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Venture Funding and the NIH SBIR Program
The ruling seems to disproportionately affect firms with demonstratedpotential for significant commercialization.
Of the top 200 Phase II winners at NIH, 43 (21.5 percent) received sufficient VC funding or VC rounds of funding to meet the criteria for VC control and are therefore excludable from the NIH SBIR program under the SBA ruling. This compares with 148 out of 1,336 (11.1 percent) for the remaining firms outside the top 200 Phase II award winners.5
The evidence suggests that the impact of the ruling falls most heavily on the limited number of firms that have been selected both by NIH for their promising technologies and by venture investors for their commercial potential.
SBIR firms—with or without venture funding—commercialize in significant numbers.6Firms that are venture-funded are somewhat less likely tocommercialize but are much more likely to generate substantial sales fromtheir SBIR-funded projects when they do commercialize than are firms thatreceive SBIR funds but are not venture-funded.
Non-venture-backed firms actually reach the market more frequently. Specifically, SBIR projects at venture-funded firms are somewhat less likely to reach the market than non-venture-funded firms—38 percent do so, compared with 55 percent for other SBIR firms.7
It is important to note that in both cases, this is positive news for the NIH SBIR program; non-venture-funded and venture-funded firms both reach the market in significant proportions.
Among the firms that reach the market, projects at firms that are venture-funded are much more likely to generate significant sales from their SBIR-funded projects than are firms that are not venture-funded. Evidence from Hoover’s data-
The high-risk nature of investing in early-stage technology means that the SBIR program must be held to an appropriate standard when it is evaluated. While venture capitalists are a referent group, they are not directly comparable insofar as the bulk of venture capital investments occur in the later stages of firm development. SBIR awards often occur earlier in the technology development cycle than where venture funds normally invest. Nonetheless, returns on venture funding tend to show the same high skew that characterizes commercial returns on the SBIR awards. See John H. Cochrane, “The Risk and Return of Venture Capital,” Journal of Financial Economics, 75(1):3-52, 2005. Drawing on the VentureOne database, Cochrane plots a histogram of net venture capital returns on investments that “shows an extraordinary skewness of returns. Most returns are modest, but there is a long right tail of extraordinary good returns. 15 percent of the firms that go public or are acquired give a return greater than 1,000 percent! It is also interesting how many modest returns there are. About 15 percent of returns are less than 0, and 35 percent are less than 100 percent. An IPO or acquisition is not a guarantee of a huge return. In fact, the modal or ‘most probable’ outcome is about a 25 percent return.” See also Paul A. Gompers and Josh Lerner, “Risk and Reward in Private Equity Investments: The Challenge of Performance Assessment,” Journal of Private Equity, 1(Winter):5-12, 1977. Steven D. Carden and Olive Darragh, “A Halo for Angel Investors,” The McKinsey Quarterly, 1, 2004, also show a similar skew in the distribution of returns for venture capital portfolios.