U.S. Small-Business Programs’ Future Is Clouded by Congressional Fight

Sen.

Rand Paul

of Kentucky, the top Republican on the Senate small-business committee, has pledged to block the programs’ reauthorization unless Congress mandates a revamp. His Democratic counterparts see some of his proposals as counterproductive to fostering innovation, so negotiations are dragging on, according to aides.

The wrangling is part of a broader debate in Washington, Silicon Valley and elsewhere about the best way for the U.S. to strengthen its defense-industrial base against China, which is determined to access U.S. innovation. Many critical technologies are now being developed by tech startups and other nontraditional defense contractors.

The small-business programs have benefited many now-established technology companies, including

Qualcomm Inc.,

a semiconductor giant, and DNA-testing firm

23andMe Inc.

The lawmakers’ differences over the programs are already having an impact. The Defense Department, which is the SBIR program’s biggest participating agency, recently canceled a coming round of award solicitations because of uncertainty over the program’s future.

In a June letter to six House and Senate committees reviewed by The Wall Street Journal, two Pentagon undersecretaries said failure to renew the programs means that many war-fighting needs won’t be addressed. They said, “Any lapse could result in thousands of small businesses being forced to lay off workers, or drive them to other sources of funding, to include foreign investment.” The Pentagon said in a 2019 report that by 2018 it saw a 22:1 return on investment from SBIR and STTR contracts made between 1995 and 2012.

The current legislative fight over the small-business funds centers on companies that have excelled at winning many awards, which generally total $50,000 to $750,000. Mr. Paul refers to these firms as “SBIR mills.” He accuses them of gaming the system to get funding for research that largely can’t be commercialized, crowding out businesses with potentially more innovative technology. He wants to cap the number of awards one company can receive annually.

“We need to stop funneling taxpayer money to these same firms over and over again,” Mr. Paul said in a statement.

Mr. Paul, along with fellow committee Republican Sen.

Joni Ernst

of Iowa, have urged Congress to require government agencies to vet companies seeking SBIR funding to prevent exploitation by adversaries like China. A Pentagon study in 2021 found instances of SBIR recipients taking Chinese investment or working with Chinese entities linked to defense industries, the Journal reported in May.

Sen.

Ben Cardin

(D., Md.) and Rep.

Nydia Velázquez

(D., N.Y.), who lead the Senate and House small-business committees, said in statements that they are open to discussing the national-security concerns. In meetings, however, they have opposed targeting the multiple award recipients so broadly, saying those companies provide invaluable research and technology, according to people involved in the discussions.

“Our primary objective is avoiding a program shutdown, and the harm it would cause,” Ms. Velázquez said in a statement. “Failure to reauthorize these programs would hurt American small businesses, innovation and national defense.”

During negotiations, Mr. Paul’s aides have cited public data showing that more than 200 businesses received over 100 SBIR awards each, with some getting more than 900 awards, according to some of the people involved in the negotiations.

Ben Van Roo, a defense entrepreneur who has received SBIR and STTR money and who has been consulting with lawmakers on the programs, argued for awards caps in a June blog post titled “Are a Few Dozen SBIR Mills Sucking the Air Out of Small Business Innovation?”

He cited Nasdaq-listed

Luna Innovations Inc.,

a maker of fiber-optic and other technologies, which he said has received $165 million from 1,200 Defense Department SBIR contracts from 2009 to 2021, representing 30% of its revenue over that time.

A Luna spokeswoman said that the company “has sold or spun off many of the SBIR-developed technologies to entities that could further commercialize those technologies.” A separate division of the company, which conducted most of the SBIR work, was sold to a private group earlier this year, and SBIR work now accounts for less than 5% of Luna Innovations’ revenue, the spokeswoman said.

Under the SBIR program, the government expects to award $3.9 billion in funding in the fiscal year ending Sept. 30. Agencies solicit different types of applications. “Open topics” are open-ended calls for companies to apply for funding for any idea or technology they think might be of use. “Conventional topics” are specific project requests by agencies.

Conventional topics tend to draw bids from larger small businesses with expertise in both grant-writing and highly specific research while open topics tend to draw newer, smaller companies developing technologies, according to researchers and industry representatives.

“This is a philosophical argument Congress needs to get a grip on: What is the SBIR program? Is it a research program or a productization program?” said Warren Katz, co-founder of the Alliance for Commercial Technology in Government, a new trade association representing approximately 70 technology startups.

Mr. Katz said the current SBIR system benefits Pentagon scientists, companies that have won multiple awards and members of Congress who see money going to their districts. On the other hand, he said, it isn’t great for the military’s tech needs, startups which can’t break into the system and taxpayers.

Alec Orban of the Small Business Technology Council, a decades-old industry association that counts among its members many companies that have received multiple awards, said: “People saying ‘100 Phase I [awards] for a single company is too much’ are missing the point of the program: Those awards represent potentially 100 different technologies or research applications.”

Mr. Orban also thinks conventional topics are preferable because they remove guesswork for small businesses. Regardless, he said, the individual agencies and services should decide how to conduct the awards process, not Congress.

A 2014 economic impact study commissioned by the Air Force found that the more SBIR and STTR awards companies received, the less likely they were to successfully commercialize their products. A 2018 Air Force decision to add open-topic competitions has brought in new applicants, including companies that are part of Mr. Katz’s trade group, he said.

A 2021 study published by the National Bureau of Economic Research, a nonprofit, nonpartisan group, also found that the Air Force’s open-topic competitions increase the probability of a company securing subsequent venture capital investment, non-SBIR Defense Department contracts and patents—all viewed as metrics of success.

Still, the Air Force told the Senate Small-Business Committee that it agrees with the Office of the Secretary of Defense’s opposition to Mr. Paul’s proposal for an awards cap and instead supports its colleagues’ recommendation to use a tiered benchmark process to measure recipients’ commercialization success, according to a June document reviewed by the Journal.

Sen. Paul and his Democratic counterparts have been trading proposals on a benchmarking system, according to the people involved in the negotiations.

Write to Kate O’Keeffe at kathryn.okeeffe@wsj.com

Sen.

Rand Paul

of Kentucky, the top Republican on the Senate small-business committee, has pledged to block the programs’ reauthorization unless Congress mandates a revamp. His Democratic counterparts see some of his proposals as counterproductive to fostering innovation, so negotiations are dragging on, according to aides.

The wrangling is part of a broader debate in Washington, Silicon Valley and elsewhere about the best way for the U.S. to strengthen its defense-industrial base against China, which is determined to access U.S. innovation. Many critical technologies are now being developed by tech startups and other nontraditional defense contractors.

The small-business programs have benefited many now-established technology companies, including

Qualcomm Inc.,

a semiconductor giant, and DNA-testing firm

23andMe Inc.

The lawmakers’ differences over the programs are already having an impact. The Defense Department, which is the SBIR program’s biggest participating agency, recently canceled a coming round of award solicitations because of uncertainty over the program’s future.

In a June letter to six House and Senate committees reviewed by The Wall Street Journal, two Pentagon undersecretaries said failure to renew the programs means that many war-fighting needs won’t be addressed. They said, “Any lapse could result in thousands of small businesses being forced to lay off workers, or drive them to other sources of funding, to include foreign investment.” The Pentagon said in a 2019 report that by 2018 it saw a 22:1 return on investment from SBIR and STTR contracts made between 1995 and 2012.

The current legislative fight over the small-business funds centers on companies that have excelled at winning many awards, which generally total $50,000 to $750,000. Mr. Paul refers to these firms as “SBIR mills.” He accuses them of gaming the system to get funding for research that largely can’t be commercialized, crowding out businesses with potentially more innovative technology. He wants to cap the number of awards one company can receive annually.

“We need to stop funneling taxpayer money to these same firms over and over again,” Mr. Paul said in a statement.

Mr. Paul, along with fellow committee Republican Sen.

Joni Ernst

of Iowa, have urged Congress to require government agencies to vet companies seeking SBIR funding to prevent exploitation by adversaries like China. A Pentagon study in 2021 found instances of SBIR recipients taking Chinese investment or working with Chinese entities linked to defense industries, the Journal reported in May.

Sen.

Ben Cardin

(D., Md.) and Rep.

Nydia Velázquez

(D., N.Y.), who lead the Senate and House small-business committees, said in statements that they are open to discussing the national-security concerns. In meetings, however, they have opposed targeting the multiple award recipients so broadly, saying those companies provide invaluable research and technology, according to people involved in the discussions.

“Our primary objective is avoiding a program shutdown, and the harm it would cause,” Ms. Velázquez said in a statement. “Failure to reauthorize these programs would hurt American small businesses, innovation and national defense.”

During negotiations, Mr. Paul’s aides have cited public data showing that more than 200 businesses received over 100 SBIR awards each, with some getting more than 900 awards, according to some of the people involved in the negotiations.

Ben Van Roo, a defense entrepreneur who has received SBIR and STTR money and who has been consulting with lawmakers on the programs, argued for awards caps in a June blog post titled “Are a Few Dozen SBIR Mills Sucking the Air Out of Small Business Innovation?”

He cited Nasdaq-listed

Luna Innovations Inc.,

a maker of fiber-optic and other technologies, which he said has received $165 million from 1,200 Defense Department SBIR contracts from 2009 to 2021, representing 30% of its revenue over that time.

A Luna spokeswoman said that the company “has sold or spun off many of the SBIR-developed technologies to entities that could further commercialize those technologies.” A separate division of the company, which conducted most of the SBIR work, was sold to a private group earlier this year, and SBIR work now accounts for less than 5% of Luna Innovations’ revenue, the spokeswoman said.

Under the SBIR program, the government expects to award $3.9 billion in funding in the fiscal year ending Sept. 30. Agencies solicit different types of applications. “Open topics” are open-ended calls for companies to apply for funding for any idea or technology they think might be of use. “Conventional topics” are specific project requests by agencies.

Conventional topics tend to draw bids from larger small businesses with expertise in both grant-writing and highly specific research while open topics tend to draw newer, smaller companies developing technologies, according to researchers and industry representatives.

“This is a philosophical argument Congress needs to get a grip on: What is the SBIR program? Is it a research program or a productization program?” said Warren Katz, co-founder of the Alliance for Commercial Technology in Government, a new trade association representing approximately 70 technology startups.

Mr. Katz said the current SBIR system benefits Pentagon scientists, companies that have won multiple awards and members of Congress who see money going to their districts. On the other hand, he said, it isn’t great for the military’s tech needs, startups which can’t break into the system and taxpayers.

Alec Orban of the Small Business Technology Council, a decades-old industry association that counts among its members many companies that have received multiple awards, said: “People saying ‘100 Phase I [awards] for a single company is too much’ are missing the point of the program: Those awards represent potentially 100 different technologies or research applications.”

Mr. Orban also thinks conventional topics are preferable because they remove guesswork for small businesses. Regardless, he said, the individual agencies and services should decide how to conduct the awards process, not Congress.

A 2014 economic impact study commissioned by the Air Force found that the more SBIR and STTR awards companies received, the less likely they were to successfully commercialize their products. A 2018 Air Force decision to add open-topic competitions has brought in new applicants, including companies that are part of Mr. Katz’s trade group, he said.

A 2021 study published by the National Bureau of Economic Research, a nonprofit, nonpartisan group, also found that the Air Force’s open-topic competitions increase the probability of a company securing subsequent venture capital investment, non-SBIR Defense Department contracts and patents—all viewed as metrics of success.

Still, the Air Force told the Senate Small-Business Committee that it agrees with the Office of the Secretary of Defense’s opposition to Mr. Paul’s proposal for an awards cap and instead supports its colleagues’ recommendation to use a tiered benchmark process to measure recipients’ commercialization success, according to a June document reviewed by the Journal.

Sen. Paul and his Democratic counterparts have been trading proposals on a benchmarking system, according to the people involved in the negotiations.

Write to Kate O’Keeffe at kathryn.okeeffe@wsj.com