An Investor's Guide to SBIR
Practical perspectives, tips, and tricks to help investors understand the SBIR program and how it can help them and their portfolio companies
SBIR for Investors in One Page
What is SBIR: Small Business Innovative Research (SBIR) allows the federal government to fund the development of solutions to needs that they have
Why SBIR may be interesting:
- SBIR funding is non-dilutive
- Funding between $50K and $1.5M
- Simplifies and accelerates future federal sales up to $100M
- Can be used to defray technical risk, especially for “first money” investors
- Provides some market and technology validation
- There are a wide variety of service providers who will write proposals, manage SBIR compliance, and run follow on sales
- Angel and seed stage investors, accelerators and incubators
- Investors that invest in B2B companies
- Investors that invest in high/med tech products or products that align to a particular federal agency’s mission
Why Investors have traditionally ignored SBIR
- Addressing federal needs is a distraction from achieving commercial product market fit
- SBIRs do not provide recurring revenue
- Fear that federal sales will push multiples down
- Concerns over IP ownership
- Long sales cycle
Note: Recent shifts in SBIR have mitigated some of the issues mentioned above and other concerns can be resolved through outsourcing and partnering
Why It's Worth Reading
Small Business Innovation Research (SBIR) is an extraordinary funding source that:
- Can provide millions of dollars for product development
- Doesn’t take any equity
- Creates an express sales lane for Federal sales
But, most investors outside of DC have never heard of SBIR or are rightly skeptical of any program run by the government. But thanks to recent changes in the SBIR program a wave of investors have begun leveraging SBIR funds to help their portfolio companies grow and maximize their own returns. Wo we wrote this guide to help investors understand the program and decide whether its worth exploring further
Download An investor’s Guide to SBIR
SBIR in Three Bullets and Whether You Should Read the Rest of This Guide
- SBIR is kind of like Kickstarter in reverse:
When the government needs something and existing suppliers don’t have a solution they can publish an SBIR describing what they want. Companies then propose solutions, and the government funds the development of the ones they like. Winners keep their equity, the government gets the solution - SBIR funding is to corporate funding as lottery tickets are to your personal finances:
If a company is serious about their growth then they should plan their funding as if SBIR doesn’t exist. Then, if they win an SBIR they get a life changing infusion of non-dilutive cash, and if they don’t get the SBIR they haven’t lost anything - Don’t let SBIR distract you from your commercial goals:
If a company is fundamentally focussed on commercial sales then they should only pursue an SBIR if the solution the government needs is practically identical to a need their commercial customers have.
Is SBIR a Good Fit for your investment model
| Your companies in your portfolio | Is SBIR likely a good fit | ||
|---|---|---|---|
| Their customers | Industry they sell to | Size of their last round | |
| Other businesses (B2B) |
AR/VR Cyber Energy Manufacturing Material Science Medical ML/AI Sensors Unmanned |
less than $500K | Read the rest of this guide now!
|
| $500K-5M | Probably still worth reading
|
||
| $5M+ | Only read if federal sales are important to your companies
|
||
|
Agriculture Construction Education |
less than $500K | Read it the next time you can’t fall asleep
|
|
| $500K-5M | Read it the next time your on a long flight
|
||
| $5M+ | Probably not worth reading
|
||
| Consumer (B2C) |
Retail Wholesale Leisure Finance |
Any |
Probably not worth reading
|
For a Startup's Perspective on SBIR
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Practical perspectives and analysis for Startups on the SBIR program. Including:
|
Relentlessly focus on commercial product market fit - once you have an MVP - the gov’t market will take care of itself. It doesn’t work the other way around.
Why SBIRs Exist and What it Can Do for Your Returns
Why SBIR Exists
The government needs lots of things, most of which are provided by commercial vendors, but when there is no “commercial off the shelf” solution the government can use SBIRs to fund the creation of a solution.
For more on the Government's perspective on SBIR see HERE
| There’s an existing solution (buy it) | There’s a solution that is “almost right” (Modify a near solution -AFWERX SBIR candidate) | There is no existing solution (Make a solution -Traditional SBIR candidate) | |
|---|---|---|---|
| Gov and industry have the same need |
E.g. Trucks, computers, and IT services (Buy from any vendor) |
E.g.: Data analytics tools that need modifications to accommodate Gov data sets; or hardware that needs to be ruggedized to meet the DOD’s durability needs (Fund modifications to a commercial solution) |
E.g.: increasing energy density/stability in chemical batteries; an alternative to li-ion batteries for storage and transfer of power (Fund the creation of a solution) |
| Gov has a unique need |
E.g.: Weapons and intelligence services (Buy from a defense contractor) |
E.g. Communications & positioning technology that doesn’t require satellites; disabling drone swarms using electro-magnetic energy (Fund the creation of a solution) |
For A Government Perspective on SBIR
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Our Government Guide to SBIR:
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What SBIR can do for your returns
If one of your portfolio companies wins an SBIR they will get a major infusion of capital to mature their product without diluting the existing investors.
Hypothetical investor value economics
|
Ex: Mixed SBIR and investor funding |
Ex: Investor funding only | |
|---|---|---|
|
You invest $200K in NEW CO at a $1M valuation |
You own: 17% |
You own: 17% |
|
+6 mo: NEW CO needs to raise another $250K |
Fund via an SBIR Phase I You own: 17% |
Raises from other investors at a $1.5M valuation You own: 14% |
|
+12 mo: NEW CO needs to raise another $1.5M |
Fund via an SBIR Phase II You own: 17% |
Raises from other investors at a $5M valuation You own: 11% |
|
NEW CO is acquired for $100M |
You own: 17% YOU GET: $17M SBIR funding nets you $6M (30%) more |
You own: 11% YOU GET: $17M |
How much money you can get
Supplemental SBIR funding
Some SBIR programs will provide even more money if you receive private investor funding:
Some agencies are experimenting with programs that provide additional SBIR money to winners that get subsequent investor funding. The process and amounts are constantly changing but generally have been very generous. For more details, check the SBIR topic and:
Many states have supplemental funding and support for SBIR winners
| State | SBIR fund matching (max): | Site |
|---|---|---|
| Arkansas | Phase I: $50K Phase II $100K |
HERE |
| Connecticut | Up to $30K | HERE |
| Florida | Fund matching | HERE |
| Hawaii | 50% fund matching | HERE |
| Indiana | 50% match up to $100K | HERE |
| Iowa | Up to $50K | HERE |
| Kentucky | Fund matching | HERE |
| Massachusetts | Phase I: $100K Phase II $200K |
HERE |
| Michigan | Phase I: $25K Phase II $125K |
HERE |
America's Seed Fund (SBIR/STTR) is more than accessing free non-dilutive R&D funding, it is an opportunity to de-risk cutting edge technologies, it’s validation for your startup, an opportunity to develop a federal revenue line and to join an ecosystem of innovative firms solving moonshot problems for the American public.
Why investors have traditionally avoided SBIR and how to make it work for you
Why investors haven’t pursued SBIR
Distraction from achieving PMF: Achieving PMF is extremely challenging and time consuming and almost all startups are under resourced so why on earth would an investor encourage one of their portfolio companies to distract themselves pursuing the federal market or building features that are not necessary for commercial PMF
Fear of negative impact on valuation: Historically product companies have received very favorable valuations but government sales almost always involve selling a product and a service bundled together risking that future investors will value the company at a lower, services company, multiple
IP concerns: Some investors are concerned that federal funding will allow the government to make claims on startup IP
It is not recurring revenue: SBIRs provide cash infusions but are not a long term recurring revenue/ contracts with the government.
Slow sales cycle: There are long gaps between SBIR funding rounds and eventual government sales are slow
For more on SBIR from a startup's perspective see HERE
Mitigation by Outsourcing to service providers
Outsource anything that is a distraction
Firewall anything that could affect IP or valuation
|
Typical solutions |
Description |
PMF Distraction |
Impact on valuation |
IP concerns |
|---|---|---|---|---|
|
Outsource funding tracking |
|
X | ||
|
Outsourcing Proposal Writing |
There are a variety of service providers who:
|
XX | ||
|
Outsource Federal marketing and sales
|
Retain an outsourced federal sales team
|
XX |
||
|
Outsource Federal technical development |
Partner with an existing company that has symbiotic technical development capabilities and retain them to do any technical development that the government customer wants but that commercial customers do not |
XX |
|
|
|
Create a new company for SBIR |
|
|
X |
X |
|
JV on a new company |
Combine all of the above by creating the New Co in a JV with an SBIR specialist firm |
XX |
X |
X |
Start Exploring SBIRs
|
Download our free SBIR App
Or use our browser interface
|
An alternative framework for “First Money” investors
If you hear a pitch that is intriguing, but too risky, consider agreeing to invest contingent on them winning an SBIR.
You outsource some diligence: SBIR review committees validate the technical merit of proposed solutions by giving the technical section of the proposal to a group of government technical SMEs in the area. If they sign off it is some validation of technical merit
They have a lot more runway: Your funding might only provide a few months of runway but your check and a Phase I SBIR could easily give them a year to figure out their solution
They have a 50% chance of a bigger round: Companies that win a Phase I have a 50% chance of winning the much larger Phase II. So risk discounted value of a Phase I is actually much larger than it appears
Validates at least one customer: The government is generally a poor customer for early stage businesses. However, most government needs are shared by the private sector giving some market validation
Encourages subsequent investment: The SBIR program carries some credibility and has historically helped companies raise more easily allowing you to exit early if you wish
More SBIR and Government Market Resources
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Our resources section has everything you need to:
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Appendix
If SBIR Was a VC, They'd Be One of the Biggest Investors in the World
The Typical SBIR Timeline
- It takes 4-10 months between publishing a need and Phase I starting
- It takes 4-15 months between completing Phase I and starting Phase II
The Difference Between Traditional and Dual-Use (AFX) SBIR
Key Characteristics
- The government defines and publishes a need
- Applicants propose a solution
- The funding decision is largely based on whether the reviewers think you can deliver the tech
Benefits to a start-up
- The government is more open to new and unproven solutions
- A government office submitted the need so there is a known customer if you successfully deliver the solution
Challenges for start-ups
Key Characteristics
- You find a government need that aligns with the commercial problem you focus on
- You have a functioning commercial solution
- You can prove that your solution works (generally by showing commercial sales)
- The funding decision is largely based on the merit of the government need and your chances of connecting to a government customer
- NOTE: You are not expected to have a fully functioning solution to the government need before applying. The SBIR funds are there to evolve your product to meet the government’s use case
Benefits to a start-up
- You are assured of an aligned topic since you propose it
- These SBIRs tend to fund MUCH faster
Challenges for start-ups
- You need to have a functioning product and commercial traction
Traditional SBIR v. Commercial Life Cycle
CON: There is a crucial asymmetry in when companies begin long and expensive enterprise sales
Investor funded commercial market development
|
|
Funding Amount |
Corporate priorities |
|---|---|---|
| Boot strapping |
N/A | Understand customer needs through interviews |
|
Friends and |
$10- 50K |
|
|
Pre-seed |
$50- 200K |
|
|
Seed |
$500K- 1.5M |
|
|
Series A |
$5M+ |
|
| Series B |
$10M+ |
|
|
Series C |
? |
|
Traditional SBIR funded government market development
|
|
Funding Amount |
Corporate priorities |
|---|---|---|
| Boot strapping |
N/A | Understand customer needs by reading SBIRs |
|
Day job |
? |
|
|
Phase I |
$50- 200K |
|
|
Phase II |
$500K- 1.5M |
|
|
Phase III |
$5M+ |
|
|
Series C |
? |
|
Dual-Use SBIR (AFX) v. Commercial Life Cycle
PRO: There is good alignment in the development of long and expensive enterprise sales capabilities
CON: Dual-Use (AFX) SBIR is for later stage companies who may not be interested in the funding amounts
Investor funded commercial market development
| Funding Amount |
Corporate priorities |
|
|---|---|---|
|
Boot |
N/A | Understand customer needs through interviews |
|
Friends and |
$10- 50K |
|
|
Pre-seed |
$50- |
|
|
Seed |
$500K- |
|
|
Series A |
$5M+ |
|
| Series B |
$10M+ |
|
|
Series C |
? |
|
Dual-Use (AFX) funded government market development
| Funding Amount |
Corporate priorities |
|
|---|---|---|
|
Boot |
Not applicable. The Dual-Use (AFX) SBIR is available to companies that have achieved some commercial PMF
|
|
|
Friends and |
||
|
Pre-seed |
||
|
Seed |
||
|
Phase I |
$50K |
|
|
Phase II |
$750K |
|
|
Phase III |
? |
|
Selling to the government with and without an SBIR
Along with providing funding an SBIR creates a master services agreement between the company and the government which removes competition and speeds follow on sales
| Month | Without an SBIR | With an SBIR |
|---|---|---|
| 0 |
|
|
| 1 |
|
|
| 3 |
|
A non-competed contract is issued to you to buy your product |
| 6 |
|
Deliver the product and get paid |
| 9 |
|
|
| 12 |
If you win:
|
Industry to agency matching
IP risks that are introduced by SBIR are generally mitigated
| Activity | Dangers to my IP | How SBIR protects your IP |
|---|---|---|
| I have an idea for a solution to an SBIR topic | I publicly share my idea (including publication as part of a patent) |
|
| I submitted a proposal where I explain my idea | Your proposal/idea gets shared |
|
| I’m building a proof of concept/ prototype using SBIR funds |
SBIR funded IP shared through collaboration with the gov.
|
|
| I’m building features and function using funds other than SBIR |
NON-SBIR funded IP shared through collaboration with the gov.
|
|
If in doubt talk to a lawyer
Who can use (license) your SBIR funded technology?
In theory everyone (in government)
In practice no one
The government reserves an unlimited license to use technologies built with SBIR dollars. So theoretically you build a solution for the Navy and then the Navy (along with every other government agency) can exercise that license to start building it for themselves.
THIS SOUNDS SCARY BUT IT ISN’T
Why do they want this license: Lots of SBIR companies want to do the R&D but don’t want to actually bring the resulting product to market. So to protect their investment the government wants to be able to use the tech if you don’t commercialize it.
BUT in practice this license is meaningless because:
- The government HAS NO MANUFACTURING: Name some physical product the government actually makes… You can’t. This is because the government makes NOTHING, so if you are building a physical product you’re safe
- The government can’t share your IP for 20 years: As described in the IP page the government can’t share the details of the technology you built for 20 years so they can’t just give your IP to another manufacturer to build
- You can add “keys” to your code: The government does have coders so theoretically if you build software then government coders could replicate and implement it without you. To avoid that make sure some critical elements of your solution were built using non-SBIR funds. That way they get the SBIR developed code, but not the privately funded code and voila, they have to come to you if they want anything to work
Glossary
SBIR: Small Business Innovation Research (SBIR) A program that funds corporate R&D and product development that the government is interested in
STTR: Sister program to SBIR that allows companies to partner with universities and other public R&D orgs for their product development. For simplicity if we say SBIR assume we are including STTR unless specifically noted
Agency: There are 11 government agencies (e.g. Dept of Defense, the Environmental Protection Agency, etc) that participate in SBIR
R&D team: The teams within each agency responsible for buying, funding, or developing new solutions to their agency’s needs
Phase I: During Phase I SBIR funded companies have to develop and deliver a proof of concept solution to the need in the SBIR
Phase II: During Phase II SBIR funded companies have to develop and deliver a prototype solution to the need in the SBIR
Phase III: During Phase III SBIR funded companies sell their solution to the government. For more on Phase III see HERE
Traditional SBIR: An SBIR where the government defines a need and may define how acceptable solution will meet that need
Dual-Use Technology: Technologies that have a commercial and government (typically Defense) applications
Dual-use (AFX) SBIR: An SBIR where the applicant identifies a need that can be addressed through their dual Use technology. Also referred to as the AFWERX or Open Topic SBIR
NSF SBIR: The NSF SBIR funds technologies that are much more technically risky than other agencies (bleeding edge ideas that may not work)
Topic: SBIRs are generally released in clusters, a topic is a single need statement within that cluster of SBIRs
Aligned Topic: When the need/work to be done under an SBIR topic is highly aligned to your existing or planned commercial product
Principal Investigator: The person responsible for delivering the solution under an SBIR contract
Methodology
Sources of data for charts: All data used to produce the charts was downloaded from:
https://www.sbir.gov/sbirsearch/award/all
The Timeline chart: The timeline data required significant cleaning reducing the n value
The discounted value of a proposal chart: We used the formula: (% of winning Phase I X (Value of Phase I + (% of winning Phase II X (Value of Phase II))))
Non-data driven analysis and recommendations: These are entirely the product of our experience directly participating in and helping companies thinking through, plan and execute in the SBIR program