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S. HRG. 110–739

REAUTHORIZATION OF THE SMALL BUSINESS INNOVATION RESEARCH PROGRAM: HOW TO

ADDRESS THE VALLEY OF DEATH, THE ROLE

OF VENTURE CAPITAL, AND DATA RIGHTS

ROUNDTABLE

BEFORE THE

COMMITTEE ON SMALL BUSINESS

AND ENTREPRENEURSHIP

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

OCTOBER 18, 2007

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

(

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

(II)

COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

JOHN F. KERRY, Massachusetts, Chairman

CARL LEVIN, Michigan

TOM HARKIN, Iowa

JOSEPH I. LIEBERMAN, Connecticut

MARY LANDRIEU, Louisiana

MARIA CANTWELL, Washington

EVAN BAYH, Indiana

MARK PRYOR, Arkansas

BENJAMIN L. CARDIN, Maryland

JON TESTER, Montana

OLYMPIA J. SNOWE, Maine

CHRISTOPHER S. BOND, Missouri

NORMAN COLEMAN, Minnesota

DAVID VITTER, Louisiana

ELIZABETH DOLE, North Carolina

JOHN THUNE, South Dakota

BOB CORKER, Tennessee

MICHAEL B. ENZI, Wyoming

JOHNNY ISAKSON, Georgia

NAOMI BAUM, Democratic Staff Director

WALLACE HSUEH, Republican Staff Director

(III)

CONTENTS

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

Page

IV

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

(1)

REAUTHORIZATION OF THE SMALL BUSINESS

INNOVATION RESEARCH PROGRAM: HOW

TO ADDRESS THE VALLEY OF DEATH, THE

ROLE OF VENTURE CAPITAL, AND DATA

RIGHTS

THURSDAY, OCTOBER 18, 2007

U.S. SENATE, COMMITTEE ON SMALL BUSINESS AND

ENTREPRENEURSHIP, Washington, DC.

The committee met, pursuant to notice, at 10:10 a.m., in room

428–A, Russell Senate Office Building, Hon. John F. Kerry (Chairman of the Committee) presiding.

Present: Senators Kerry and Tester.

OPENING STATEMENT OF HONORABLE JOHN F. KERRY,

CHAIRMAN, SENATE COMMITTEE ON SMALL BUSINESS AND

ENTREPRENEURSHIP, AND UNITED STATES SENATOR FROM

MASSACHUSETTS

Chairman KERRY. Well, thank you all. We will come to order and

I appreciate everybody’s patience. I am sorry to be a little late, but

I had an off-campus meeting this morning and Washington traffic

seems to be getting worse, not better. I think every road is under

repair and every detour is closed, so it is fun.

Let me just say up front that we are going to run this as we have

in the past, and the staff will principally drive the discussion. This

is not because of our lack of interest or anything, but I have a competing transportation hearing down in the Commerce Committee

which I need to be at because of Massachusetts interests, and also

we have a new Congresswoman being sworn in in about 40 minutes, so I need to attend to that.

However, let me try to focus this conversation, if I can. I want

to start by thanking Kevin Wheeler for her terrific efforts with

these roundtables, which I think are enormously productive. I can’t

tell you how helpful they are to the committee because they allow

for a back and forth discussion. There are a lot of faces around the

table that have been here many times, and as I have said before

roundtables are just so much more effective than the hearings in

many ways, and the discussions are really helpful to us and provide a very strong record in the process.

For those who aren’t here who wanted to participate, we will accept their thoughts and comments in writing, and the record will

remain open for a couple of weeks in order to adequately do that

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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

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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.

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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.

5

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

6

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

7

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-anda-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 IVerDate 11-MAY-2000 15:44 Feb 26, 2009 Jkt 044597 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 C:\DOCS\44597.TXT CELINA PsN: CELINA
8

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

9

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.

10

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 proVerDate 11-MAY-2000 15:44 Feb 26, 2009 Jkt 044597 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 C:\DOCS\44597.TXT CELINA PsN: CELINA
11

gram 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

12

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.

13

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

14

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.

15

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

16

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

17

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 movVerDate 11-MAY-2000 15:44 Feb 26, 2009 Jkt 044597 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 C:\DOCS\44597.TXT CELINA PsN: CELINA
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ing 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

19

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.

20

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-Bpluses 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

21

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?

22

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

23

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

24

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,

25

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, exfriends 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.

26

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.

27

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

28

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,

29

$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

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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 poVerDate 11-MAY-2000 15:44 Feb 26, 2009 Jkt 044597 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 C:\DOCS\44597.TXT CELINA PsN: CELINA
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tential 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.

32

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.

33

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 setasides.

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

34

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

35

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 hightech 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 definiVerDate 11-MAY-2000 15:44 Feb 26, 2009 Jkt 044597 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 C:\DOCS\44597.TXT CELINA PsN: CELINA
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tion, 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

37

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

38

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 inVerDate 11-MAY-2000 15:44 Feb 26, 2009 Jkt 044597 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 C:\DOCS\44597.TXT CELINA PsN: CELINA
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fection, 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 comVerDate 11-MAY-2000 15:44 Feb 26, 2009 Jkt 044597 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 C:\DOCS\44597.TXT CELINA PsN: CELINA
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mercialization 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 majorityowned 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.

41

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.

42

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.

43

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.

44

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

45

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 hardwareoriented 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.

46

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 selfcertify. 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?

47

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 AdminisVerDate 11-MAY-2000 15:44 Feb 26, 2009 Jkt 044597 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 C:\DOCS\44597.TXT CELINA PsN: CELINA
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tration. 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

49

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

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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 SBIRinitiated 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?

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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,

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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.

53

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

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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.

55

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 beVerDate 11-MAY-2000 15:44 Feb 26, 2009 Jkt 044597 PO 00000 Frm 00059 Fmt 6633 Sfmt 6633 C:\DOCS\44597.TXT CELINA PsN: CELINA
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tween 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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