--
    Someone keeps raising the comment that we will be funding 
even later stage research. There are no data to show that. We 
have data to show that these firms have been in the program. 
The GAO study didn't explain when they received the VC or what 
their percent ownership is, but the Academy's report probably 
speaks more to the fact that they did receive it, and it is 
those early, early stage ideas that aren't downstream in the 
Phase II to Phase III stage that we are actually looking at 
funding for----
    Ms. Wheeler But the issue is not whether any VCs should 
participate. Nobody has a problem with that. What we are 
struggling with here is how much.
    Ms. Goodnight. How do we identify small business? I can't 
tell you how to fix it. What I can say is, you know, thought 
could possibly be given to if a company is, in fact, owned by 
multiple venture capital firms, then perhaps some thought as to 
what percentage do you own of that company? And if you can be 
under some X-percent that the policymakers decide is the 
appropriate amount and certify that, on a day-to-day 
operational basis you are doing the R&D to get that project to 
the stage where it is going to then attract venture capital or 
other resources, that may be the approach to take to keep it 
simple, because while part of me is pained by we are talking 
about keeping the rules simple, I also understand that small 
businesses need to understand the rules and be able to self-
certify. So we don't want to make them too complex.
    But for a community such as ours where small businesses 
have these high and intense capital needs, we want to see all 
four goals of the program realized to the extent that Phase II 
is a successful endeavor. We want to see life extended and 
health improved. These are some of the same firms who were 
participating and who no longer are eligible, and there can be 
some simple fixes.
    Ms. Wheeler OK. Thank you. Jere, did you want to make some 
comments?
    Mr. Glover. Yes. I want to make several comments. One, 
putting this all in context, 40 percent of all scientists and 
engineers work for small business and are self-employed. We 
still only get 4.3. So there is a clear problem. And when you 
talk about, for example, in the House bill that was passed, you 
have to be very careful about how definitions change because, 
for example, they want to include nonprofits and universities. 
They already get 44 percent of Federal dollar R&Ds. I don't 
think they need a bigger share of the Federal R&D dollar. Small 
business with 4.3 probably does need a bigger share. So it is 
fairly clear and fairly obvious on that score.
    There is also a lot of discussion recently about SBIR 
mills. Let me simply say, no one is talking about the huge 
number of contractors in the Defense Department who get the 
lion's share, nor are they talking about the fact that, for 
example, Johns Hopkins gets 1,299 awards in 2005 for $607 
million. The University of Pennsylvania got 1,157 for $471 
million. So the mill issue, I think, is really a non-issue 
since the National Academy of Sciences study came out, 
definitively looked at it, and said that those companies do a 
better job of commercialization and did the evaluation.
    Let me just point out a few other things quickly, because I 
know the hour is late. We surveyed all NIH winners and asked 
them the specific question of should VCs be included. At an 8-
percent response rate, which is fairly good by survey 
standards, 92 percent of small businesses involved in the SBIR 
program who had won at NIH do not want the VC-controlled firms 
in. We did an objective study. We referenced BIO's website, our 
websites, and you can read it and figure it out.
    No matter where we cut the definition off, there is always 
someone complaining. Women-owned businesses, 49-51, they 
complain why shouldn't it be 50-50? You get--no matter what SBA 
definition it uses, there is always someone who are hurt on the 
other side of the things.
    The other thing is every venture capital-owned company that 
receives an SBIR award takes money from some other small 
business who are eligible. On average, there are six companies 
that don't get an award for every one that does under the SBIR 
program. Those numbers basically have stayed the same for a 
good while.
    The unintended consequences and definitions are something 
you have to be very careful about because what seems to be a 
minor change turns out to be a huge change. Little things like, 
for example, the VC company has to be domiciled and 
incorporated in the United States. A Chinese company that sets 
up a U.S. subsidiary that is domiciled in the U.S. and 
incorporated in the U.S. suddenly becomes eligible to take 
Federal Government money offshore.
    No matter how you define this, you have got to be very 
careful and you need SBA's career staff to look at any 
definition, any change that we make, to make sure that we don't 
open Pandora's box and do things that we don't seem that should 
be done.
    Ms. Wheeler Thank you. Dr. McGarrity?
    Dr. McGarrity. Thank you, and I will be very, very quick. I 
just want to speak from my experience, 20 years in the biotech 
industry in four different companies, and I appreciated all of 
the comments from the different industries and from the Small 
Business Administration. From my take or my conclusion from 
what I have heard here today, I think that the biggest 
stumbling block and the biggest obstacle for early stage 
biotechnology companies is the concept of the affiliated 
companies, and I think that is what is really having a strong 
negative impact and potential on the early stage biotechnology 
company.
    I would just say that I would welcome and we would all 
welcome the opportunity to work with you and the committee to 
see if we can somehow modify this so that the United States 
will be able to maintain its international lead in the 
biotechnology field, because I think if this continues, I 
strongly believe that this is going to have a strong negative 
impact on international competition and the whole technology 
industry in terms of jobs, economic development, and more 
importantly, cures and better lives for our citizens. Thank 
you.
    Mr. Necciai. I agree with you. I don't think it seems quite 
fair with the affiliation or with the 49 percent, with certain 
aspects. In more of the contracting aspect, Administrator 
Preston sent out a letter asking that if you are a large 
business and you have small business--in other words, a small 
business who grows and has a contract and goes over, they 
maintain that contract until the life of the contract. They 
just can't get any more contracts as a small business because 
they are no longer a small business.
    It doesn't seem fair that a small firm who has an SBIR 
grant goes over a number of employees and all of the sudden 
loses its grant. So there is job loss, there is NIH funds that 
are lost, there is a potential cure that was lost, versus being 
able to maintain that SBIR award until the life of the award--
--
    Dr. McGarrity. Well, I believe----
    Mr. Necciai [continuing]. That only seems reasonable.
    Dr. McGarrity [continuing]. And I would defer to Ms. 
Goodnight, I believe your eligibility is determined at the time 
the grant is awarded.
    Ms. Goodnight. Correct.
    Dr. McGarrity. So if I am eligible today and I get the 
award today, if I grow tomorrow or next week, then I still 
maintain that award. But it still will mean that I----
    Mr. Necciai. But you cannot get a Phase II award? You are 
only limited to that Phase I award.
    Dr. McGarrity. That is right, but see, with the affiliated 
companies, I am not in control of my own destiny because I can 
be a 20-employee company. If another company from that VC hits 
it big, then suddenly I am being punished for something that I 
had no control over at all.
    And I think the statements that, gee, you have access to 
all these other management and these other companies, I think 
that is grossly overstated. I think that doesn't happen, 
because, as Doug said, generally, it is not the same--the other 
companies, the other companies in the stable, the portfolio, 
are not in the same specific business and there is very minimal 
interaction, as a matter of fact.
    Ms. Wheeler Erik, do you mind if we just give everybody 60 
seconds, and then we will move on to data rights. We will have 
to figure out a different way to keep this conversation going 
after this roundtable so maybe we can get something concrete, 
or just not agree. I don't know.
    Dr. Abramson. Sure. Absolutely.
    Ms. Wheeler Sixty seconds.
    Dr. Abramson. Sixty seconds. I think the issue that the 
committee has to grapple with, the way I would summarize the 
discussion, is the majority of VC investment-owned firms want 
to shift the business risk over research to Government. That is 
it in a nutshell. And the policy question is, should that take 
place or should the program be continued as it is, which would 
not allow them to shift that risk. Thank you.
    Ms. Wheeler Thank you. Ron?
    Mr. Cooper. Let me see. Yes. The one thing that we have 
heard a lot about is what Dr. Mehra was mentioning, the spin-
offs and the ways in which SBIR firms are using spin-offs and 
asset sales to pursue this in spite of the--once they become 
VC-majority owned, so I am very interested in your comments and 
further discussing that.
    I just wanted to mention that the--well, you have to be 
careful with the statistics on the grant applications. That is 
a, what was it, a 4-year window. If you zoom out a little bit, 
then you see that there is a broad trend of increasing 
applications with these cyclical events and it could be due to 
our rise and fall in our outreach or other economic conditions.
    The way you were phrasing the question, how can we make 
these firms eligible for the program, I would maybe rephrase 
that as what is the best kind of public policy, what is the 
best program vehicle that we can think of at this point for 
assisting these bio firms that are faced with this long lead 
time due to--that are in drug development, because it is what 
appears to be a narrow segment of that industry, the ones that 
are requiring FDA approval.
    Ms. Wheeler I think that is an excellent point, and we are 
going to move on to the data rights section, but you are right. 
There was a proposal to take these firms and set up a separate 
pot of money so that they could compete for that since they did 
look a little different, but we can debate that a different 
time.
    Now we are going to move on to data rights. Unfortunately, 
because we are already 10 minutes over, I am going to say we 
have 20 minutes for this and basically we just want the firms--
I know that Dr. Fanucci is an example, I don't know if anybody 
else is to explain to us what is happening. As we see it, 
Congress intended for firms to keep their data rights, their 
intellectual property rights in Phase III, but it seems that 
they are running into the prime contractors as well as the 
agency that will often fight them on their rights. It means 
that they have to go to expensive lawyers to fight for what we 
intended for them to have already. And then an unintended 
consequence is that it is a waste of money, because if they 
don't use the SBIR, then they are going to end up duplicating 
the research, which wastes time and money.
    So can you give us your example?
    Dr. Fanucci. Sure. We have lots of examples, but one good 
example is the big commercialization success we talked about 
earlier about with the ship cargo support. There, we developed 
that clearly under SBIR. There really was not argument about 
whether it was done under SBIR by anyone, but both the prime 
contractor--in this case, it happened to be NASCO, which is a 
General Dynamics company, and the Navy contracting people, 
either or both didn't understand, or did understand--either 
way, it doesn't matter--they actively worked not to allow those 
rights to pass forward, which in our case would have meant 
someone else would be building these things, not us. In other 
words, nothing special once you see what it is to go out and 
have someone else make it.
    So long story short, after 6 months of negotiating, and to 
the credit of the General Dynamics people, they finally did 
agree that it was appropriate for us to call this an SBIR Phase 
III and retain the data rights to them.
    And there are many other examples of that, I guess we won't 
go into, that Kazak has been involved with where companies 
really don't understand the rules. It is a complicated rule. 
They don't encounter it much. And actually, the Clause 718, the 
DFAR clause, is in opposition to the one that is in their prime 
contract, 713. They really say the opposite thing.
    So one issue that always comes up from the primes is, well, 
how can we protect your data rights as a subcontractor when our 
prime contract doesn't say anything about that? So somehow--I 
don't know what the right way to do this is--they have to be 
either made to understand, which our attorney, David Metzger, 
will say is it is inserted, not flowed down, but it might be 
just easier to put that in the prime contract, that if you are 
dealing with an SBIR company, you can give them SBIR data 
rights. Once they understand that, that seems to be at least 
one part of the pie that needs to be solved here.
    Before that can happen, there needs to be the education 
process, the contracting people both in the Government and in 
the primes understand what SBIR data rights are in a simple 
page or two that even I could read and understand. It is not 
simple to understand all of the subtleties there. But really it 
comes down to the definition, which is derived from--extends or 
logically concludes SBIR-initiated technology. We have had 
large contracts dropped by prime contractors with us because 
they refused to either admit--or I guess they would admit, but 
they refused to grant those data rights.
    One argument that they sometimes will use is that, well, 
this isn't a Government contract, it is our own IR&D, but if it 
is a missile on a ballistic missile defense application, the 
ultimate user is the Government, so I believe that somehow 
something has to be done to make it clear that even though they 
might be using $50,000 of their own IR&D money, it really is a 
Government application after all and the data rights should 
apply to that kind of deal.
    Time is short. I guess that really summarizes. It is an 
understanding issue on the side of the Government people, an 
education problem, and then also an attitude that why should 
these small businesses have these special rights that the big 
companies don't get.
    Ms. Wheeler Thank you, Jerry.
    Kunal?
    Mr. Mehra. Just very quickly, we have had experiences on 
both sides. I have had a number of program managers basically 
tell us either drop your data rights or we are not going to 
give you an award, which is, again, like holding a gun to the 
entrepreneur's head.
    On the other hand, you know, we have kind of very nicely 
explained to prime contractors, listen, the only reason why 
these data rights are there is to make sure that the small 
business retains a stake in the game, and that has worked well 
for us, also.
    So in general, I think there just needs to be much better 
education throughout the DOD of what the small business data 
rights are, what they are intended to protect for and what they 
are not, so that people are not paranoid when they come up and 
they don't try to basically pressure the companies into giving 
up their data rights.
    But I think the second issue also is how do you exercise 
your data rights. What has happened in the DOD is it is almost 
like program managers are conditioned that the only thing they 
ever have to pay for is hardware, and the reason is that so 
much software is developed under Government funding that there 
is no direct cost associated with it, so they almost believe 
that if it is software, it is at no cost. Well, if the small 
business retains the data rights to it, then the free market 
takes over and they should be able to pay for it. What I have 
found is that Government sponsors don't understand that concept 
whatsoever.
    So as a taxpayer, what disappoints me is that smart small 
businesses just take software, put it into hardware, and it 
ends up costing the Government five times as much as it would 
have if they had sold it as software, and sell it to the 
Government that way. It is just a waste of money. So I think 
there needs, again, to be better education about why small 
businesses have this right and why the Government needs to 
honor it, and in the end, it will just save money for everybody 
involved.
    Ms. Wheeler Mike, since you are representing DOD, would you 
like to comment on how DOD looks at these data rights, if they 
have heard that there are issues with this, and if there is 
anything we can do to educate the acquisition managers and 
various employees?
    Mr. Caccuitto. I am not quite sure what to say. I am not a 
lawyer. I am not a contracting officer. Education is great. 
More would be better. I mean, I am not familiar with the 
specific examples that were cited here, but I have heard about 
them. Our contracting community is huge. We are spread out all 
over the country, indeed, all over the world. Educating them is 
perhaps something we need to look at.
    Ms. Wheeler Is DOD aware that firms sometimes run into this 
problem through their contracts and they are pressured to give 
up these rights or that they are frustrated that the folks 
within the agency don't know the rules? Has that come to your 
attention?
    Mr. Caccuitto. Yes.
    Ms. Wheeler OK.
    Mr. Mehra. I will just say, I think the SBIR program within 
the DOD has done a tremendous job of trying to protect the 
interests of small businesses. The issue is not on the SBIR 
side of the house, it is in the general contracting side of the 
house that has not educated their staff on how to deal with 
this.
    Ms. Wheeler Thank you for that clarification.
    Now, SBA, would you like to explain to us what your role 
is, because as Jerry has pointed out, sometimes they just need 
an advocate. So what is the appeals process or the grievance 
process that the businesses have when they feel that their 
rights have been violated?
    Mr. Brown. Yes. We have authority via the SBIR policy 
directive to intervene on behalf of a small firm that has 
concerns, and as you well know, we have come forward to the 
committee via a couple of instances with small firms. I am not 
going to name the firms.
    Again, they can provide us what took place. In most 
instances, it has been cases, and I will call it a backhanded 
way of dealing with the data rights issue, and that is that the 
firm is alleging that it is a Phase III and they were not 
awarded the Phase III and they contact us to look into it with 
the agency and they are saying it is a follow-on and it 
naturally follows up or extends technology that was developed 
in Phase II. And we contact the agency and let them know we 
have a notice of appeal. They have 5 days to follow up with us 
in terms of, you know, why it is a different technology or the 
grounds for them to make the award above and beyond the fact 
that it is a Phase III.
    That is a hole in the policy directive, because even worst-
case scenario, as we have been talking, and this is a whole 
another discussion, is even in the worst-case scenario, if it 
is a follow-on in terms of the technology, we really don't have 
any way to follow up with it. I mean, even if it was, you know, 
no question about it, there is really nothing we can do. The 
agency could say that in the interest of time or in the best 
interests of the United States, we must proceed on this, so it 
is wide open.
    But, of course, there are concerns about the firm losing 
out on the data rights and ability to move the technology 
forward, and again, it is very difficult, as all the program 
managers here know, as well, to define exactly what is a Phase 
III. We get this all the time. Is this a Phase III? So----
    Ms. Wheeler Does SBA think that the agencies are reporting 
when they don't give Phase IIIs to these businesses? Do we have 
accurate data?
    Mr. Brown. I will say--I will put it to you this way. In 
the time that I have been there, the 3 years that I have been 
there, I believe we have received two instances where an agency 
met their regulatory requirement to let SBA know ahead of time 
that we are going to go ahead and make this award. It is a 
Phase III. Or is it not a Phase III and for the following 
reasons. If you have any questions, please come back to us to 
open up discussion as to why or why not this is a Phase III.
    In most instances, it winds up being an SBIR award 
recipient that has already received two or three other awards, 
and this has happened multiple times. It is not the first time 
it has happened. It has happened two or three other times with 
other agencies and they have had enough and they come forward 
to us and we move it forward.
    So again, I will predict that--again, I really wouldn't 
have any way of knowing what the numbers are, but the numbers 
are a lot greater than what we receive because the firms are 
concerned about being blackballed, obviously.
    Ms. Wheeler And who is the employee at the agency who is 
supposed to be reporting it? Is it an acquisition manager? Does 
it vary?
    Mr. Brown. Well, really, it is supposed to be the 
contracting officer when they make the award. And as I think 
Mike has already alluded to, some of this, they don't know. I 
mean, I will say this right now. Some of them, and some of the 
program managers are here and they can jump in, but some of 
them really don't know. So on behalf of SBA and the program 
managers in general, I and we can take some of the blame. But 
again, when you get out of the SBIR program and you get to the 
point of the award being made and it is in contracting, a lot 
of times the agendas are different and it is out of the SBIR 
program and it is now meeting the mission, et cetera, so----
    Ms. Wheeler Thank you.
    Mr. Necciai. I think you hit a really good point there. It 
seems that 1102s or contracting officers only refer to the FAR. 
And you mentioned the SBA directive. It actually specifically 
says contracting officers representing the Government are 
prohibited from exerting pressure or coercion, which is kind of 
what we talked about before, with primes on SBA companies and 
that the directive expressly states that the agency must not in 
any way make assurances that the SBIR Phase III award is 
conditional on data rights. But that is in the SBA directive, 
and then there is the FAR and the contracting officers are 
looking at the FAR. So there seems to be a disconnect or a lack 
of either education or just understanding that these both 
apply, not just one. Would you agree?
    Mr. Brown. Yes, I agree, and I think this all gets back to 
part of the reason why we are here today. The program is really 
evolving. We are a greater than $2 billion program now and we 
are getting a lot more attention and a lot more sophisticated 
issues than we did this time in the last reauthorization. And a 
lot of the issues that we are discussing now were barely on the 
radar screen the last reauthorization. So again, we need to do 
the best that we can to fine-tune it.
    But again, we also have to be honest when we look in the 
mirror. It is not a panacea. There is no way we are going to be 
able to be everything to everybody. There is just no way. So we 
have to do the best job that we can with what we have to 
maintain propriety of the program as we move forward.
    Ms. Wheeler Jere?
    Mr. Glover. Yes, just some of our Government officials are 
somewhat modest. Mike Caccuitto has been working internally on 
getting regulations and reforms and improvements with his 
bosses and I think that is to be commended. That will help make 
the process work better. The Commercialization Pilot Program is 
a great leap forward, and certainly the amendment that Senator 
Kerry and Senator Snowe sponsored this year is going to, 
assuming it passes the House, is going to be very helpful in 
encouraging incentives in reporting on Phase III. And to 
Edsel's credit, he just got a ``stop work'' order on a specific 
contract while the SBA procedure is going through.
    So there are things in place. Good things can happen. They 
are happening on the Phase III and the issue and the data 
rights. But clearly, it would help if we didn't call this the 
SBA policy directive or policy guidelines, we called them SBA 
regulations, because that is legally what they are. It is just 
people choose to ignore them because they think they are less 
than what they really are, and there is an educational 
challenge each time it comes up.
    Mr. Mehra. First of all, I want to just echo what Jere 
said. The SBIR program and the SBA are two of the greatest 
friends for small businesses working in the DOD, so thank you 
both for everything that you have done. They are tremendous 
advocates throughout all the services, both within the SBIR 
program and outside the SBIR program for small businesses.
    But just to the quote that you just read about how 
acquisition officers should not make awards conditional on data 
rights, I can send you numerous broad agency announcements 
where at the end, when they list criteria for making an award, 
No. 1 is technical, No. 2 is cost, and No. 3 or four is that 
the Government gets full data rights to all of the IP. I mean, 
that is pretty shocking.
    Ms. Wheeler Thank you. Erik, did you have a question?
    Mr. Necciai. No.
    Ms. Wheeler I had one last point. Last year, Senator 
Snowe's staff tried to address some of the data rights issues 
regarding the night vision case. Can somebody just tell me very 
quickly what that night vision case was? Are you familiar with 
that, Jere?
    Mr. Glover. Yes. The night vision case is a case in which 
the small business did virtually everything procedurally wrong 
that they should do. They didn't avail themselves of any of the 
rights, that they went--my understanding is they probably did 
not contact either SBA or the Small Business Office at DOD to 
try to preserve their rights.
    Having said that, the Air Force bullied the small business, 
did about everything a Government shouldn't do to a small 
business, and the court ended up saying the Air Force could get 
away with it. We don't know what would happen had they actually 
exercised their rights and challenged it at SBA or gotten DOD 
at the senior levels involved in that, but the law in that 
case, which came out of U.S. Circuit for the District of 
Columbia, did say that SBIR data rights are preferences, but 
not requirements, and that the DOD was permitted to go forward.
    The issue of the policy directive was not really in play 
because it was done after that procurement occurred, and, quite 
frankly, they never exercised those rights under that. So that 
is the thrust of what was there.
    Ms. Wheeler Thank you. And Michael, are these some of the 
steps that they are taking to make sure that that doesn't 
happen again? Jere had given you credit for what you are doing 
internally. Is that partially in response to what happened with 
the night vision case? Or are you taking that initiative on 
your own?
    Mr. Caccuitto. I think Jere might have been referring to 
some efforts we are making to improve reporting and data 
collection on activity.
    Ms. Wheeler I see.
    Mr. Caccuitto. Program activity is--getting good data that 
characterizes that is difficult, particularly difficult in 
Phase III because much of it happens at subcontract levels. 
More than 50 percent of it happens in the commercial 
marketplace, not our direct or subcontract marketplace. And our 
systems aren't set up to actually collect it. So we are taking 
steps to improve that, and I think that might have been what he 
is referring to. We have also had some engagements with our 
procurement policy folks to address a host of issues, one of 
them being this Phase III issue.
    But relative to night vision in particular, the courts 
have, in a sense, spoken here. I mean, I could go through all 
the facts of that case. It happened well before my time and 
involvement with this program. And again, outside of our 
awareness at this level.
    I don't think I have answered your question. What was your 
question?
    Ms. Wheeler Well, I think the main thing is that we are 
worried about the night vision case and we would like to know, 
even though we hear that the SBIR people at DOD are doing 
everything they can, if you are aware of other things that DOD 
is doing to prevent this from happening again, such as 
reporting to SBA, justifying why they didn't give that firm a 
Phase III if, indeed, it was their technology and they had the 
right to it.
    Mr. Caccuitto. Are we doing anything specifically right 
now? I can't say we are.
    Ms. Wheeler OK.
    Mr. Caccuitto. I unfortunately can't.
    Ms. Wheeler Thank you. Edsel, did you have one final 
comment before we wrap up?
    Mr. Brown. Just real quick. Jere already got into the 
particulars for night vision, but night vision was a really bad 
case, and unfortunately, it turned on the facts of that case 
and that facts of that case got applied to the whole program. 
It involved a prototype, and SBA is considering--let me 
underscore considering--possibly changing our policy directive, 
but we are still looking at it because it is more than just 
making that little minor change. What impact will that have on 
other things if we make that change about prototypes?
    Ms. Wheeler And you could do that regulatorily? That is not 
something you would need our committee to do as part of SBA 
reauthorization?
    Mr. Brown. I don't believe so, but that is one of the 
reasons why we are going easy, because we have to go through 
our legal counsel before we do that. So that is why I am not 
committing that we are going to do that definitely, but it is 
under consideration.
    Ms. Wheeler OK. Thank you.
    Erik, did you have any final comments before we wrap up?
    Mr. Necciai. No, just to reiterate if anyone has any other 
additional comments, of course, the record will be open.
    Ms. Wheeler Well, thank you, everyone. On all of these 
issues, particularly on the VC issue there is never enough time 
to come up with a solution and to air all the facts, I think 
what we will try to do on the VC issue is come back to you and 
take one more run at this and see if there is any common ground 
we can find between the two sides that would protect the goal 
of the congressional intent of the program. So thank you, and I 
look forward to talking to you and I am sure Erik does, too. 
Thank you.
    [Whereupon, at 1:32 p.m., the committee was adjourned.]





























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