[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
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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
Available via the World Wide Web: http://www.access.gpo/gov/congress/
senate
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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
---------- -
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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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