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Does the Small Business Innovation Research Program Foster Entrepreneurial Behavior? Evidence from Indiana

David B. Audretsch, Juergen Weigand, and Claudia Weigand

Indiana University

EXECUTIVE SUMMARY
Purpose

This paper identifies the degree to which (1) recipients of Small Business Innovation Research (SBIR) awards have altered their career choices as a result of SBIR, particularly with respect to commercialization in the form of a new firm; and (2) their behavior has “spilled over ” by inducing other colleagues to commercialize their knowledge in the form of starting a new firm. This identification provides insight to answering the question, “To what degree has the SBIR contributed to changing the behavior of knowledge workers and in creating a science-based entrepreneurial economy?”

The relevant information for this study came from a series of 12 case studies and the responses to a survey from a broader sample of firms. In particular, the case studies and survey helped to determine

  • the career background of the firm founder,

  • what led to the decision to commercialize knowledge,

  • why commercialization took the form of a new firm,

  • what would have happened in the absence of the SBIR program,

  • specific ways in which the founder’s career path has been altered by SBIR, and

  • specific people who have been influenced by his/her experience and who have commercialized knowledge via a start-up firm.



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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Does the Small Business Innovation Research Program Foster Entrepreneurial Behavior? Evidence from Indiana David B. Audretsch, Juergen Weigand, and Claudia Weigand Indiana University EXECUTIVE SUMMARY Purpose This paper identifies the degree to which (1) recipients of Small Business Innovation Research (SBIR) awards have altered their career choices as a result of SBIR, particularly with respect to commercialization in the form of a new firm; and (2) their behavior has “spilled over ” by inducing other colleagues to commercialize their knowledge in the form of starting a new firm. This identification provides insight to answering the question, “To what degree has the SBIR contributed to changing the behavior of knowledge workers and in creating a science-based entrepreneurial economy?” The relevant information for this study came from a series of 12 case studies and the responses to a survey from a broader sample of firms. In particular, the case studies and survey helped to determine the career background of the firm founder, what led to the decision to commercialize knowledge, why commercialization took the form of a new firm, what would have happened in the absence of the SBIR program, specific ways in which the founder’s career path has been altered by SBIR, and specific people who have been influenced by his/her experience and who have commercialized knowledge via a start-up firm.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Conclusions The evidence provided here is of a preliminary nature, partially because of the smallness of the sample, which consisted of 12 case studies and 20 firms’ responses to a survey instrument, but also because of the particular context within which SBIR operates in a state such as Indiana. The fact that a viable cluster of knowledge-based small firms has been lacking in Indiana has implications for the commercialization possibilities for scientists and engineers. Perhaps a more subtle impact is that it limits knowledge about commercialization possibilities and the existence of ancillary services and institutions facilitating commercialization. The results suggest that the SBIR has influenced the career paths of scientists and engineers by facilitating the start-up of new firms. Furthermore, there are indications that the experience of scientists and engineers in commercialization via a small business has an externality by spilling over to influence the career trajectories of colleagues. Both the survey and the case studies provide the following consistent evidence: A significant number of the firms would not have been started in the absence of SBIR. A significant number of the scientists and engineers would not have become involved in the commercialization process in the absence of SBIR. A significant number of other firms are started because of the demonstration effect produced by the efforts of scientists to commercialize knowledge. As a result of the demonstration effect by SBIR-funded commercialization, a number of other scientists alter their careers to include commercialization efforts. Technology-based entrepreneurs start firms because they have ideas that they think are potentially valuable; they do not start firms and then search for useful ideas or products. This is reflected by the fact that not a single respondent on either the survey or from the case studies suggested that he or she would have tried to start the firm with a different idea in the absence of SBIR funding. However, once the firm exists, one-quarter of the respondents and one-sixth of the case studies indicated that they would have tried to continue the firm with a different idea in the absence of SBIR funding. These different results may suggest that the SBIR has a greater impact on potential entrepreneurs than on existing small firms in commercializing ideas that otherwise would not find their way into the market. Recommendation A large-scale study spanning a broad spectrum of SBIR awardees should be undertaken to confirm these preliminary findings. Incorporating greater variation in either the funding agency or the underlying science could help to identify how the impact of SBIR on influencing the entrepreneurial behavior of scientists differs across scientific fields and funding agencies.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE INTRODUCTION The magnitude of the Small Business Innovation Research (SBIR) program of around $1.2 billion annually has attracted the attention of both policy makers and scholars. However, only recently have studies begun to identify the impact of the SBIR program (U.S. General Accounting Office, 1998). The best of these studies has focused on the impact of the SBIR program in terms of the likelihood of survival and growth rates of firms selected for SBIR funding (Lerner, 1999). Two bothersome questions have been raised about measuring the success of SBIR in terms of growth and survival. The first involves selection bias in that the SBIR program may give awards to firms that already have the characteristics needed for a higher growth rate and likelihood of survival. The second argues that a number of SBIR recipients would have followed the same commercialization process even in the absence of an SBIR award. Although enhanced firm growth and survival are important aspects of SBIR, they do not capture all of the benefits of the program. A very different way in which SBIR may benefit the economy is by changing the behavior of knowledge workers. An important finding by Audretsch and Stephan (1996), who trace the career paths of scientists starting biotechnology firms, is that the scientist deviates from an academic career path or a career with a large pharmaceutical corporation to start a new firm in a new industry. How to induce knowledge workers in general and scientists and engineers in particular to change their behavior to take advantage of commercialization opportunities is a focal point of the policy debate in European countries such as Germany and France.1 It may be that policies such as SBIR have contributed more to the creation of an entrepreneurial economy, where the costs of commercializing knowledge are reduced, than is captured in studies simply focusing on the links between SBIR, survival, and growth. There are at least two important ways that the behavior of knowledge workers may be influenced by SBIR. The first way is that it may induce some scientists and engineers, who otherwise never would have engaged in the commercialization process, to commercialize their knowledge by starting a firm. The second involves the demonstration effect when the examples of successful science-based entrepreneurs who received SBIR support influence the behavior of their colleagues by inducing subsequent commercialization. Although a large literature exists on the importance of learning, this literature typically focuses on firms’ learning. This second aspect, by contrast, focuses on individual knowledge-workers learning by observing the choices and outcomes of their colleagues. For example, Audretsch and Stephan (1996) found that the clustering of scientists working with biotechnology firms in a particular location is attributable to the demonstration effect on their colleagues of scientists involved with commercialization. Thus, rather than focusing on the diffusion of particular processes, it focuses on the diffusion of behavior (Audretsch and Feldman, 1996). The third impact of SBIR may be to alter the type of science being undertaken. 1   As the former Chair of the President’s Council of Economic Advisors, Laura Tyson, points out, this is also a critical debate in Eastern and Central Europe (Tyson et al., 1994).

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE This project focuses on the benefits of SBIR. In particular, we propose identifying the degree to which (1) SBIR recipients have altered their career choices as a result of SBIR, particularly with respect to commercialization in the form of a new firm; and (2) their behavior has “spilled over” by inducing other colleagues to commercialize their knowledge by way of starting a new firm. This will enable us to shed light on the question, “To what degree has the SBIR contributed to changing the behavior of knowledge workers and in creating a science-based entrepreneurial economy?” To shed light on these issues, we undertook a series of 12 case studies and surveyed a broader sample of firms to determine the career background of the firm founder, what led to the decision to commercialize knowledge, why commercialization took the form of a new firm, what would have happened in the absence of the SBIR program, specific ways in which the founder’s career path has been altered by SBIR, and specific people who have been influenced by his/her experience and who have commercialized knowledge via a start-up firm. From the responses to these questions, we have been able to shed some light on the degree to which the SBIR program has altered the behavior of knowledge workers, especially scientists and engineers, in terms of commercialization. We also have been able to identify the role that the SBIR program plays in influencing the career trajectories of some scientists and engineers, in particular, the role it plays in the commercialization process. The impact of SBIR on fostering science-based entrepreneurial behavior is likely to vary across industries, sciences, and technologies. Thus, we would not restrict ourselves to any particular industry or science, but rather include a broad spectrum to ascertain differences in the contribution of SBIR in fostering science-based entrepreneurial behavior. The impact of programs such as SBIR on sparking entrepreneurial activity may be of particular interest in states such as Indiana. Systematic evidence suggests that Indiana does not generate much innovative activity, measured in terms of research and development (R&D), patented innovations, or the introduction of new product innovations (Audretsch and Feldman, 1996). Scientists are mainly employed by universities and large corporations in Indiana. There has not been significant start-up activity of technology-based firms. This may imply that scientists and other knowledge workers do not have low-cost access to information indicating (1) that commercialization through starting a new firm is a feasible and profitable action and (2) how a new firm can be started and maintained. Thus, the SBIR program may actually have a greater impact in states such as Indiana, where greater market imperfections exist in terms of linking entrepreneurial activities to scientific talent. In addition, small firms tend to

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE face brighter prospects in regions where a rich cluster of small firms already exists. The lack of an existing cluster of knowledge-based small firms may deter the start-up of technology-based firms. The SBIR program can play an important role in overcoming this barrier to start-up. The second section of this paper explains how the 12 case studies were selected. The third section explains how a survey instrument was devised and sent out to all SBIR firms in Indiana. The fourth section includes a description of the 12 firms included in the case studies. The fifth section describes the technologies involved in the SBIR projects. The sixth section describes the impact of the SBIR program on the firms. The seventh section identifies suggestions by the firms for improving SBIR program administration. The eighth section focuses on the perspectives of third-party investors, and the ninth section on crosscutting research questions. A summary and conclusions are provided in the final section. The principal finding from the case studies and the survey is that there is evidence suggesting that in some cases the SBIR program has altered the career trajectory of scientists. In the absence of the SBIR program, at least some of the scientists and engineers contacted in this project would not have become involved in the commercialization process. These preliminary results based a limited sample size and context—Indiana—suggest that a larger-scale project should be undertaken to identify the impact that the SBIR has on changing entrepreneurial behavior. SELECTION OF THE CASE STUDIES The firms interviewed were selected on the basis of (1) inclusion in the 1999 Directory of Small Research and Development Companies of Indiana, published by the Indiana University Industrial Research Liaison Program; and (2) the recommendation of Ben Dulaski and Sid Johnson of the Indiana University Industrial Research Liaison Program. The Industrial Research Liaison Program was founded in 1986 to provide R&D assistance as well as information services to Indiana’s business and industrial communities. The Industrial Liaison Office is responsible for implementing the SBIR program in Indiana. To accomplish this, the office serves as a link between specific SBIR funding opportunities and particular research interests and capabilities of scientists, engineers, and small firms in Indiana. The staff of the office spends considerable time in the field, getting to know the interests and capabilities of individual scientists, and then tries to recommend specific projects to potential scientists working for universities, firms, and the government. In addition, the office publishes a monthly newsletter, R&D NOTES: SBIR and STTR, in which it announces the solicitation dates of SBIR, as well as upcoming conferences and particular funding opportunities associated with SBIR. Recent SBIR awards in Indiana are also listed in the newsletter. In addition, the office sponsors a number of seminars where the purpose of SBIR is explained and potential entrepreneurs have an opportunity to meet scientists and engineers who have successfully obtained SBIR awards.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Mr. Dulaski and Mr. Johnson recommended several firms that they felt would be articulate in discussing their experience with SBIR. Although the Directory of Small Research and Development Companies of Indiana provides a comprehensive list of all firms receiving SBIR awards in Indiana, the recommendations of Mr. Dulaski and Mr. Johnson result in a more biased selection of firms. However, since the goal of this study is to uncover some of the different types of impacts that the SBIR has, we felt that the value of having articulate and willing participants more than outweighed the selection bias. However, an important qualification to be emphasized is that the firms selected were not statistically representative. Table 1 provides a list of the firms that were interviewed. The interviews typically lasted between 45 minutes and 3 hours. In addition, each of these firms was sent a written questionnaire. Most of the firms were contacted on several occasions to ensure the consistency of information and to correct any misunderstandings that might have arisen in the interview process. THE SURVEY INSTRUMENT The survey listed in the Appendix was mailed to what were identified by the Industrial Liaison Office as SBIR firms. The survey was evaluated and approved by the Bloomington Campus Committee for the Protection of Human Subjects. After its first evaluation of the survey, a number of changes were recommended and the survey was modified. The survey was then mailed to all 84 SBIR firms identified by the Industrial Liaison Office. Of these 84 questionnaires, 20 were returned with answers. An additional 24 came back because the firm no longer existed. TABLE 1 Firm Characteristics—Case Studies Firm Date Founded Funding Agencya Size (employees) STAR Enterprises, Inc. 1985 NASA 5 Genetic Models, Inc. 1991 NIH 25 Ash Medical Systems, Inc. 1980 NIH 23 Batch Processing Technologies, Inc. 1983 NSF 2 Endotech, Inc. 1986 NIH 7 Agdia, Inc. 1981 USDA 23 Advanced Process Combinatorics 1993 NSF 10 Medical Decision Modeling, Inc. 1994 NIH 3 Beard Industries, Inc. 1965 DOE 50 Terronics Development Corporation 1985 USDA 16 Focus Surgery, Inc. 1996 NIH/NCI 10 Hard Coating, Inc. 1998 DOE 2 aDOE = U.S. Department of Energy, NASA = National Aeronautics and Space Administration, NCI = National Cancer Institute, NIH = National Insitutes of Health, NSF = National Science Foundation, USDA = U.S. Department of Agriculture.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE DESCRIPTION OF THE FIRMS Table 1 identifies the age, funding agency, and size of the 12 case study firms. Table 2 classifies the origins of the founder(s) and the other participants who work closely with the firms. Note that because of multiple founders in some of the firms the total number of founders exceeds 12. We did not actually interview all of the founders, and so, there are some founders associated with these firms that are not included in Table 2. The most important point to be emphasized in Table 2 is that the most important career trajectory of the founders is from the university. However, a number of founders also came from large corporations. It is also important to note that only a few founders actually had experience with other small firms. A stylized fact in the literature on small business economics is that most founders of new firms already have experience in a small business. This could indicate that the SBIR may be a mechanism to compensate for the lack of experience with a small firm. STAR Enterprises, Inc. STAR Enterprises is located in Bloomington, Indiana. Jeff Alberts founded STAR on the basis of an SBIR award. The company currently has five employees and a Phase III SBIR Award to build hardware for animals to live in the Space Station. The SBIR award is from the National Aeronautics and Space Administration (NASA). The origins of the company date back to 1985, when Jeff Alberts, who was a professor at Indiana University, was the first investigator in the United States to work with the Soviet scientists in a Soviet-launched spaceflight. His research involved experiments with live animals. Jeff wrote proposals for two years to obtain access to the Soviet spaceflights. He subsequently became the first U.S. scientist to work with the Soviets in doing his own experiment on board a Soviet spaceflight. TABLE 2 Classification of the Firms from Case Studies Founders Number of Respondents Other Participants Number of Respondents? From university 10 From university 3 From corporation 1 From corporation 0 From university and corporation 1 From university and corporation 3 From large corporation 7 From large corporation 2 Previous small business 2 From small business 1 Government 0 Government 2

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Genetic Models, Inc. Genetic Models was founded in 1991 by five individuals. It is located in Indianapolis. The firm employs 25 people and provides high-quality jobs that include medical, dental, disability, and retirement benefits. In the 1970s, Joe Pesek began working for Union Carbide as a sales and marketing representative. After working for about 11 years, Pesek was asked by the president of Union Carbide to manage the Lindy Division, a subsidiary that specialized in producing special carbon linings for pipelines. In about four years, Pesek helped the division to grow from about $4 million to $12 million annually. The Lindy Division was a national company that licensed its technology abroad. Around 1984, one of Joe Pesek’s bosses asked him to help out a small cryogenics business in Indianapolis. The cryobusiness developed two products: (1) large tanks to house liquids and gases under pressure; and (2) technologies that used molecular sieves, such as oxygen tanks, oxygen masks, and cryogenic freezers. Pesek’s goal was to turn the cryobusiness around and make it profitable. In 1985, Union Carbide needed to raise money to help pay for the methyl isocyanate disaster at its plant in Bhopal, India. Joe Pesek was instructed to sell parts of the business, and he viewed it as a good divestment opportunity to purchase one of the product lines. Unfortunately, Pesek lost his bid for the molecular sieve technology division and thus proceeded to look for other investment opportunities. While Joe Pesek was looking for other small business deals, he took a consulting job with American Monitor, which later became AM Diagnostics. AM Diagnostics manufactured clinical chemical analyzers and reagents. Pesek eventually became the CEO of the company. By updating the product, Pesek was able to achieve a $5 million sales backlog, but with no working capital. Finally, in 1990, after working four years with AM Diagnostics, Joe Pesek met Professor Dick Peterson of Indiana University. Dr. Peterson had developed a diabetic rat model, but needed small breeding rooms to develop genetic reagents from mice antibodies. Additionally, Dr. Peterson had a list of people that had used or expressed interest in the diabetic model and he needed to find a way to market his technology outside Indiana University. As the demand for the genetic model grew, Dr. Peterson could no longer supply all of the companies with his genetic model. Pesek recognized the market potential for the genetic model and performed some market research to find a building with a very low lease rate. Hence, Joe Pesek, Dr. Peterson, and three other investors founded Genetic Models on a single rat model. In 1991, Joe Pesek and the other founders constructed their first laboratories for Genetic Models. Although the others helped on the weekends with the carpentry, Pesek was the only full-time employee. The first building was about 7,200 ft2 (seven years later the company would have a second building that is about 18,000 ft2). Genetic Models became incorporated in November 1991 and bought its first

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE breeding stock in January 1992. One of the company’s first customers was Eli Lilly, who bought the animals for use in drug testing. The company has experienced 50 percent growth every year since its inception. The core product of Genetic Models consists of inbred animal models (mostly rats and mice). The animals are bred with specific diseases, such as obese male rats with diabetes. These animals are then sold to research laboratories seeking cures for particular diseases. Genetic Models combines the science of the model (e.g., physiology) with the application of the model for the customer. So far, the combination of science and testing the model for customers has been favorable. Genetic Models has found that crossbreeding two models produces a very interesting end result of gene combinations. One of the models they use is a model for congestive heart failure developed by researchers at Ohio State University. However, the main model used by Genetic Models is the Zucker Diabetic Fatty (ZDF) model developed by Walter Shaw, a former employee of Eli Lilly. While at Eli Lilly, Dr. Shaw conducted diabetic research and isolated the first colony of Zucker strains from male rats. During his research, he saw one fat male rat become spontaneously diabetic. Building on Dr. Shaw’s research, Dr. Peterson and Dr. Julia Clark, also of Indiana University, refined and developed the ZDF model into a reliable and inbred model that ensures that all obese male rats will acquire diabetes between 7 and 12 weeks in their development. The Indiana researchers also learned that they could feed rats certain foods that would lead to hypertension in the rats. Joe Pesek and Dr. Peterson believe that their company produces the “premier advanced aging model” because their rat specimens are bred with many of the same pathologic conditions (high triglyceride and cholesterol levels, heart hypertrophy [enlarged heart]) that occur in older humans in America. Further, the main cause of mortality for these rat models is end-stage kidney disease, not congestive heart failure. Thus, Joe believes that the ZDF model could become the most reliable kidney failure model for pharmaceutical companies that need animal specimens to test their drugs. Ash Medical Systems, Inc. Ash Medical Systems was started in 1980 by Steve Ash, who is also a professor at Purdue University. The firm’s main product is plasmatherapy. Dr. Ash had the idea for starting the firm while he was doing research at Purdue. He has the only company producing an artificial liver. Batch Processing Technologies, Inc. Batch Processing Technologies was established in 1983. The firm currently employs two people and grosses about $150,000 annually in sales revenues (this estimate of sales revenues has not really changed since 1997). The focus of Batch

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Processing Technologies is to develop simulation software for chemical engineering firms. In 1981, Girish Joglekar earned his Ph.D. in computer science from Syracuse University. After receiving his Ph.D., Dr. Joglekar began conducting his post-doctoral research at Purdue University. While at Purdue, Girish and two other professors came up with the ideas for starting Batch Processing Technologies. Endotech, Inc. Endotech was founded in 1986 and specialized in developing human cell culture technologies. After earning his B.A. in Biology from Indiana University in 1971, Anthony Hubbard worked for medical research firms in Indianapolis, at both the staff and executive levels. In 1984, Anthony earned his M.B.A. from Indiana University and continued working for a medical research firm in Indianapolis. During this time, he met a physician who had invented a human cell culture technology. Recognizing the market potential of the physician’s technology, Anthony persuaded the primary inventor to fund part of the start-up costs of producing and marketing the cell culture technology. Thus, in 1986, Anthony Hubbard founded Endotech, Inc., on the basis of a human cell culture technology. By 1992, Endotech had gone out of business because of a lack of consistent revenues. From his experience with Endotech, Anthony learned that the SBIR award was a viable source of “additional” funding, but not a reliable “primary” source of funding. Agdia, Inc. Agdia develops nucleic acid hybridization techniques for commercial use. The privately held company currently employs 23 people. Last year, sales revenues for the company increased by 20 percent compared to the previous year. In 1959, R. Henn received his Ph.D. in physical chemistry from Iowa State University. Before founding Agdia in 1981, Dr. Henn conducted biochemical research for Miles Labs in Ames County, Iowa, and Ortho Diagnostics, a subsidiary of Johnson and Johnson. Through working at a high position in a major corporation, Dr. Henn learned from customers and professional collaborators about some innovative technologies in the immunochemistry field. On the basis of these technologies and his own corporate experience, Dr. Henn decided to pursue his own technical business ideas and found Agdia. Advanced Process Combinatorics Established in 1993, Advanced Process Combinatorics commercializes mathematical optimization technologies. Currently, the firm employs 10 people, 3 of

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE whom are the company founders. All three founders have earned their doctoral degrees and were formerly employed in one of the following careers: a professor at Purdue University, a research scientist at DuPont, and a postdoc at Purdue University. Last year, Advanced Process Combinatorics experienced a 70 percent increase in sales revenues compared to the previous year. The ideas for starting Advanced Process Combinatorics came from industrial and university cooperative research programs. Timing and business climate for mathematical optimization technologies also influenced the founders’ decision to start the firm. Medical Decision Modeling, Inc. Established in 1994, Medical Decision Modeling disseminates information about the outcomes of medical studies through the Internet. The firm is a Sub-chapter S corporation that currently employs three people; in the previous year, the firm employed only one person. Harry Smolen, the 32-year-old founder of Medical Decision Modeling, earned his B.S. in electrical engineering from the University of Southern California in 1989, and his M.S. in industrial engineering from Purdue University in 1994. While working on his Master’s thesis at the Indiana University School of Medicine, Harry Smolen learned bout the SBIR program from one of the leaders of his research group. This same person also influenced Smolen to start his own company and commercialize the outcomes of medical studies using the Internet. Beard Industries, Inc. Beard Industries is a Subchapter S corporation that was established in 1965. Currently, the firm employs 50 people and sells about $15 million annually. Last year, sales revenues decreased by 20 percent compared to the previous year. Before founding Beard Industries, William Beard earned his B.S. in agriculture from Purdue University in 1949, and worked for farm partnerships in north central Indiana. The focus of Mr. Beard’s firm is to manufacture computer controls of drain dryers. Terronics Development Corporation Established in 1985, Terronics Development Corporation manufactures electrostatics technologies. Currently, the firm employs 16 people and sells about $1.2 million annually. Last year, sales revenues decreased by 50 percent compared to the previous year. Before founding Terronics Development Corporation, Eduardo Escallon earned his B.S.M.E. from Carnegie Tech in 1965, and worked from 1977 to 1984 as a principal engineer for Ball Corporation.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Genetic Models, Inc. Dr. Peterson and Joe Pesek, cofounders of Genetic Models, strongly suggest improving the review process for SBIR award proposals. They feel that the process needs more scientific scrutiny with a greater understanding of the topics being proposed. “Most companies can’t afford an in-house expert to understand a kidney failure model.” Both Pesek and Dr. Peterson propose an integrated review board that comprises both scientists and economists. Their most recent experience with the SBIR review process was negative. Dr. Peterson’s understanding of the SBIR review panel was that the panel consisted of two outside reviewers, basically an ad hoc independent review, with no meeting of a single review board. Dr. Peterson and Joe Pesek shared the following suggestions for improving the SBIR award program: Build better communication between the review board, independent reviewers, and candidates. Change the review board’s mentality from a “University RO1 Grant” mentality (which only looks at genetic research proposals that focus on discovering the mechanism) to an “innovative, open-minded” mentality (which recognizes the value of a broad product on which different pharmaceutical companies can test different drugs—the purpose of the SBIR award is to develop a product that is different). “There is no mechanism at the university to develop/fund the animal model. Molecular biology has perturbed the animal-model genetic mechanism.” Use performance measures to evaluate the benefits of a potential product; that is, the review board should not look only at the number of rats sold or millions of dollars earned. Rather, it should consider the extra contract research, employee development, and benefits to other companies. “Banks wouldn’t invest in our product because the present value of the start-up costs are too high compared to the long-term benefits. ” “If value is found in intangible benefits, are there practical and prudent ways to prevent pork-barrel projects where people just throw our money?” The biggest concern that Peterson and Pesek have about the SBIR program is the review process. They feel that “the reviewer doesn’t understand the science.” In their experience, the reviewers have made false assumptions or have not taken the time to understand the underlying science. Peterson and Pesek argue that the review process needs a business perspective as well as that from university scientists. They feel that almost all of the reviewers have imposed a basic science standard on proposals that are oriented toward developing a commercial product. They feel that reviewers need to be more sensitive to the fact that SBIR is not necessarily about progress for basic science. They also perceive that it has become increasingly difficult to obtain

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE approval for an SBIR proposal. Peterson has a strong record at the university of obtaining academic grants and has considerable experience. He feels that the SBIR review process is too much like the RO1 university grant proposals, even though the goals for basic research and SBIR are different. They suggest that the SBIR review process be changed from including only two outside scientific reviewers to including a broader group of reviewers. They also suggest that a bridge program is needed between Phase I and Phase II to facilitate keeping the staff onboard. This is because the turnover of personnel is the biggest problem the firm faces. They also suggest that the SBIR program would benefit from better communication between the agencies and the firms. Ash Medical Systems, Inc. Dr. Ash of Ash Medical Systems finds that the Fast Track instructions “are terrible and self-contradictory.” For example, the instructions emphasize calling someone at the agency, yet there he found only confusion. This is due to a high turnover of personnel involved with the SBIR program. Dr. Ash also finds the streamlined procedure for evaluating SBIR proposals to be inappropriate. This streamlining process involves tossing out the worst applications from the applicant pool in the first stage. Dr. Ash feels that this leaves applicants “at the mercy of two reviewers who may or may not know what they are doing.” In addition, the reviewers may know what they are doing “but may have a personal or vested interest in the opposite approach.” This leaves him “disappointed and frustrated.” He feels that several of his Phase I and Phase II applications that have been rejected were better than those that had been approved. Dr. Ash also criticizes the requirement that a Phase I be completed before a Phase II. He suggests that if the critiques for a rejected application would arrive a week earlier they could be revised and resubmitted to make the next deadline. Dr. Ash was just notified of Fast Track approval. He says that originally he submitted one application but was told that even with Fast Track you need to submit a Phase I and Phase II application. He subsequently divided his submissions into two separate applications. He feels that this administration wastes a lot of time on needless paperwork. Dr. Ash does say that “Fast Track is great. It enables us to keep key personnel.” He greatly values the reduction in uncertainty between Phases I and II that comes with Fast Track approval. Batch Processing Technologies, Inc. The review process for the Phase II SBIR award was frustrating for Girish Joglekar, founder of Batch Processing Technologies, because the SBIR review board did not provide him with any comments as to why they rejected his proposals.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE When asked how he would improve the SBIR program, Joglekar offered the following suggestion: The SBIR Review Board needs to provide feedback in the form of comments to a firm applying for an SBIR award, especially when the review board rejects the firm’s proposal. Endotech, Inc. Anthony Hubbard’s strong feeling that the SBIR awards are an unreliable source of funding is based primarily on his Phase II experience. Hubbard felt that Endotech had a very strong proposal for Phase II, which included all Phase I data and results. However, Hubbard felt that the comments on his Phase II proposal were significantly different from the Phase I comments he had received one year earlier. “There was no continuity of reviewers between our Phase I and Phase II proposals. It was like the Phase II review board ignored our Phase I results and overlooked that we had met our Phase I goals.” Hubbard offered the following suggestions for improving the SBIR program: Before reviewing a Phase II proposal, the SBIR review board needs to track a firm’s success in meeting its Phase I goals. The SBIR program needs to establish continuity of reviewers between Phase I and Phase II submittals. This way, a firm submitting a proposal will be assured of a more consistent review in the SBIR process. Focus Surgery, Inc. Before Focus Surgery received its ultimate start-up funds, some of the firm’s SBIR applications for financing were rejected by venture capitalists from Indiana and venture capitalist firms outside Indiana. The firm’s first SBIR application for $3 million to $5 million was rejected in 1997 because the venture capital firms from Indiana “were not interested and thought the project was too high tech.” In 1999, venture capital firms outside Indiana were ready to invest if the company would move out of Indiana. Thus, the firm’s second SBIR application for $15 million was rejected because the venture capital firms thought that (1) the firm needed a new CEO who had raised money before, and (2) Indiana is not a competitive place for the medical device business. PERSPECTIVES ABOUT THIRD-PARTY INVESTORS STAR Enterprises, Inc. To date, STAR Enterprises has had no third-party investors. Jeff Alberts, company founder, feels that it is essential to the product development of STAR to maintain control of the firm and not to lose any element of control to a venture capitalist.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Genetic Models, Inc. Genetic Models has never had external financing. This is because when the firm was founded, “We had no credit to get a loan.” The firm has generally leased equipment and so has required only a minimal of financing, which has come from the SBIR program. The firm tried to get venture capital type of funding for a while, but “stagnated” every time. It has a clear bias against venture capital. The owners do not want to lose control of the company. Joe Pesek and Dr. Peterson, cofounders of Genetic Models, also argue that it would not be possible to obtain financing from traditional financial institutions because the scientific content eludes the capabilities of evaluators in traditional financial institutions. CROSSCUTTING RESEARCH QUESTIONS STAR Enterprises, Inc. The founder of STAR Enterprises, Jeff Alberts, does not feel that Fast Track would have really benefited his firm very much. This may be because he does not have too much investment sunk in key personnel and he has ready access to qualified personnel at the university. Jeff Alberts feels that the usual large corporate contractors for NASA would never have been able to deliver the same quality of product for the low cost. A typical rival contractor would have been Lockheed. According to Alberts, “Lockheed would screw it up” because they would put the engineering first and the rats second. In his experience with Lockheed, Alberts feels that Lockheed “would follow the book” in the both the prototype design and the actual construction. Although they have first-class engineering capabilities, “they don ’t know the rats the way I do.” Alberts observed that, “At STAR, rats are part of the design team.” This has led to a product that is more effective, and undoubtedly costs less. In fact, NASA originally turned to Alberts because they had a bid for the product by Lockheed, which Alberts reviewed. The bid involved lower technological standards at twice the cost. Lockheed and McDonnell Douglas were each funded $5 million a year to develop designs. Jeff Alberts had written the product requirements for NASA and evaluated the original proposals by Lockheed and McDonnell Douglas. They each had a budget of $80 million for “a much less interesting design.” Jeff Alberts observes that a benefit of SBIR is that it provides the agencies with a superior quality product at lower cost: “The corporate structures of the traditional contractors evolved in an era when they couldn’t afford to build simple things.” STAR avoids employing university students. Jeff Alberts says this is to avoid any possible conflict of interest between the educational goals of the students and the commercial interests of firms. However, he emphasizes that there are many

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE spillovers from STAR. Although he is building hardware for the space station, including hardware for experiments, he anticipates being awarded the opportunity to undertake some scientific experiments in the space shuttle. This will benefit his university research and the research of his students. Some of his doctoral students have been influenced by STAR’S success and have pursued careers involving the commercialization of science. One example involves a former female student who became a professor at the University of Vermont. As a result of Jeff’s example, she has started her own firm and is now the lead habitat person for the space station. Genetic Models, Inc. Peterson and Pesek, cofounders of Genetic Models, have not applied for Fast Track. They do not feel that Fast Track would have helped their firm. At the same time, they see the advantages of Fast Track. They think that the biggest advantage is that it enables a firm to maintain employment of skilled, trained technical personnel. “Keeping people and equipment employed” is critical. They also pointed out that Fast Track would be important if there are other partners involved, such as distributors or networks. Ash Medical Systems, Inc. Dr. Ash of Ash Medical Systems was just notified that he has a score of 249 on a Fast Track application. He anticipates Fast Track approval for Phases I and II. CONCLUSIONS Although it is important to analyze the impact of a government promotion program such as the SBIR on the performance of firms, such as their ability to survive and grow, there may be an even more fundamental impact on whether the scientists and engineers start the firms in the first place (Audretsch, 1995). The project has attempted to shed some light on the influence that the SBIR program has had on altering the career paths of scientists and engineers by facilitating the commercialization process by either starting a new firm or becoming involved in an existing small firm. The evidence provided here is of a preliminary nature, partially because of the small sample size consisting of 12 case studies and 20 firms responding to a survey instrument, but also because of the particular context within which the SBIR program operates in a state such as Indiana. Not only does the relatively low amount of private R&D and innovative activity limit commercialization opportunities for scientists and engineers, but perhaps a more subtle impact is that it limits knowledge about commercialization possibilities and the existence of ancillary services and institutions facilitating commercialization. A stylized fact that has emerged in the literature on small business economics

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE is that the propensity for people to start new firms is greater in the context of a viable cluster of dynamic small firms. In Indiana, such a cluster of knowledgebased small firms has been lacking. With these qualifications in mind, there are indications that the SBIR program has influenced the career paths of scientists and engineers by facilitating the start-up of new firms. In the case studies, one-half of the scientists indicated that the SBIR award influenced their decision to start the firm. In the absence of the SBIR program, 20 percent of them would not have started the firm, and another 40 percent would not have continued the firm. There are also indications that the experience of scientists and engineers in commercialization via a small business has an externality in that it spills over to influence the career trajectories of colleagues. One-quarter of the scientists interviewed in the case studies named specific examples of colleagues who were either starting a new firm or becoming involved in a small firm to commercialize their knowledge. This externality may, in theory, have a negative effect. If university researchers are lured away from the academic setting by commercial opportunities, then a core mission of universities—teaching students and priming the pipeline for future research—may be undermined. The evidence from Indiana suggests that SBIR grants are not creating such an effect. Moreover, the SBIR awards may serve to attract students interested in research projects known to have attracted public funding through the SBIR program. The evidence from the broader survey generally confirms the findings from the case studies. Both the survey and the case studies provide consistent evidence of the following: A significant number of the firms would not have been started in the absence of the SBIR program. A significant number of the scientists and engineers would not have become involved in the commercialization process in the absence of the SBIR program. A significant number of other firms are started because of the demonstration effect of the efforts of scientists to commercialize knowledge. As a result of the demonstration effect of SBIR-funded commercialization, a number of other scientists alter their careers to include commercialization efforts. Technology-based entrepreneurs start firms because they have ideas that they think are potentially valuable; they do not start firms and then search for useful ideas or products. This is reflected by the fact that not a single respondent on either the survey or from the case studies suggested that he would have tried to start the firm with a different idea in the absence of SBIR funding. However, once the firm exists, one-quarter of the respondents and one-sixth of the case studies indicated that they would have tried to continue the firm with a different idea in the absence of SBIR

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE funding. These different results suggest that the SBIR program has a greater impact on potential entrepreneurs than on existing small firms in commercializing ideas that otherwise would not find their way into the market. It should be emphasized that these results are of a preliminary nature. They reflect one context in Indiana in which scientists and engineers make career decisions. It may be that the relatively low amounts of R&D and innovative activity in the state enhance the impact that the SBIR program has, both in terms of inducing scientists to start a new firm to commercialize knowledge and in terms of influencing other scientists, through the demonstration effect, to commercialize knowledge. In addition, there is not enough variation in either the funding agency or the underlying science to identify how the SBIR program’s influence on the entrepreneurial behavior of scientists differs across scientific fields and funding agencies. Until the necessary large-scale study spanning a broad spectrum of technological and regional context is undertaken, these preliminary findings will remain conjectural. However, on the basis of this preliminary evidence on the impact of the SBIR program on the entrepreneurial behavior and career paths of scientists in Indiana, such a large-scale study is warranted. ACKNOWLEGMENTS We are grateful for the helpful comments of Al Link, John Scott, Chuck Wessner, and the participants at the Workshop on Evaluating the SBIR and the Fast Track, sponsored by the National Academy of Sciences, Washington, D.C., May 5, 1999. REFERENCES Audretsch, David B. 1995. Innovation and Industry Evolution. Cambridge, MA: MIT Press. Audretsch, David B., and Maryann P. Feldman. 1996. “R&D spillovers and the geography of innovation and production,” American Economic Review 86:630-640. Audretsch, David B., and Paula Stephan. 1996. “Company-scientist locational links: The case of biotechnology,” American Economic Review 86:641-652. Lerner, Josh. 1999. “The government as venture capitalist: The long-run effects of the SBIR program,” Journal of Business. July, v. 72 (3), pp. 285-297. Tyson, Laura, Tea Petrin, and Halsey Rogers. 1994. “Promoting entrepreneurship in Eastern Europe,” Small Business Economics 6:165-184. U.S. General Accounting Office. 1998. Federal Research: Observations on the Small Business Innovation Research Program. Report to Congressional Committees, April.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE APPENDIX Questions Part 1 Please answer the following questions about your firm and about the SBIR-award. When answering the questions, please check the boxes, fill in the corresponding blank lines or tables, or circle your answer, as appropriate. You are not limited to one answer on many of the questions. Please check all answers that apply, as appropriate. Firm Characteristics When was the firm established? ____________ How many employees does the firm currently have? ___________ What are the current sales of the firm? $_________________ By what percentage have sales revenues or employees changed (increased/decreased) during last year compared to the previous year (Please circle) Sales revenues/employees; increase/decrease _______ % What technology or basic science is the firm based on? ______________ _______________________________________________________ What is the firm’s legal form? Corporation Limited Liability Corporation Subchapter S Corporation Partnership Sole Proprietorship other

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Characteristics of the founder What is the founder’s age? Year of birth: ________________ What is the founder’s education level? Include degrees earned, dates, and educational institution. Where and in what capacity were you employed in the 10 years before being fully self-employed?

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Questions about SBIR From which agency/agencies did you receive your SBIR award(s)? ___________ ____________________________________________________________ List dates and phases of SBIR awards. Did the SBIR award influence the decision to start the firm or continue with the firm? Yes / No In regard to the firm or project-idea, what would you have done differently if you had not been awarded the SBIR? (More than one answer is possible.) I would not have started the firm. I would not have continued the firm. I would have started the firm with money from an alternative source. I would have continued the firm with money from an alternative source. I would have commercialized the idea through an existing firm. I would have abandoned the idea. I would have tried to start the firm with a different idea. I would have tried to continue the firm with a different idea.

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The Small Business Innovation Research Program: AN ASSESSMENT OF THE DEPARTMENT OF DEFENSE FAST TRACK INITIATIVE Has your SBIR experience with starting a firm influenced the activities or possible activities of any of your colleagues? It has had no influence on colleagues. It has led ___ colleagues to express interest in starting their own firm. (Please fill in the number.) It has led ___ colleagues to start their own firm. (Please fill in the number.) Starting up the firm What (and who) influenced your decision to start a firm? ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ Where did you get your ideas that are the basis of the firm? ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ Cooperation Do you work closely with any other firms, individuals, or research institutions? If so, which ones? _____________________________________________ _____________________________________________ _____________________________________________ _____________________________________________ _____________________________________________ _____________________________________________ _____________________________________________