Small businesses unable to exploit research grants.

For a majority of the small businesses that have received government funding for their high-risk research and development efforts, crossing the so-called "valley of death" to bring products to market remains a futile effort. Experts have suggested changes to the federal program to improve support for these endeavors and there are indications that a bridge may be in sight.

The federal government's small business innovation research program, established 25 years ago, provides up to $850,000 of funding to firms with fewer than 500 workers.

There are two award phases. In phase I, the government funds companies $100,000 to explore innovative concepts. If successful within six months, the company may apply for a two-year phase II grant of up to $750,000 to develop a prototype. At the end of the term, the firm is expected to obtain private funds to commercialize its product.

That is where many small businesses' problems begin. While the SBIR program has funded more than 90,000 projects with $19 billion through the years, analysts say many innovations slip through the cracks in the commercialization process and fail to reach the marketplace.

In a congressional hearing on SBIR reauthorization, Jon Baron, former counsel to the House Small Business Committee, testified that as many as half of phase II awardees are unable to convert their SBIR awards into viable new products sold to commercial or government customers.

"These are companies which usually have strong research capabilities --which is why they win SBIR awards--but lack the entrepreneurial capabilities, and in some cases the motivation, to convert their research into successful new products," he said before the House subcommittee on technology and innovation. "Many of these companies find the commercialization process to be unfamiliar, outside their skill set, and daunting."

Federal agencies have recognized this as a problem and have attempted to ameliorate the situation through a variety of approaches, including awarding additional funding to SBIR applicants who obtain matching funds, providing training in commercializing technologies and involving acquisition program offices in the development of SBIR solicitation topics.

However, Baron said, none of these approaches has been studied for effectiveness. He proposed that Congress direct agencies to allocate 1 percent of their SBIR funds to conduct evaluations to determine which methods might improve commercialization.

The Defense Department's SBIR program, in particular, has experienced difficulty in transitioning research results for two reasons, testified Bruce Held, senior policy researcher for the Rand Corp. Management of the program has focused more on the process issues associated with executing the thousands of SBIR awards than applying the results of those awards, and most of the SBIR program is managed out of laboratories and research centers that have long development and transition cycles, he wrote in a report.

Held proposed increasing the participation of Defense Department acquisition program managers in managing SBIR projects and urging the department's officials to shift its process-based program to one that is outcome-oriented. To that end, funding of SBIR projects needs to be increased and managed more flexibly, he concluded.

The SBIR funding levels, comprising 2.5 percent of the federal research and development budget, have not budged since 1992. Almost all of the hearing's witnesses voiced support for increasing those levels to $150,000 for phase I awards and $1.25 million for phase II awards.

"While smaller awards mean that more awards are available, larger awards mean increased flexibility to address the [Defense Department's] technology requirements through the SBIR program. That added flexibility has the potential to improve the probability that SBIR research outcomes will transition into products and services that the small-business participants can market to the [Defense Department] and to the broader defense industry," said Held.

Congress last year enacted the Commercialization Pilot Program into law as part of the 2006 defense authorization bill. The law suggests ways to improve commercialization across the government. Though the program has been in place in the Defense Department for a year, it has greatly increased the focus on SBIR insertion in the department's procurement process, testified Robert Schmidt on behalf of the Small Business Technology Council.

"Actions taken by key officials during the past six months strongly suggest that a surge of SBIR technology insertion is ahead in the next one to two years," he said.

The SBIR program expires next September, but Sen. John Kerry, D-Mass., chair of the Senate Committee on Small Business and Entrepreneurship, has said he will move to extend the program by the end of this year.

"I will continue to push to make the SBIR program permanent this reauthorization cycle," he told National Defense.

The SBIR program is the largest single source of patents in the United States, said Schmidt, who in his testimony recommended that Congress make the program permanent and conduct normal cycles of congressional oversight and management hearings.

In response to questions from National Defense, Kerry wrote that he agreed with many of the recommendations and added that he is in favor of increasing the SBIR funding for phase I and phase II awards.

"But the most important thing we can do to improve this program is figure out how to help small firms bridge the so-called 'valley of death,' and successfully transition from phase II to phase III," he said. "The Commercialization Pilot Program is helping, but we need to build on that ... Because firms cannot use SBIR funds for phase III, we should explore a phase II enhancement--something to get away from the current inefficient reliance upon earmarks."

To explore possible solutions, the committee is working with SBIR firms, experts in the field, program managers and the National Academy of Sciences, he said.

Schmidt pointed out that beefing up the phase I and II awards could mean that as many as 40 percent fewer companies would actually receive SBIR funding. However, by increasing the percentage of federal R&D spending on SBIR to 5 percent, from 2.5 percent, Congress could counter the effect, he said.

Last year the Senate committee adopted a bill that would have improved the SBIR program and made it permanent, said Kerry. "That bill did not get consideration by the full Senate, but I firmly believe we were on the right track and I will try to get a bill out of the Senate this year," he said.

"By making the program permanent, increasing the 2.5 percent allocation level, providing some funds to bridge the gap to phase III, and increasing oversight in SBIR contracting so that prime contractors and acquisition managers integrate these firms, Congress can ensure that the program is strengthened for the long-term while enabling more small firms to bypass a 'valley of death' scenario."

Overlooked Business Model Could Benefit Small Firms

SUPPOSE A SMALL BUSINESS has produced a technology that will help troops fighting in Iraq, and it would like to put that product into the war zone. Does it try to sell the product directly to the government? Does it sell the product to a large company as a subcontractor? Does it sell its company to a prime contractor? Or does it sell off the business unit that developed the product?

The latter choice is the best option for small firms, says a government contracts lawyer.

Transferring an entire product line, from the people and the data rights to the technology itself, allows the purchasing company to market the product and handle any upgrades while freeing up the small business to do what it does best--innovate, says David Metzger, partner at Arnold and Porter, LLP, based in Washington, D.C.

"At that point, you don't own that product--it's gone. You have engaged in a liquid transaction, and you now have money and they have the product," he says at the Navy's Opportunity Forum.

The method is an oft-overlooked business model, he adds.

Typically, firms will sell their products directly to the government or to large prime contractors. In some cases, they even sell the firm to the prime, which inherits the phase Ill, or commercialization, rights. But by selling a product line to the prime, small companies can take the money they earn from the transaction and invest in their next product without having to go to venture capitalists for funding.

That encourages small businesses to keep innovating, says Metzger. But the model won't work for companies that are "one-trick ponies," or for businesses that see its technologies as its children that are not for sale, he cautions.

Primes need to recognize that these innovations exist in small firms and they ought to stop duplicating the research, he adds.

Large companies tend to spend much more money to do the same research that small companies can accomplish with less than $1 million in small business innovation research program funding, says Garrett Okamoto of San Diego Research Center Inc., which has developed a technology that permits radio communications in frequency jamming situations.

In addition, small businesses sometimes are jilted by prime contractors who have pledged to bring their innovations to the table, but forget them once the project is underway, says Sen. John Kerry, D-Mass., chair of the Senate Committee on Small Business and Entrepreneurship.

"Unfortunately, small businesses get overlooked in this process in far too many cases and it's high time to put a stop to it. If a prime gets a contract by using small business in its proposal, the government should make sure the prime keeps its promise and the small firm gets to do the work. If it doesn't, it should penalize the firm. Right now, the government just looks the other way," he says.

Both prime contractors and the government have a responsibility to ease the commercialization process for small businesses, says Metzger.

"You've got to facilitate this. You've got to help in it--you can't stand in the way," he says. If primes and federal agencies understand their roles and remain committed to small firms, then the SBIR program, the nation, and the world will benefit, he adds.-GRACE JEAN