SBIR Improvements -- Allowing Majority Investor Participation and More

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1 January 2012 SBIR Imprvements -- Allwing Majrity Investr Participatin and Mre On December 31, 2011, President Obama signed the Natinal Defense Authrizatin Act fr 2012, which included the SBIR/STTR Reauthrizatin Act f 2011 (the "Act"). H.R , Divisin E. Many changes, large and small, were made t the Small Business Innvatin Research Prgram ("SBIR") and the Small Business Technlgy Transfer Prgram ("STTR"). The Small Business Administratin ("SBA") is required t issue prpsed regulatins implementing the Act generally by April 30, 2012, and regarding fraud, waste, and abuse preventin by March 30, Fr basic infrmatin abut the SBIR/STTR prgrams, see the SBA's website. Generally: Id. SBIR targets the entrepreneurial sectr because that is where mst innvatin and innvatrs thrive. Hwever, the risk and expense f cnducting serius R&D effrts are ften beynd the means f many small businesses. By reserving a specific percentage f federal R&D funds fr small business, SBIR prtects the small business and enables it t cmpete n the same level as larger businesses. SBIR funds the critical startup and develpment stages and it encurages the cmmercializatin f the technlgy, prduct, r service, which, in turn, stimulates the U.S. ecnmy. STTR is a highly cmpetitive prgram that reserves a specific percentage f federal R&D funding fr award t small business and nnprfit research institutin partners. Small business has lng been where innvatin and innvatrs thrive. But the risk and expense f cnducting serius R&D effrts can be beynd the means f many small businesses. The mst interesting and cmplex change is t permit small business cncerns that have majrity investments by venture capital, hedge fund, r private equity firms, even if the investment firms are large businesses, t receive a prtin f SBIR awards. That tpic is discussed in detail later in this article. General Changes A tp level list f changes that are als significant, but are relatively simple, include: Increase in the percentage f the agency's extramural research and develpment budget t be allcated t SBIR (2.6% in 2012 thrugh 3.2% in 2017) and STTR (.35% in 2012 thrugh.45% in 2016) Increase in the value f the awards t $150,000 in Phase I and $1M in Phase II fr bth SBIR and STTR Phase II awards may be frm a different agency than the Phase I award where bth agencies make written determinatins that the tpics are the same

2 Phase II awards shuld be made fllwing cmpletin f a Phase I agreement withut any invitatin, pre-screening, r pre-selectin prcess fr eligibility fr Phase II Phase II awards may be made t applicants that have nt perfrmed a Phase I agreement Nt nly must the applicant assert that each applicatin is nt duplicative f anther applicatin, the federal agencies must als verify there is n duplicatin f funding Federal agencies may nt make cllabratin with a federal labratry a cnditin t award f an SBIR r STTR agreement Federal agencies may nt apprve any agreement (the Act fcuses n Cperative Research and Develpment Agreements) that takes mre rights in data frm the small business cncern than the defined SBIR rights A federal labratry may nt require advance payment frm a small business cncern any greater than the amunt necessary t pay fr 30 days f activities Fr Department f Defense ("DD") cntracts f $100M r mre, gals fr transitin f Phase III technlgies must be required in subcntracting plans Allws agencies t use 3% f SBIR funding fr and requires agencies t prvide technical assistance, utreach, versight, implementatin f cmmercializatin, and related activities Requires agencies t make a final decisin whether t make awards within 90 days after the slicitatin clses, except the NIH and NSF are permitted ne year NIH authrized $5M fr special "Phase 0" Prf f Cncept Partnership Pilt Prgram t accelerate the creatin f small businesses and the cmmercializatin f research innvatins frm qualifying institutins Requires the Cmptrller General t cnduct a fiscal and management audit t determine, amng ther things, whether the agencies cmply with the expenditure amunt requirements Requires the Cmptrller General t cnduct a study f the SBIR prgram t assess whether federal agencies cmply with the data rights prtectins fr SBIR awardees and their technlgies, whether the data rights prtectin laws and plicies are sufficient t prtect SBIR awardees, and if there are effective grievance tracking and reslutin prcesses regarding data rights F raud, Waste and Abuse Preventin Changes Requires SBIR and STTR applicants t make fraud, waste, and abuse cmpliance certificatins at varius stages in the award, perfrmance and clse-ut f the agreements, which may require: Certificatin f cmpliance with the "principal investigatr primary emplyment" requirement, the "small business cncern" definitin requirement, and the "perfrmance

3 f wrk" (in STTRs 40% f the wrk by the small business and 30% by the research institutin) requirement Certificatin that it is nt applying fr funding fr identical r essentially equivalent wrk t that already perfrmed, r will perfrm, in cnnectin with any ther SBIR r STTR award frm any ther agency Certificatin that it will perfrm the wrk at its facilities with its emplyees unless therwise indicated Changes Permitting Venture Capital, Hedge Fund, and Private Equity Investment in SBIR Requirements t be eligible t receive an SBIR award include: U.S.-wned and under independent cntrl Fr-prfit The principal researcher must be emplyed by the business Cmpany size limited t 500 emplyees In 2006, venture capital, hedge fund, and private equity firms (hereinafter referred t cllectively as "Investment Cmpanies") were shcked t learn that the SBA may cnsider the Investment Cmpany and all f its prtfli cmpanies affiliated fr purpses f determining cmpany size under the SBA's affiliatin rule. 13 CFR (a). Fr purpses f SBIR prgram eligibility, if the aggregate f the number f emplyees f all f the prtfli cmpanies and the Investment Cmpany tgether exceeded 500, nne f the prtfli cmpanies wuld be eligible fr the SBIR prgram. N specific regulatin describing this situatin was ever issued, but the SBA's decisin in the size prtest f Apptis, Inc., SIZ interpreted the SBA's affiliatin rule in a manner that treated the Investment Cmpanies mre like traditinal crprate parents than banks. The Apptis case recgnized sme exceptins and in subsequent size prtests, the SBA recgnized additinal exceptins, but Investment Cmpanies have lacked certainty. It has becme difficult t predict whether a small business wuld be able t retain the cntracts it was perfrming after a transactin with an Investment Cmpany. This has had a chilling effect n Investment Cmpany activity in the federal gvernment cntractr small business space. Fr well ver a decade, the SBA and its stakehlders have been wrestling with a means t permit private investment, as it typically ccurs in the marketplace, while still preserving the SBIR prgram fr independent, small businesses. If an agency determines it is in its best interest, the Act nw authrizes a federal agency t use a prtin f its SBIR funds t award SBIR cntracts t small business cncerns with majrity investments by Investment Cmpanies: The Natinal Institutes f Health ("NIH"), the Department f Energy ("DOE"), and the Natinal Science Fundatin ("NSF") may award up t 25% f its SBIR funds and all ther federal agencies may award up t 15% f their SBIR funds t small business cncerns that are wned in majrity part by multiple Investment Cmpanies The Act has created an express exceptin t the affiliatin rule (hereinafter referred t as the "15/25% Rule"). The exceptin applies t small business cncerns where the majrity interest is wned by multiple Investment Cmpanies, nt ne Investment Cmpany. Anyne experienced in the SBA affiliatin rules knws that there is ften a great deal f uncertainty in determining whether a relatinship has been established in a manner that will nt create unwanted affiliatin. Cngress has attempted t gain sme certainty fr the investment cmmunity in the Act:

4 The SBA must submit a reprt t Cngress analyzing what restrictins, cnditins, r cvenants cntained in a nte, bnd, debenture, r ther evidence f indebtedness, r preferred stck shuld cnstitute affiliatin under the SBA rules. In general, the Act's guidance t determine if an Investment Cmpany r any ther business that the Investment Cmpany has financed creates an affiliatin with the applicant that makes it ineligible fr SBIR is: If the Investment Cmpany that is determined t be affiliated with an applicant is a minrity investr in the applicant, the prtfli cmpanies f the Investment Cmpanies shall nt be determined t be affiliated with the applicant unless The Investment Cmpany wns a majrity f the prtfli cmpany r The Investment Cmpany hlds a majrity f the seats n the bard f directrs f the prtfli cmpany The SBA may nt determine that a prtfli cmpany f an Investment Cmpany is affiliated with an applicant based slely n 1 r mre shared investrs The SBA retains discretin t cnsider ther factrs in affiliatin By January 30, 2012, the SBA is required t: Pst n the SBA website a clear explanatin f the current SBIR and STTR affiliatin rules and Pst n the SBA website cntact infrmatin fr SBA fficers r emplyees wh: Upn request, shall review an issue relating t the affiliatin rules and Respnd t a request nt later than 20 business days after the date n which the request is received On and after the date when the new rules are made final, similarly pst a clear explanatin Implementatin f the 15/25% Rule will be a majr challenge fr agencies since the awards t SBIR cmpanies with majrity wnership by investment firms must be made thrugh cmpetitive, merit-based prcedures that are pen t all eligible small business cncerns and may nt use investment by an Investment Cmpany as an evaluatin criterin. This requirement will make it difficult t spread the awards acrss tpics r rganizatinal subunits f the agency, if that wuld be the agency's preference. There are several accunting and reprting requirements t implement the new authrity: An SBIR/STTR awardee must: Register with the SBA if it is majrity-wned by multiple Investment Cmpanies n the date that it submits an applicatin fr an SBIR award

5 Reprt n any SBIR prpsal that it is registered as majrity-wned by multiple Investment Cmpanies An SBIR/STTR awardee must als reprt significant infrmatin, mst is which is made available publicly: The amunt f Investment Cmpany investment that the awardee has received as f the date f the award The amunt f additinal capital that the awardee has invested in the STTR technlgy Whether an awardee has an investr that Is an individual wh is nt a citizen f the United States f a lawful permanent resident f the United States, and, if s, the name f any such individual Is a persn that is nt an individual and is nt rganized under the laws f a State r the United States, and if s, the name f any such persn Whether an awardee is wned by a wman r has a wman as a principal investigatr Whether an awardee is wned by a scially r ecnmically disadvantaged individual r has a scially r ecnmically disadvantaged individual as a principal investigatr Whether an awardee is a faculty member r a student f an institutin f higher educatin Whether an awardee is lcated in certain States that have been identified as receiving a disprprtinally lw share f SBIR/STTR awards The Act even addresses an anticipated issue -- if a small business cncern has a majrity f its interests purchased after submissin f an SBIR applicatin, but befre award: If the award is made mre than nine (9) mnths after the applicatin is submitted, an award t the applicant can be made as thugh the Investment Cmpany wnership des nt exist, but The agency must transfer the amunt f the award frm its nn-sbir fund accunt t the SBIR fund accunt. The Act requires regulatins t establish the criteria fr meeting the U.S. wned and perated requirement, including: Whether the applicant is at least 51 percent wned r cntrlled by citizens f the United states r dmestic Investment Cmpanies Whether the applicant is dmiciled in the United States Whether the applicant is a direct r indirect subsidiary f a freign-wned firm

6 Any Investment Cmpany that wns mre than 20 percent f the applicant is a direct r indirect subsidiary f a freign-wned entity In the aggregate, entities that are direct r indirect subsidiaries f freign-wned entities wn mre than 49 percent f applicant Finally, Cngress requires the Cmptrller General t prduce a reprt every three (3) years t describe the impact f the Investment Cmpany requirements and invlvement n the SBIR and STTR prgrams. The Act was drafted with great specificity, which shuld leave the SBA with little discretin in drafting implementing regulatins, and perhaps making the drafter's jb easier. The rules are fairly cmplex, but cmpanies and investrs can manage their relatinships t take advantage f the new SBIR/STTR rules, nce implemented. Shuld yu have any questins abut the cntents f this alert, please feel free t cntact Hlly Emrick Svetz ; r any member f ur Gvernment Cntracts Team. Wmble Carlyle client alerts are intended t prvide general infrmatin abut significant legal develpments and shuld nt be cnstrued as legal advice regarding any specific facts and circumstances, nr shuld they be cnstrued as advertisements fr legal services. IRS CIRCULAR 230 NOTIC E: T ensure cmpliance with requirements impsed by the IRS, we infrm yu that any U.S. tax advice cntained in this cmmunicatin (r in any attachment) is nt intended r written t be used, and cannt be used, fr the purpse f (i) aviding penalties under the Internal Revenue Cde r (ii) prmting, marketing r recmmending t anther party any transactin r matter addressed in this cmmunicatin (r in any attachment).