Over the past 22 years, we have had a number of clients who have received significant amounts of SBIR funding. In this deal note® we will highlight a few of the problems with SBIR funding, from an M&A perspective.
First, a quick overview of SBIR funding. The Small Business Innovation Research (SBIR) program was established under the Small Business Innovation Development Act of 1982 (P.L. 97-219). The stated goals of the legislation included: “To stimulate technological innovation and to Increase private-sector commercialization of innovations derived from federal R&D spending.” Federal agencies with research and development (R&D) budgets over $100 million are required to administer SBIR programs. Currently, there are 11 federal agencies participating in this program, including the two largest: the Department of Defense (DOD), and the Department of Health and Human Services (HHS). Because the DOD’s R&D budget is the largest of all federal agencies (representing nearly 50% of all federal R&D), the DOD is the largest provider of SBIR, at approximately $2 billion this fiscal year. The ultimate goal of SBIR funding is to enable recipients to use the funding to develop ancillary commercialized products, which will provide future economic benefit to the recipient. Unfortunately, 6 out of 7 SBIR grants do not result in future commercialized technologies, according to consulting firm E.B. Howard*.
To be entitled to SBIR funding, an entity must meet the following criteria:
- Organized for profit, with a place of business located in the United States.
- More than 50% owned and controlled by one or more individuals who are citizens or permanent resident aliens of the United States.
- No more than 500 employees, including affiliates.
- The entity may be owned by a private equity firm, so long as no one such firm owns a majority of the stock.
There are two significant potential problems with SBIR funding for the owners of companies in the middle market of the aerospace and defense industry who are considering selling. The first is the size limit. Once a company, including its affiliates, has more than 500 employees, it no longer qualifies for SBIR funding. Therefore, when a buyer (with an aggregate of more than 500 employees, post-acquisition) values the company, they will eliminate future cash flows related to SBIR funding. The second potential problem is that SBIR funding has restrictions that effectively cap the profit margins at approximately 7%.
In July of this year, Managing Director Bruce Andrews wrote a Deal Notes® regarding some of the pitfalls of Small Business Set Asides. Therein he said, “if you are thinking about selling your middle market defense company, as part of your preparation, it is critical to thoroughly understand your reliance on the small business qualification and develop projections that do not rely on a continuation of that qualification after the business is sold.”
A nearly exact comment can be said for SBIR funding. If your middle market defense company is receiving significant SBIR funding, it is critical to thoroughly understand your reliance on the SBIR funding and develop projections that do not rely on a continuation of that qualification after the business is sold.
Have a great day, everyone.
William Alderman
President
