Guest Bloggers: Richard Oliver and Agustin Orozco McKenna Long & Aldridge LLP
The Small Business Administration (“SBA”) recently issued a proposed rule which, for the first time, would allow venture capital operating companies, hedge funds and private equity firms (“investment companies”) to meaningfully participate in the Small Business Innovation Research (“SBIR”) and Small Business Technology Transfer (“STTR”) programs. This proposed rule would implement provisions of the National Defense Authorization Act for Fiscal Year 2012. Specifically, the proposed rule would revise the affiliation rules for participants in the SBIR and STTR programs to permit participation by concerns that are majority-owned by multiple investment companies. See 77 Fed. Reg. 28520-30, May 15, 2012.
Access to the SBIR and STTR programs would be a significant funding opportunity for small businesses that are largely owned by investment companies. The SBIR and STTR programs were created to award federal research grants to small businesses. Specifically, the purpose of the SBIR program is to stimulate technology innovation by strengthening the role of innovative small business concerns in federally-funded research and development. Federal agencies may award up to $150,000 for a Phase I SBIR contract and up to $1,000,000 for a Phase II contract. Agencies also will have discretion to exceed the SBIR contract award amounts by up to 50 percent and even to award a second Phase II contract. Similarly, the STTR program requires certain federal agencies to enter into funding agreements with small business concerns that engage in a collaborative relationship with research institutions.
The proposed rule would allow investment companies to participate in the SBIR and STTR programs, as long as no single investment company owns more than 50 percent of the concern. The proposed rule would modify the affiliation rules solely for the SBIR and STTR programs. Currently, such concerns would not be eligible, because the concern would be considered to be affiliated with not only the investment companies, but also the other companies owned by these investment companies. SBA’s general principles of affiliation state that if two or more persons own, control or have the power to control less than 50 percent of the concern’s voting stock, but the blocks of stock are equal or approximately equal in size, the SBA presumes each person to control the business concern. By contrast, SBA’s proposed rule provides that where an SBIR or STTR applicant’s voting stock is widely held or where two or more persons (including investment companies) hold large blocks of voting stock but no one person owns more than 50 percent of the stock, the board of directors controls the applicant. The investment companies, therefore, would not be affiliated with the SBIR or STTR applicant.
The proposed rule would also amend the current affiliation rules with respect to an investment company’s portfolio companies. Under the proposed rule, an SBIR or STTR applicant would not be affiliated with a portfolio company of an investment company solely on the basis of shared investors. Additionally, the proposed rule states that if an investment company is determined to be affiliated with an SBIR or STTR applicant, the applicant will not be affiliated with a portfolio company of the investment company, unless: (1) the investment company owns a majority interest in the portfolio company; or (2) the investment company holds a majority of the seats of the board of directors of the portfolio company.
There are several aspects of the proposed rule that may be addressed during the public comment period. While the proposed regulation references stock ownership by “multiple” investment companies, it does not address the allowable percentage amount of minority ownership. Thus, two investment companies could each own 49 percent of the concern. The proposed rule also does not require that the multiple investment companies not be affiliated. Two “sister” investment companies could each own 49 percent of the stock, with the small business being 98 percent owned by two related investment companies.
In order to participate in the SBIR and STTR programs, these small businesses must qualify as a “domestic business concern.” The proposed rule would revise the definition of domestic business concern in anticipation of the participation of small businesses owned by multiple investment companies. The new definition would continue to use the SBA’s definition of “business concern or concern,” however, it would also require the business concern to be created or organized in the United States, or under the law of the United States or of any State.
The proposed rule would amend the time at which SBA makes size and eligibility determinations for SBIR and STTR contracts. Currently, size and eligibility are determined at the time of award for both Phase I and Phase II awards. The proposed rule, however, would require the SBIR or STTR applicant to meet the size and eligibility requirements both at the time of submission of the application and at award.
Finally, with respect to certification, the proposed rule would require concerns that are majority-owned by multiple investment companies to register with SBA on or before the date they submit a response to an SBIR solicitation. In addition, these concerns would be required to indicate in their SBIR proposals that they have completed this registration.
Comments on the proposed rule are due on or before July 16, 2012.