VENTURE FUNDING AND THE NIH SBIR PROGRAM

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VENTURE F UNDING AND THE NIH SBIR PROGRAM Committee for Capitalizing on Science, Technology, and Innovation: An Assessment of the Small Business Innovation Research Program Policy and Global Affairs Charles W. Wessner, Editor

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THE NATIONAL ACADEMIES PRESS 500 Fifth Street, N.W. Washington, DC 20001 NOTICE: The project that is the subject of this report was approved by the Governing Board of the National Research Council, whose members are drawn from the Councils of the National Academy of Sciences, the National Academy of Engineering, and the Institute of Medicine. The members of the committee responsible for the report were chosen for their special competences and with regard for appropriate balance. This study was supported by Contract/Grant No. N01-OD-4-2139 (Task Order #99) between the National Academy of Sciences and the U.S. Department of Health and Human Services. Any opinions, findings, conclusions, or recommendations expressed in this publication are those of the author(s) and do not necessarily reflect the views of the organizations or agencies that provided support for the project. International Standard Book Number-13: 978-0-309-12997-8 International Standard Book Number-10: 0-309-12997-4 Limited copies are available from the Policy and Global Affairs Division, National Research Council, 500 Fifth Street, N.W., Washington, DC 20001; 202-334-1529. Additional copies of this report are available from the National Academies Press, 500 Fifth Street, N.W., Lockbox 285, Washington, DC 20055; (800) 624-6242 or (202) 334-3313 (in the Washington metropolitan area); Internet, http://www.nap.edu. Copyright 2009 by the National Academy of Sciences. All rights reserved. Printed in the United States of America

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The National Academy of Sciences is a private, nonprofit, self-perpetuating society of distinguished scholars engaged in scientific and engineering research, dedicated to the furtherance of science and technology and to their use for the general welfare. Upon the authority of the charter granted to it by the Congress in 1863, the Academy has a man - date that requires it to advise the federal government on scientific and technical matters. Dr. Ralph J. Cicerone is president of the National Academy of Sciences. The National Academy of Engineering was established in 1964, under the charter of the National Academy of Sciences, as a parallel organization of outstanding engineers. It is autonomous in its administration and in the selection of its members, sharing with the National Academy of Sciences the responsibility for advising the federal government. The National Academy of Engineering also sponsors engineering programs aimed at meeting national needs, encourages education and research, and recognizes the superior achievements of engineers. Dr. Charles M. Vest is president of the National Academy of Engineering. The Institute of Medicine was established in 1970 by the National Academy of Sciences to secure the services of eminent members of appropriate professions in the examina - tion of policy matters pertaining to the health of the public. The Institute acts under the responsibility given to the National Academy of Sciences by its congressional charter to be an adviser to the federal government and, upon its own initiative, to identify issues of medical care, research, and education. Dr. Harvey V. Fineberg is president of the Institute of Medicine. The National Research Council was organized by the National Academy of Sciences in 1916 to associate the broad community of science and technology with the Academy’s purposes of furthering knowledge and advising the federal government. Functioning in accordance with general policies determined by the Academy, the Council has become the principal operating agency of both the National Academy of Sciences and the National Academy of Engineering in providing services to the government, the public, and the scientific and engineering communities. The Council is administered jointly by both Academies and the Institute of Medicine. Dr. Ralph J. Cicerone and Dr. Charles M Vest are chair and vice chair, respectively, of the National Research Council. www.national-academies.org

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Committee for Capitalizing on Science, Technology, and Innovation: An Assessment of the Small Business Innovation Research Program Chair Jacques S. Gansler (NAE) Roger C. Lipitz Chair in Public Policy and Private Enterprise and Director of the Center for Public Policy and Private Enterprise School of Public Policy University of Maryland David B. Audretsch Charles E. Kolb Distinguished Professor and President Ameritech Chair of Economic Aerodyne Research, Inc. Development Henry Linsert, Jr. Director, Institute for Development CEO Strategies Columbia Biosciences Corporation Indiana University W. Clark McFadden Gene Banucci Partner Executive Chairman Dewey & LeBoeuf, LLP ATMI, Inc. Duncan T. Moore (NAE) Jon Baron Kingslake Professor of Optical Executive Director Engineering Coalition for Evidence-Based Policy University of Rochester Michael Borrus Kent Murphy Founding General Partner President and CEO X/Seed Capital Luna Innovations Gail Cassell (IOM) Linda F. Powers Vice President, Scientific Affairs and Managing Director Distinguished Lilly Research Scholar Toucan Capital Corporation for Infectious Diseases Tyrone Taylor Eli Lilly and Company President Elizabeth Downing Capitol Advisors on CEO Technology, LLC 3D Technology Laboratories Charles Trimble (NAE) M. Christina Gabriel CEO, retired Director, Innovation Economy Trimble Navigation The Heinz Endowments Patrick Windham Trevor O. Jones (NAE) President Founder and Chairman Windham Consulting Electrosonics Medical, Inc. 

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PROJECT STAFF Charles W. Wessner Sujai J. Shivakumar Study Director Senior Program Officer David E. Dierksheide Adam H. Gertz Program Officer Program Associate i

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RESEARCH TEAM Zoltan Acs Irwin Feller University of Baltimore American Association for the Advancement of Science Alan Anderson David H. Finifter Consultant The College of William and Mary Philip A. Auerswald Michael Fogarty George Mason University University of Portland Robert-Allen Baker Robin Gaster Vital Strategies, LLC Innovation Ecologies Robert Berger Albert N. Link Robert Berger Consulting, LLC University of North Carolina Grant Black Rosalie Ruegg University of Indiana South Bend TIA Consulting Peter Cahill Paula E. Stephan BRTRC, Inc. Georgia State University Dirk Czarnitzki Andrew Toole University of Leuven Rutgers University Julie Ann Elston Nicholas Vonortas Oregon State University George Washington University ii

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POLICY AND GLOBAL AFFAIRS Ad hoc Oversight Board for Capitalizing on Science, Technology, and Innovation: An Assessment of the Small Business Innovation Research Program Robert M. White (NAE), Chair University Professor Emeritus Electrical and Computer Engineering Carnegie Mellon University Anita K. Jones (NAE) Mark B. Myers Lawrence R. Quarles Professor of Senior Vice President, retired Engineering and Applied Science Xerox Corporation School of Engineering and Applied Science University of Virginia iii

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Contents PREFACE xi EXECUTIVE SUMMARY 1 1 INTRODUCTION 5 1.1 SBIR and the Innovation “Valley of Death”, 5 1.2 SBIR Program Structure, 7 1.3 The NRC Assessment of SBIR at NIH, 9 1.4 The SBA Ruling on Venture Participation in SBIR Firms, 9 1.5 Overview of Reactions to the SBA Ruling, 11 1.6 The National Research Council’s Study of the Venture Capital Eligibility Ruling, 18 2 STUDY METHODOLOGY 22 2.1 Identifying Venture-funded Firms and Estimating the “Exclusion Effect”, 22 2.2 Methodology for Measuring the Impact of the SBA Ruling, 26 2.3 Case Study and Other Data, 28 3 VENTURE FUNDING FOR NIH PHASE II WINNERS, 1992-2002 30 3.1 Control and Individual Ownership, 31 3.2 Elimination I: Effective Control, 32 3.3 Elimination II: Firm Size and Ownership, 34 3.4 Further Awards to Possibly Excluded Firms, 37 ix

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x CONTENTS 4 FOCUS ON THE TOP 200 AWARD WINNERS 39 4.1 Methodology, 39 4.2 Additional Research, 40 4.3 Sequencing, 40 5 OTHER SOURCES OF DATA ON THE PARTICIPATION OF VENTURE-OWNED FIRMS 43 5.1 Non-participant Survey, 43 5.2 NIH-identified Excluded Firms, 46 5.3 Balancing Objectives: A View from Martek’s Experience, 47 6 COMPARING PROJECT OUTCOMES 49 6.1 Caveats, 49 6.2 Respondent Pools and Response Rates, 50 6.3 Outcomes from Surveys, 52 6.4 Firm-level Outcomes from Hoover’s Small Business Database, 57 6.5 Conclusions: Outcomes from SBIR Funding, 59 7 IMPACT OF THE SBA RULING ON THE NIH SBIR PROGRAM: FINDINGS AND RECOMMENDATIONS 61 7.1 Main Findings, 61 7.2 Recommendations, 65 APPENDIXES A Venture-funded Firms Among the 200 Most Prolific Winners of NIH Phase II Awards 1992-2002 71 B NRC Non-participant Survey 76 C NIH List of Firms Excluded on the Grounds of Venture Capital Ownership 80 D Venture-funded Firms: Data from Hoover’s Small Business Database and VentureSource 82 E Analysis of the Evidence Submitted by BIO 92 F SBA Administrative Ruling on Appeal of Cognetix, Inc. 95 G Letter from Elias A. Zerhouni, Director, National Institutes of Health to Hector V. Barreto, Administrator, U.S. Small Business Administration, June 28, 2005 103 H Testimony by Steven C. Preston, SBA Administrator, to the House Small Business Committee, March 13, 2008 107 I Bibliography 112

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Preface Today’s knowledge-based economy is driven in large part by the nation’s capacity to innovate. One of the defining features of the U.S. economy is a high level of entrepreneurial activity. Entrepreneurs in the United States see opportu - nities and are willing and able to take on risk to bring new welfare enhancing, wealth generating technologies to the market. Yet, while innovation in areas such as genomics, bioinformatics, and nanotechnology presents new opportunities, converting these ideas into innovations for the market involves substantial chal - lenges.1 The American capacity for innovation can be strengthened by addressing the challenges faced by entrepreneurs. Public-private partnerships are one means to help entrepreneurs bring new ideas to market.2 The Small Business Innovation Research (SBIR) program is one of the larg - est examples of U.S. public-private partnerships. A premise of the SBIR program is that small businesses are an important font for new ideas, but that they likely will need some support in their early stages as they translate these ideas into innovative products and services for the market. Founded in 1982, SBIR is de - signed to encourage small business to develop new processes and products and to provide quality research in support of the many missions of the U.S. government. By including qualified small businesses in the nation’s R&D effort, SBIR awards 1 See Lewis M. Branscomb, Kenneth P. Morse, Michael J. Roberts, and Darin Boville, Managing Technical Risk: Understanding Priate Sector Decision Making on Early Stage Technology Based Projects, Washington, DC: Department of Commerce/National Institute of Standards and Technology, 2000. 2 For a summary analysis of best practice among U.S. public-private partnerships, see National Research Council, Goernment-Industry Partnerships for the Deelopment of New Technologies: Summary Report, Charles W. Wessner, ed., Washington, DC: The National Academies Press, 2002. xi

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xii PREFACE are intended to stimulate innovative new technologies to help agencies meet their missions in many areas including health, the environment, and national defense. Governments around the world are increasingly adopting SBIR type programs to encourage the creation and growth of innovative firms in their economies. Sweden and Russia have adopted SBIR-type programs. The United Kingdom’s SIRI program is similar in concept. In the Netherlands, a successful pilot SBIR program has led the government to expand its scope across the government. In Asia, Japan, Korea, and Taiwan have adopted the SBIR concept as a part of their respective national innovation strategies. And India has adopted an SBIR type program to advance its biotechnology sector. Other countries are actively adopting SBIR type programs. This level of emulation across national innova - tion systems is striking and speaks to the common opportunities and challenges addressed by SBIR awards and contracts. As a part of the 2000 reauthorization of the SBIR program, Congress called for a review of the SBIR programs at the Departments of Defense, the National Institutes of Health, the Department of Energy, the National Aeronautics and Space Administration, and the National Science Foundation. HR 5667 directed the National Research Council (NRC) to evaluate the qual- ity of research and value to the agency mission of the SBIR program. It called for an assessment of the extent to which SBIR projects achieve some measure of commercialization, as well as an evaluation of the program’s overall economic and non-economic benefits. It also called for additional analysis as required to support specific recommendations in areas such as measuring outcomes for agency strategy and performance, increasing federal procurement of technologies produced by small business, and overall improvements to the SBIR program. These reports are being published by the National Academies Press. While this study was still in progress, the Small Business Administration issued a policy directive in 2002 that to be eligible for SBIR the small business concern should be “at least 51 percent owned and controlled by one or more indi- viduals who are citizens of, or permanent resident aliens in, the United States, except in the case of a joint venture, where each entity to the venture must be 51 percent owned and controlled by one or more individuals who are citizens of, or permanent resident aliens in, the United States.”3 The effect of this directive has been to exclude innovative small firms in which venture capital firms have a controlling interest from the SBIR program. To better understand the impact of the SBA exclusion of firms receiving venture funding (resulting in majority ownership), the NRC proposed that the NIH study be extended to include this empirical analysis by the NRC. This report seeks to illuminate the consequences of the SBA ruling excluding majority-owned venture capital firms from participation in SBIR projects. 3Access the SBA’s 2002 SBIR Policy Directive, Section 3(y) (3) at .

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xiii PREFACE STATEMENT OF TASK This report presents the NRC analysis of the effect of the Small Business Administration’s eligibility rules with regard to the majority-owned venture capi- tal participation in the NIH SBIR program. Using data from SBIR awards made from fiscal years 1992 to 2002 and with specific attention to the challenges faced by firms in the biomedical field and employing a combination of surveys and case studies adapted from the Methodology developed as part of the current five- agency analysis,4 the NRC investigated the following questions: • Which NIH SBIR participating companies have been or are likely to be excluded from the program as a result of the 2002 rule change on venture capital company ownership? • What is the likely impact of the 2002 ruling had it been applied during the 1992-2002 timeframe and what is its probable current impact? Key variables include the presence and amount of SBIR support, the receipt of venture capital funding or other outside funding, and output measures including those related to commercialization and knowledge generation. This consensus report contains statistical analysis, case study findings, and also presents the NRC Committee’s findings and recommendations. ACKNOWLEDGMENTS On behalf of the National Research Council, we express our appreciation and recognition for the insights, experiences, and perspectives made available by the participants of the overall study’s conferences and meetings, as well as survey respondents and case study interviewees who contributed to elements of this study. We are also very much in debt to officials from the leading departments and agencies. Among the many who provided assistance to this complex study, we are especially in debt to Jo Anne Goodnight, the Program Coordinator for the National Institutes of Health SBIR program, who was instrumental in facilitating this review of the impact of policy directive on the NIH SBIR program. As the lead member of the Committee’s research staff, Dr. Robin Gaster deserves major recognition for his instrumental role in the research team’s prepa - ration of this report. Sujai Shivakumar also merits thanks for his careful review, edits, analysis, and written contributions which were essential for the prepara - tion of this report. Without their sustained efforts, amidst many other competing priorities, it would not have been possible to prepare this report. 4 NationalResearch Council, An Assessment of the Small Business Innoation Research Program— Project Methodology, Washington, DC: The National Academies Press, 2004. Access at .

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xi PREFACE NATIONAL RESEARCH COUNCIL REVIEW This report has been reviewed in draft form by individuals chosen for their diverse perspectives and technical expertise, in accordance with procedures ap- proved by the National Academies’ Report Review Committee. The purpose of this independent review is to provide candid and critical comments that will assist the institution in making its published report as sound as possible and to ensure that the report meets institutional standards for objectivity, evidence, and responsiveness to the study charge. The review comments and draft manuscript remain confidential to protect the integrity of the process. We wish to thank the following individuals for their review of this re- port: Richard Bendis, National Association of Seed and Venture Funds; Douglas Doerfler, Maxcyte Inc.; David Goldston, Harvard University; Heidi Jacobus, Cybernet Systems; Anu Mittal, United States Government Accountability Office; Carol Nacy, Sequella, Inc.; Michael Rodemeyer, University of Virginia; Donald Siegel, University of Albany; Michael Squillante, Radiation Monitoring Devices, Inc.; and Judith Tanur, Stony Brook University. Although the reviewers listed above have provided many constructive com- ments and suggestions, they were not asked to endorse the conclusions or recom- mendations, nor did they see the final draft of the report before its release. The review of this report was overseen by Robert White, Carnegie Mellon University. Appointed by the National Academies, he was responsible for making certain that an independent examination of this report was carried out in accordance with institutional procedures and that all review comments were carefully considered. Responsibility for the final content of this report rests entirely with the authoring committee and the institution. Jacques S. Gansler Charles W. Wessner