Small Business Innovation Research Program Policy Directive – Good News for Emerging Technology Companies
 
March 4, 2003
 

Less than five years ago, emerging technology companies were the darlings of the “new economy,” with seemingly endless financing options to pursue innovative ideas. Angel investors, venture capital firms, incubators, investment banks and virtually anyone with money clamored to get in on the action and invest for fear of being left behind. Often an entrepreneur’s biggest funding challenge was parrying back eager outside investors so as not to give up too much of the upside when the inevitable high multiple exit occurred. The landscape has certainly changed. In the wake of the economic recession and Internet bust, the once bountiful well of private funding has rapidly dried to drought levels, with technology companies, both large and small, anxiously awaiting some form of relief.

Some good news finally has emerged for small technology companies, and perhaps even some medium-sized ones, in the form of the Small Business Administration’s (SBA) latest Small Business Innovation Research Program (SBIR) Policy Directive, issued on September 24, 2002 (the Directive). The Directive serves as the government’s new playbook for implementing the SBA’s SBIR Program, a program created by Congress in 1982¹ to assist innovative small businesses, including minority-owned small businesses, with federally funded research and technology development. Federal funding of technology development raises issues that differ from commercial financing, but offers a viable route to development if those issues are understood.

The new Directive implements statutory reforms to the SBIR Program contained in the SBIR Reauthorization Act of 2000, Public Law 106-554, and establishes many helpful clarifications and changes to the SBIR Program. It is likely to receive greater focus and attention as many technology entrepreneurs increasingly view government funding and contracting as a viable means to start or grow their businesses, during a tough capital market.

The SBIR Program and Process

Only “small business concerns” (SBCs), as defined by the Directive,² are eligible to participate in the SBIR program. In order to qualify as an SBC, a company must meet several requirements, including being at least 51% owned or controlled by individuals (which, notably, makes wholly owned subsidiaries ineligible for SBIR applications) and having no more than 500 employees, including affiliates. Significantly, however, under the Directive, Phase III awards, described below, can be awarded to SBCs that have grown beyond the 500-employee size standard, thus, insuring continued growth for SBIR firms.

All federal agencies, including civilian and military agencies, with an annual, “extramural R&D budget” exceeding $100 million are required to participate in the SBIR Program. These agencies currently include: Department of Agriculture, Department of Commerce, Department of Education, Department of Energy, Department of Health and Human Services, Department of Transportation, Environmental Protection Agency, National Aeronautics and Space Administration, National Science Foundation and the Department of Defense (Office of the Secretary of Defense, Army, Navy, Air Force, Defense Advanced Research and Projects Agency (DARPA), Missile Defense Agency, and Special Operations Command). The “extramural R&D budget” consists of monies allocated by federal agencies for research activities performed by non-federal agency employees, and the Directive requires those agencies to reserve, in each fiscal year, not less than 2.5% of that budget, or $2.5 million, for Phase I and Phase II awards.

Every participating agency must publish topics for solicitation and eligible SBCs must submit proposals in response. Thus, unsolicited proposals are not eligible for funding. Agencies make SBIR awards based on SBC qualification, degree of innovation, technical merit, availability of funding, and future market potential. SBCs that receive awards or grants then begin a three-phase program.

Phase I is the startup phase. During Phase I, the SBC explores the technical merit or feasibility of an idea or technology. Phase I awards may be up to $100,000 and last for approximately six months.

Phase II is the development phase. After successful completion of a Phase I project, the program manager(s) may invite the Phase I awardee to submit a Phase II proposal expand the Phase I results. Only Phase I awardees are eligible to participate in Phase II awards. Thus, a separate Phase II solicitation is not issued, and unsolicited SBIR proposals are not accepted. Phase II awards may be up to $750,000 and last for as many as two years. During this phase, the SBC performs R&D work and evaluates the technology’s commercialization potential.

Phase III is the commercialization phase. During Phase III, innovations developed through Phases I and II move from the laboratory into the marketplace. No SBIR funds support this phase and the SBC must find funding in the private sector or other non-SBIR federal agency funding to support the commercialization. There is no limit on the number, duration, type or dollar value of Phase III awards. Additionally, any important change in the SBIR Policy Directive permits a company, even if its size has grown beyond the 500-employee limitation, to retain eligibility for a Phase III and enjoy the advantages afforded under the SBIR Policy Directive and Program.

The SBC’s Rights

Whenever a private company develops technology or technical data as a result of contracts with the government, a unique system of government rules apply to determine what rights the government receives in that technology. For contracts with civilian agencies, the rules exist in the “data rights” section of the Federal Acquisition Regulation (FAR) Part 27.4. For those with military agencies, the rules exist in the data rights section of the 1988 Defense Federal Acquisition Regulation Supplement (DFARS) Subpart 227.4 and of the 1995 DFARS Subpart 227.71 and 227.72. A comprehensive discussion of data rights is beyond the scope of this article, however, generally speaking, the category of rights a government takes in any technology or technical data developed by a private entity depends on who paid for the development expense.

For technology and technical data developed at private expense and which embody trade secrets or are commercial or financial and confidential or privileged, the government is entitled to receive only specified “limited rights.” Both the FAR and the DFARS require a contractor to review the government’s requirements and to specify any technology or technical data to which limited rights would apply. The FAR further directs the contractor to withhold those items and to furnish form, fit, and function data in its place. The DFARS requires contractors to specifically identify any technology or technical data being provided with restrictions. Every copy of any item furnished to the government with less than unlimited rights must be identified with certain specified legends.

On the other hand, for technology and technical data developed at entirely government expense, the government usually takes “unlimited rights.” The government then may use the technology and technical data as it wishes and even sell or give it to the company’s fiercest competitor. Any right the developer otherwise would have under commercial intellectual property laws (including patent, copyright and/or trade secret laws) to prevent others from using its proprietary tools or developing a competing product based on those tools is significantly curtailed when the government receives unlimited rights.

The question arises, however: If an SBC participates in a Phase I and Phase II SBIR Program and receives up to $850,000 in seed money to conduct research and development efforts that result in the creation of gangbuster technology, does the government receive unlimited rights in the technology? As discussed below, under both the FAR and DFAR the answer is NO. Further, the Directive contains important rules of conduct for SBIR agencies, which give SBIR awardees significant advantages in both the commercial and government sectors.

Under the Directive, the contracting officers representing the government are prohibited from “exerting pressure or coercion” on SBIR companies to give up their technical data rights in exchange for SBIR awards. For example, Section 8(a)(4) of the Directive expressly states that an agency “must not, in any way, make issuance of an SBIR Phase III award conditional on data rights.” These data rights are non-negotiable and contracting officers must use the exact data rights terminology of the law and the Directive in every funding agreement and contract with the SBC.

Additionally, under FAR 52.227-20, applicable to SBIR funding from civilian agencies, and under DFARS 252.227-7018, applicable to SBIR funding from military agencies, the government and its support contractors generally receive a limited license to use technical data or computer software³ generated and delivered under the SBIR contract for United States government purposes.⁴ The technical data and computer software may not be used for commercial purposes. Furthermore, during the license period, the government may not release or disclose technical data to any person other than its support services contractors.⁵ This non-disclosure prohibition for government funded technology development is unique to the SBIR Program.

Both the limited license and non-disclosure obligations continue for a period starting with the SBIR contract award and ending five years (in the case of military agencies) or four years (in the case of civilian agencies) after the completion of the project under which the data was generated (Phase I, Phase II and/or Phase III). After the expiration of that time period, the government will have broader rights in the SBIR technical data.⁶

However, because of two new and important requirements under the Directive, the expiration of the government’s non-disclosure obligations could be extended for well over the five- or four-year period. First, if follow-on SBIR work (Phase II, Phase III, or follow-on Phase III) is awarded within the four- or five- year disclosure protection period, the non-disclosure period for all earlier awards is extended through the non-disclosure period of the latest award. This roll-over prevents wrangling over what agencies may properly disclose when disclosure periods for earlier awards expire. Second, for all Phase III commercialization awards, agencies are expected to give preference, including sole source awards, to the Phase I or II awardee that developed the technology.⁷ The preference/sole source award requirement virtually assures the continued roll-over of the non-disclosure protections in each Phase III award.

In light of the new reforms to the SBIR Program, emerging technology companies that qualify as a “small business concern” are well advised to consider SBIR participation as a viable business strategy. In this cash-strapped economy, $850,000 over a 30-month period represents significant seed money that entrepreneurs may use to establish a competitive advantage in a burgeoning government sector, and ultimately, in the commercial sector. Of course, regardless of a company’s size, doing business with the government can be tricky and understanding the government’s rules of the road is critical to maximizing the opportunities presented by the SBIR Program.

For more information, contact Edward J. Naughton, toll free, at 1-888-688-8500.

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[1] Congress enacted the Small Business Innovation Development Act of 1982 (SBIDA), Public Law 97-219 (codified at 15 U.S.C. 638), which established the SBIR Program. SBIDA requires the SBA to issue policy directives for the general conduct of the SBIR programs within the federal Government. 15 U.S.C. 638(j)(1).

[2] The Directive adopts the SBA’s size regulations restricting eligibility for the SBIR Program to only small business concerns. Under the Directive, a “small business concern” is one that:

(a) is organized for profit, with a place of business located in the United States, which operates primarily within the United States or which makes a significant contribution to the United States economy through payment of taxes or use of American products, materials or labor;

(b) is in the legal form of an individual proprietorship, partnership, limited liability company, corporation, joint venture, association, trust or cooperative, except that where the form is a joint venture there can be no more than 49 percent participation by foreign business entities in the joint venture;

(c) is at least 51 percent owned and controlled by one or more individuals who are citizens of, or permanent resident aliens in, the United States, except in the case of a joint venture, where each entity to the venture must be 51 percent owned and controlled by one or more individuals who are citizens of, or permanent resident aliens, in the United States; and,

(d) has, including its affiliates, not more than 500 employees. The term “affiliate” has the same meaning as set forth in 13 CFR 121.103.

[3] FAR and DFARS do not use the same definitions for “technical data” and “computer software.” Depending on the agency with which the SBC desires to transact, it should review carefully the applicable regulations to determine the exact scope of the government’s license.

[4] Under DFARS 252.227-7018 (a)(13), “government purpose” means “any activity in which the United States Government is a party, including cooperative agreements with international or multi-national defense organizations or sales or transfers by the United States Government to foreign governments or international organizations. Government purposes include competitive procurement, but do not include the rights to use, modify, reproduce, release, perform, display, or disclose technical data or computer software for commercial purposes or authorize others to do so. Unlike DFARS, FAR does not define “government purpose” and expressly prohibits the use of SBIR data for procurement purposes.

[5] Under DFAR 252.227-7018, certain exceptions exist to the government’s non-disclosure obligations but only if the intended recipient agrees to a use and non-disclosure agreement required under the regulations.

[6] Under DFARS 252.227.7018, the government receives unlimited rights to use and disclose technical data and computer software as it wishes. In contrast, under FAR 52.227-20(d)(1), the government receives the right to use and disclose technical data and computer software for government purposes only.

[7] More specifically, the SBIR Policy Directive requires an agency that pursues research, development or production of a technology developed by an SBIR awardee in a Phase I or Phase II, with a concern other than the one that developed the SBIR technology to notify the SBA of its intention, prior to the award. The SBA may, in turn, appeal the decision to the head of the contracting activity who must then suspend further acquisition until a decision on the SBA’s appeal is issued. The preference given to Phase I and Phase II awardees exists even if the original company has grown larger than SBA’s size limits for Phase I and II. Further, the SBIR Policy Directive expressly requires that a Phase III award be accorded SBIR data rights. These instances of award of a firm’s SBIR technology to another firm will eventually be reported to Congress in SBA’s Annual Report to Congress.