[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 102-000
THE IMPORTANCE OF THE BIOTECHNOLOGY INDUSTRY AND VENTURE CAPITAL
SUPPORT IN INNOVATION
=======================================================================
HEARING
before the
SUBCOMMITTEE ON RURAL ENTERPRISES, AGRICULTURE & TECHNOLOGY
of the
COMMITTEE ON SMALL BUSINESS
HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
WASHINGTON, DC, JULY 27, 2005
__________
Serial No. 109-28
__________
Printed for the use of the Committee on Small Business
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
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COMMITTEE ON SMALL BUSINESS
DONALD A. MANZULLO, Illinois, Chairman
ROSCOE BARTLETT, Maryland, Vice NYDIA VELAZQUEZ, New York
Chairman JUANITA MILLENDER-McDONALD,
SUE KELLY, New York California
STEVE CHABOT, Ohio TOM UDALL, New Mexico
SAM GRAVES, Missouri DANIEL LIPINSKI, Illinois
TODD AKIN, Missouri ENI FALEOMAVAEGA, American Samoa
BILL SHUSTER, Pennsylvania DONNA CHRISTENSEN, Virgin Islands
MARILYN MUSGRAVE, Colorado DANNY DAVIS, Illinois
JEB BRADLEY, New Hampshire ED CASE, Hawaii
STEVE KING, Iowa MADELEINE BORDALLO, Guam
THADDEUS McCOTTER, Michigan RAUL GRIJALVA, Arizona
RIC KELLER, Florida MICHAEL MICHAUD, Maine
TED POE, Texas LINDA SANCHEZ, California
MICHAEL SODREL, Indiana JOHN BARROW, Georgia
JEFF FORTENBERRY, Nebraska MELISSA BEAN, Illinois
MICHAEL FITZPATRICK, Pennsylvania GWEN MOORE, Wisconsin
LYNN WESTMORELAND, Georgia
LOUIE GOHMERT, Texas
J. Matthew Szymanski, Chief of Staff
Phil Eskeland, Deputy Chief of Staff/Policy Director
Michael Day, Minority Staff Director
SUBCOMMITTEE ON RURAL ENTERPRISES, AGRICULTURE AND TECHNOLOGY
SAM GRAVES, Missouri, Chairman JOHN BARROW, Georgia
STEVE KING, Iowa TOM UDALL, New Mexico
ROSCOE BARTLETT, Maryland MICHAEL MICHAUD, Maine
MICHAEL SODREL, Indiana ED CASE, Hawaii
JEFF FORTENBERRY, Nebraska RAUL GRIJALVA, Arizona
MARILYN MUSGRAVE, Colorado
Piper Largent, Professional Staff
(ii)
?
C O N T E N T S
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Witnesses
Page
Doerfler, Mr. Douglas A., President & CEO, MaxCyte, Inc.......... 4
Broderick, Mr. Daniel J., Managing Director, Mason Wells......... 7
Michael, Mr. Barry, President, B.A. Michael Consulting, Small
Business Technology Council.................................... 9
Glover, Mr. Jere W., Executive Director, Small Business
Technology Council, Brand Law Group............................ 11
Cruz, Mr. Anthony P., Senior Vice President, Finance &
Administration, AviGenics, Inc................................. 13
Appendix
Opening statements:
Graves, Hon. Sam............................................. 28
Prepared statements:
Broderick, Mr. Daniel J., Managing Director, Mason Wells..... 30
Glover, Mr. Jere W., Executive Director, Small Business
Technology Council, Brand Law Group........................ 41
Cruz, Mr. Anthony P., Senior Vice President, Finance &
Administration, AviGenics, Inc............................. 60
Additional material:
Biotechnology Industry Organization.......................... 63
(iii)
THE IMPORTANCE OF THE BIOTECHNOLOGY INDUSTRY AND VENTURE CAPITAL
SUPPORT IN INNOVATION
----------
WEDNESDAY, JULY 27, 2005
House of Representatives
Subcommittee on Rural Enterprises, Agriculture and
Technology
Committee on Small Business
Washington, DC
The Subcommittee met, pursuant to call, at 2:05 p.m. in
Room 311, Cannon House Office Building, Hon. Sam Graves
[Chairman of the Subcommittee] presiding.
Present: Representatives Graves, Barrow, Bartlett,
Velazquez
Chairman Graves. Good afternoon everybody, and welcome to
this hearing of the Subcommittee on Rural Enterprises,
Agriculture and Technology on the Small Business Committee. I
apologize for being a little bit late. We have got a string of
votes that could happen at any time now so I thought we would
go ahead and get started and get some of the opening statements
out of the way. Then we will take our votes, and we will come
back as soon as those are over.
Today, we are going to be discussing the importance of the
biotechnology industry and venture capital support in
innovation, and I appreciate everybody's support and
participation, anyway, in today's hearing. We are going to have
a good hearing. I think it is going to reflect both sides of
this issue, and we are trying to find out as much as possibly
about venture capital when it comes to the biotechnology field.
The Small Business Innovation Research program [SBIR] was
created by Congress in 1982 to increase the participation of
small technology firms that participate in federal research and
development activities. Federal agencies with R&D budgets of
over $100 million or more are required to allocate 2.5 percent
of all federal research and development grants to small
business applicants.
I take a particular interest in this issue since my
undergraduate studies yielded me a degree in agronomy,
particularly plant physiology. I understand the importance of
and potential in biotechnology and the research these small
companies do. In fact, the State of Missouri is slowly
attracting more of these biotechnology firms from all across
the country into our state. This means jobs for rural America
and value-added products for farmers.
Without question, the United States remains the global
leader in the field of biotechnology. Part of this success can
be attributed to the federal government's role in promoting
critical research and development. This program allows for
cutting-edge research that may not, in its earliest stages,
attract funding from other sources.
Venture capital funding is critical to the small biotech
companies. They provide the initial seed money to help get some
of these innovative ideas off the ground and running. Without
this investment, given the nature of the biotech industry, it
would be very difficult to finance this process. These small
businesses are providing the country with the ideas and
innovation that have become the identity of the United States.
The biotechnology industry is unique in that it takes
hundreds of millions of dollars to bring a product to market
from its conception. Biotechnology companies must rely on
venture investment as well as grants for sufficient funding.
SBA regulations require that, to be eligible, a small
company must be at least 51 percent owned by one or more
individuals. The SBA recently clarified the definition of an
``individual'' to include only actual human beings and not
other forms of investment. This clarification now excludes many
of the small biotech companies that participated in the SBIR
program in the 20 years prior to this SBA clarification.
Again, this hearing is going to examine this clarification
and legislation that has been introduced, the Save America's
Biotechnology Innovation Research Act. This legislation seeks
to address the eligibility issue and restore the success of the
SBIR program experienced prior to the 2002 SBA
``clarification.'' The rule change resulted in the
disqualification of many of the small biotech firms engaged in
that research.
It is now my pleasure to turn the mike over to Ranking
Member Barrow for his opening statement.
[Chairman Graves opening statement may be found in the
appendix.]
Mr. Barrow. Thank you, Mr. Chairman. Mr. Chairman, some of
the nation's fastest-growing and most successful small
businesses are responsible for introducing many of America's
high-tech products, and the economic benefits of these small
firms is undeniable. They employ almost 40 percent of the
country's high-tech workers. In Georgia, over half a million
working men and women currently are employed in the high-tech
industry.
The technology boon of the 1990's fueled the rise of these
high-tech firms, an industry that has changed the face of the
American economy. From biotechnology to information sciences,
these industries have created good-paying jobs, and they have
provided considerable benefits to Americans of all walks of
life. We all recognize the significance of these firms, and I
believe that Congress has to work together to keep
technological innovation at the top of our agenda.
For over 20 years, one of the keys to sustaining our
nation's technology advantage has been the SBA's Small Business
Innovation Research program, providing between one to $2
billion a year in grants to start-ups and emerging firms. This
program has invested over $14 million in Georgia companies. The
SBIR program plays a critical role in technology development by
providing small companies with the valuable seed funding they
need to get their ventures off the ground. This has helped
thousands of small businesses across the entire high-tech
spectrum to grow, taking their product from an idea to an
established technology.
While the SBIR program provides an important source of seed
capital, it alone cannot meet the financial needs of these
emerging businesses. Research and development in the technology
industry is incredibly expensive, often reaching millions upon
millions of dollars. In order to fund new research and meet the
goals of technology development and scientific advances, these
businesses must have a healthy amount of venture capital.
Without this vital source of financing, all of the great ideas
that the SBIR program fosters will never have the opportunity
to move from the drawing board to the board room.
Today's hearing will give us an opportunity to look at the
important role that venture capital plays in the SBIR program.
It will also allow us to review a current SBA rule that is
limiting this critical source of financing for America's small
technology companies, a rule that needs to be revisited.
In 2003, the SBA set an arbitrary cap on the type of
investments that small businesses can receive, limiting the
nation's emerging high-tech businesses' access to SBIR program.
This rule runs contrary to the goal of the SBIR program, which
is to assist in the development of technology that will have a
place in the global marketplace.
I am sure we can all agree that it is not the intention of
the SBA to block small firms in the SBIR program form
succeeding. Clearly, there is a need to ensure that legitimate
small businesses have access to SBIR awards, but putting a rule
in place that appears to protect small businesses on the
surface but ends up only hurting them in the process is not
good policy. There are no few industries that need the infusion
of venture capital funding more than small business technology
sector. If left unchanged, this current rule will have a
chilling effect on the future of the venture capital and high-
tech industries.
Today's hearing will give us the opportunity to learn more
about the nuances of the SBIR program. Those testifying this
afternoon will present a firsthand account of how important the
SBIR program is to small businesses, and their testimony will
show that without proper public/private partnerships, we will
be denying American small businesses the tools they need to
grow in today's economy.
I have invited a fellow Georgian to come testify here
today. His name is Tony Cruz, and he works for AviGenics, Inc.,
in Athens, Georgia. AviGenics is a biotechnology company that
is developing therapeutic proteins for oncology infections and
autoimmune diseases.
Mr. Cruz, thank you for being here today, and I look
forward to hearing your testimony.
Thank you, Mr. Chairman.
Chairman Graves. Mr. Bartlett?
Mr. Bartlett. I am very pleased to be here today to welcome
an old friend, Jere Glover. It is good to see you again after
many years.
In a former life, I was a small business person. I ran a
company for 12 years and met a payroll every Wednesday morning,
so I know the discipline that small business goes through. I am
very pleased to be here in Congress today helping to look after
the needs of small business, clearly the backbone of the
economy in our country. Thank you, gentlemen, for being here.
Chairman Graves. We are going to break now. We have
probably about five, six, seven minutes left on this vote, and
then there are three, five-minute votes. We will break and then
come back here immediately, pick up immediately after those
votes are over. Then we should be clear for the rest of the
afternoon to have a good hearing. But we will recess for just a
few minutes, and we will be back.
[Whereupon, at 2:14 p.m., a recess was taken.]
Chairman Graves. We will bring the hearing back to order. I
apologize again for the interruption with votes. Neither I nor
Mr. Barrow make the schedule, unfortunately, so we have to
abide by it when votes do come up, and hopefully we are going
to have plenty of time this afternoon now to work through our
hearings.
I want to point out that all of the statements made by
Members and the witnesses will be placed in the record in their
entirety, just so everybody knows, and we will start out with
Mr. Douglas Doerfler, President and CEO of MaxCyte, Inc., and
also you are here to represent the Biotechnology Industry
Organization from Gaithersburg, Maryland.
I appreciate you being here. I know you have come not quite
as far as some others, but I appreciate it very much. I know
you all are very busy, and I am glad that you did take the time
to testify. This is a very important subject. I appreciate you
being here. I look forward to hearing your testimony.
STATEMENT OF DOUGLAS A. DOERFLER, MAXCYTE, INC.
Mr. Doerfler. Thank you, Chairman Graves and Ranking Member
Barrow. Thank you for the opportunity to testify today on the
SBIR grant program.
As you mentioned, I am Doug Doerfler. I am the president
and CEO of MaxCyte. We are a biotechnology therapeutics company
located in Gaithersburg, Maryland. I have led professionally
the development of a number of successful biotechnology
companies and products over the last 25 years.
We founded MaxCyte in 1999. We have 20 employees and are
developing novel therapeutics to treat serious diseases. We
have one product in Phase I clinical human testing for the
treatment of patients with leukemia and additional products in
pre--clinical testing for the treatment of lymphoma, breast
cancer, and ovarian cancer. These programs are in combination
with a number of major universities, including Baylor College
of Medicine, the University of Pennsylvania, and Harvard
University. MaxCyte was a recipient of a Phase I SBIR grant in
2003, but we are no longer eligible to participate based solely
on our source of investment capital.
Today, I am testifying on behalf of the Biotechnology
Industry Organization, an organization representing over 1,100
biotech companies, universities, research institutions, and
state biotechnology associations, in all 50 states. I want to
thank the Subcommittee for holding this hearing on the SBIR
grant program and applaud the introduction of H.R. 2943, the
Save America's Biotechnology Innovative Research Act, by
Chairman Graves.
I ask your permission to submit for the record a letter in
support of Chairman Graves' legislation signed by 281 biotech
CEOs from 37 states.
B.I.O. represents many established companies in the
industry. Over 85 percent of BIO members are small emerging
companies with fewer than 500 employees and half with less than
50 employees. Not surprisingly, the SBIR program has played a
critical role in providing necessary financing for many of my
fellow small biotechnology companies.
Unfortunately, a recent interpretation by the SBA regarding
eligibility requirements for the SBIR program has prevented the
majority of BIO members from participating in the program.
Specifically, beginning in 2003, the SBA Office of Hearings and
Appeals ruled that companies that were venture capital backed
in excess of 50 percent were no longer eligible for SBIR
grants. Prior to this ruling, during the 21 years the SBIR
program has been in existence, the majority of venture capital-
backed biotechnology companies fully participated in this
program.
H.R. 2943 would rectify this problem and allow venture-
backed, small biotech companies to once again pursue their
innovative and cutting-edge research under the SBIR program.
By way of background, I would like the Committee to
understand the unique aspects of the biotechnology industry.
The average development cycle for a successful biotechnology
product is 15 years, and only one of five make it from the
start of Phase I human testing until it is approved. Therefore,
before most products can become commercially available, years
of research and often hundreds of millions of dollars are
required to complete testing, gain product approval, and build
the necessary manufacturing infrastructure. While there are
many different funding strategies, the typical form of
investment in promising, early stage biotechnology companies is
venture capital.
In our industry, even the relatively small amount of money
a company will raise in its first round,--this is called a
``Series A''--between five and $8 million, generally results in
new investors, usually a collection, a syndicate, if you will,
of venture capital funds, owning more than 50 percent of the
company.
Therefore, both SBIR and VC funding is necessary to support
the lengthy and costly clinical development process. Limiting
government support for biotech R&D risks delaying the discovery
and development of promising new therapies for cancer,
diabetes, Parkinson's Disease, and, significantly, many
diseases where there is less commercial focus, like
tuberculosis or diseases that would qualify for orphan drug
designation.
In fact, according to a recent letter from Dr. Zerhouni,
director of NIH, to the SBA, which I would also like to submit
for the record, the SBA's current eligibility rule excluding
majority venture capital-backed biotech companies, and let me
quote this, ``undermines NIH's ability to award SBIR funds to
those applicants whom we believe are most likely to improve
human health, which is the mission of the NIH.'' That is a
direct quote from his letter.
While almost all BIO members will need to raise venture
financing to advance their products toward the marketplace,
many small biotechnology companies have come to rely upon the
SBIR program to fund cutting-edge research in areas where
venture capital and other sources of financing are difficult to
obtain.
For example, while a company is working on a lead research
program, it often comes across a new application or new project
opportunities that will need to be tested before attempting to
raise additional funds. These new opportunities are precisely
the type of research projects that should be eligible for SBIR
grants. MaxCyte, my company's, project fell into this category.
During our fund-raising process in 2003, we submitted a
proposal to NIH to do basic research on our technology and
expand its capabilities so that one day it may be used for
biodefense or for pandemic influenza vaccine development.
Venture funds were not interested in this particular project,
as it was too early and risky. We received $95,000 in funding
for our Phase I and subsequently, in 2004, closed a $10.7
million venture round. We were able to satisfy the rigorous
milestones of our project, including breakthrough science to
prove general concept, but we are now not eligible to
participate in any further funding for this project by the SBIR
program. Due to this ineligibility, this project has been
suspended. This is extremely frustrating for us since we
believe that this project will have potentially a major impact
on biodefense and in preventing potentially the pandemic flu
crisis.
The legislative history makes it abundantly clear that
Congress intended for the SBIR program to assist small
businesses in commercializing their creations and products and
to stimulate small, U.S.-owned firms to produce innovative
technologies. Congress viewed the SBIR program as providing the
necessary ``proof of concept'' to encourage venture capital
investment in promising small businesses seeking to bring
products from the lab bench to the marketplace. Moreover,
Congress even created an SBIR Phase II preference for companies
that attracted venture capital investment by providing special
consideration in the funding review of Phase II proposals.
B.I.O. believes that this enormous promise of biotech R&D
merits exploration and investment on a variety of fronts and by
spectrum of creative, dynamic, and dedicated entities.
Biotechnology is a fertile field, from which patients can reap
huge benefits, if it is supported by both public and private
investment. The rewards of biotech are limitless unless we
choose to limit those who can participate in this effort. I
urge the Subcommittee to favorably report H.R. 2943. I thank
you, and I am pleased to take any questions you may have.
Chairman Graves. Thank you very much, Mr. Doerfler.
Next, we are going to hear from Daniel Broderick, who is
the managing director of Mason Wells. You are representing the
National Venture Capital Association from Milwaukee, Wisconsin.
I appreciate you being here. I might point out to you that we
generally do give minutes for statements, but I do not adhere
to that very closely, so if you go over, it is no big deal. I
am not going to crack any whips or anything. So I look forward
to hearing your testimony, and thank you for coming today.
STATEMENT OF DANIEL J. BRODERICK, MASON WELLS
Mr. Broderick. It is my pleasure to be here. Again, my name
is Dan Broderick. I am a founding managing director of Mason
Wells Biomedical Fund, located in Milwaukee, Wisconsin. Mason
Wells is a small, venture capital fund focused on seed and
early stage investing in the life sciences in companies located
in mid-America.
Today, I respectfully submit testimony on behalf of the
National Venture Capital Association and those venture-backed
companies that are developing innovative technologies that
improve the quality of our lives and raise our standard of
living. For the last 20 years, the dual financing sources of
the SBIR program and the venture capital community have allowed
many of these promising companies to conduct ground-breaking,
scientific research while simultaneously building viable
businesses that will bring these innovative products to the
marketplace.
Venture capital is the investment of equity to support the
creation and development of new, growth-oriented businesses. In
terms of global competitiveness, the entrepreneurial segment of
the economy is the true differentiator in America. U.S.
companies originally funded with venture capital, like
Genentech and Amgen, now represent 11 percent of our annual GDP
and employ over 10 million Americans.
There appears to be a misunderstanding that venture capital
firms are large corporations that control the small start-up
company by having a majority control over the company's board.
It is important to understand the organizational structure of a
venture capital firm, its limited partners, and the
relationship between the VC firm and the portfolio company.
Private venture capital funds are organized as limited
partnerships and are managed by general partners. The general
partners, like myself, are the individuals staffing the venture
capital firm. They are responsible for and control all aspects
of the fund's operations, including making the investment
decisions. The venture capital funds are small organizations.
In fact, the average number of general partners in any one firm
in the United States is only 10. The investors in these limited
partnerships are usually pension plans, foundations, trusts,
and accredited investors, and they are called limited partners
because they are limited from liability because they exert no
control in the day-to-day operations of the VC fund, they do
not participate in setting the strategic direction of the fund,
and they take no role in making the investment decisions.
The limited partners' investment in a venture capital fund
is not a revenue stream for the fund; rather, the money that
LPs invest in a venture fund are to make investments in
portfolio companies and as loans to fund the day-to-day
operation of the fund. These investment dollars and loans must
be repaid by the venture capitalist before the firm can then
profit.
Based on my experience, the great number of companies that
I see have established a board of three to seven members prior
to any venture capital involvement. Members of these boards
comprise founders, management, investors, and industry experts.
Once a venture capital firm is involved, most boards slightly
increase in size, with members representing the same groups of
people. Each vote on the board is equal, and it is the
fiduciary duty of each individual board member to act in good
faith and in a manner to be in the best interest of the
corporation. The groups involved generally do not vote as a
bloc; rather, each member votes their own conscience.
I would also like to briefly address the relationship
between corporate venture capital and traditional venture
capital firms, as outlined above. Typically, corporate venture
capitalists play a different role than a traditional venture
firm. They generally only co-invest alongside a traditional
firm and usually do not take a board seat. They also generally
own less than 20 percent of the portfolio company because of
corporate-reporting rules. Furthermore, corporations manage
only 4 percent of all venture capital under management.
So why do venture capital firms care about SBIR grants? For
the last two years, portfolio companies have continually
alerted the NBCA to situations in which an SBIR grant has been
denied because they have venture investors. Many of these firms
were caught by surprise because this program has been working
well for 20 years.
It is paramount not to confuse the role of venture capital
funding with the role of basic R&D funding. Both are critical
to bringing innovation to the marketplace; however, basic
research funding is targeted at discovery and invention. It is
this type of activity that the SBIR program has historically
supported. Venture capital dollars, even those labeled early
stage, are used to build a strong and viable business so that
promising discoveries can be brought to market.
Some would argue that if a company receives venture
capital, that it has hit the lottery and does not need
government funding. Nothing could be further from the truth. In
the life sciences sectors, the cost and time associated with
bringing a discovery to market is colossal. Multiple rounds of
financing at millions of dollars per round are required.
The cost of bringing a new drug to market is about $800
million. Young biotechnology companies cannot divert precious
venture capital funds earmarked for business growth to embark
on new research projects, although these projects may hold the
next ground-breaking treatment for Alzheimer's, cancer, or
other diseases.
Another belief is that venture investment only impacts
select regions of the country. To the contrary, venture capital
is a national phenomenon. While Massachusetts and California
are the leading regions for venture capital investment, VC
dollars have been flowing to all 50 states over the last 20
years and have directly benefitted regional economies across
the country. Ironically, however, the SBIR program eligibility
rule hurts the low-tech regions it is trying to support.
Mid-America is one example where investing in early stage
technology companies is difficult because of the smaller
percentage of venture capital investment. From my experience as
the founder of the Mid-America Health Care Investors Network, I
know the inability of small businesses to compete for and
receive SBIR funds is of particular concern to venture-backed
companies in mid-America. The ruling that disqualified VC
finance companies from competing for SBIR grants removed an
essential source of financing, causing R&D at many technology
companies located in mid-America to slow or stop altogether.
A way to ensure the ongoing success of the SBIR program is
to reopen it to the broadest and most qualified base of small
businesses possible. This requires allowing venture finance
companies to compete once again.
Since SBIR's inception some 25 years ago, venture capital
and SBIR funding have been proven to work together to research,
commercialize, and distribute innovative products on an
accelerated basis. Recently, Congressman Graves introduced
legislation that clarifies SBIR eligibility requirements for
venture-backed, start-up companies. NVCA applauds this effort
and encourages quick action on this legislation, and we look
forward to working with the Committee to address this spiraling
problem, and I thank you all for the opportunity to express my
views.
[Mr. Broderick's testimony may be found in the appendix.]
Chairman Graves. Thank you, Mr. Broderick.
Next, we are going to hear from Barry Michael, who is
President of B.A. Michael Consulting and here with the Small
Business Technology Council from Clifton, Virginia. I
appreciate you being here. Thank you very much.
STATEMENT OF BARRY MICHAEL, B.A. MICHAEL CONSULTING
Mr. Michael. Good afternoon. My name is Barry Michael, and
I head a consulting company whose primary focus is life science
start-up companies in the Mid-Atlantic region of the U.S.
My business career began in 1972, after serving as a Naval
Supply Corps officer during Vietnam. I have been part of the
health care industry for the last 23 years. Many of these
years, I worked for two major Fortune 100 health care
companies. However, since 1993, I have worked primarily with
start-up companies, with my focus including finance, strategy,
tactics, and marketing. I have an engineering degree from Brown
University and an M.B.A. from Wharton.
I am here today to support the small start-up company. I
believe that it would be bad policy to expand the current
criteria for SBIRs to include large, venture capital, majority-
controlled start-ups.
I have worked closely with four different organizations
that have had SBIRs awarded by the NIH. I believe that it is
important to note their collective stories. SBIRs were critical
as they formulated start-up strategies, developed products, and
matured as businesses. For the purposes of perspective, I have
also played a key role in a majority-controlled, venture-
backed, biotech start-up. Therefore, I am at least somewhat
aware of the fundamental differences, both financial and
strategic, of these two types of start-up organizations.
Venture capitalists usually think in terms of investing
several millions of dollars. They represent very sophisticated
investors who demand that the VCs hit their specific financial
targets and have specific timelines for success. Early, small,
science start-ups almost never meet these conditions and thus
almost never qualify for VC funding in their early stages when
it is most critical financially and strategically. Their risks
are too great, their timelines too long, and their management
teams are still too unproven. But this unproven group is still
taking the personal risk, and they represent one of the crucial
ways that important life science breakthroughs can start.
When a person or a group of persons starts to develop their
life science idea or invention, they are faced with daunting
technology, market, and finance challenges. They will rely on
their creativity and technical training to develop their idea,
but usually they have to learn product development, business,
and finance until their idea is proven.
Most of these life science companies are so unproven or so
clearly risky that established companies shy away from
supporting them until the data show some glimmer of hope. SBIRs
support the generation of that data. The NIH also provides
valuable feedback to SBIR applicants, and if the proposal does
not make it the first time, it may make the grade when
resubmitted. Getting an SBIR Phase I contract award represents
important validation. Getting a follow-on Phase II, like one of
the companies that I have worked with, makes it possible to
undertake follow-up studies, and theirs was a medical device
clinical study.
Many small start-ups plan to become competent enough to
eventually be eligible to be financed by venture capitalists,
both large and small. In the meantime, however, these start-ups
have to rely on savings, spouse's income, friends and family,
second mortgages on their homes, angels, and, most importantly,
SBIRs to provide critically needed seed capital. SBIRs provide
a significant percentage of this early financing effort. Small
start-up companies typically generate several hundred thousands
of dollars in funding. Funding for large, VC-controlled
companies, when it is available, would be on the order of
several million dollars.
Currently, the 2.5 percent of the NIH budget allotted to
SBIRs creates a zero-sum game. Adding more types of eligible
organizations that could threaten the current environment that
very properly benefits the early, small, life science start-up
company is something I would not recommend. These life science,
young, start-up organizations represent the ongoing start of
our country's innovation process. Said another way, in three of
the four start-up companies I have personally worked with,
there would not have been a company and a development effort if
it had not been for SBIRs. None of these organizations were
even remotely mature enough to qualify for VC investment, but
their creativity and entrepreneurial spirit needed a chance.
Changing the current criteria to allow SBIR participation
by large, venture capital-majority-controlled start-ups would
be a major detriment to the life science start-up community.
Bringing in new players with deep pockets will divert the
current pool of money away from small start-up companies. These
early stage companies will be faced with even greater
challenges.
Yesterday, the Small Business Technology Coalition released
a survey of companies that received SBIR awards from the NIH.
This survey is attached to Mr. Glover's statement for the
record. Please note that nine out of 10 of these companies
oppose giving large VCs greater access to the SBIR program
funds. We are told that these companies are among the likely
beneficiaries if large VCs are allowed to play a greater role.
Yet these supposed beneficiary companies clearly oppose greater
large VC involvement in the program.
While preparing this talk, I had an interesting comment
from an expert in the public financial markets. He said, ``I do
not understand the issue. Venture-backed-capital companies
already have their money.'' In fact, as noted in my attachment,
they have $53 billion currently available to invest, and they
cannot figure out how to invest it. Thank you.
Chairman Graves. Thank you, Mr. Michael.
Now we are going to hear from Jere Glover, who is the
Executive Director of the Small Business Technology Council.
Jere, thanks for being here today. I appreciate it.
STATEMENT OF JERE W. GLOVER, SMALL BUSINESS TECHNOLOGY COUNCIL,
BRAND LAW GROUP
Mr. Glover. Thanks for inviting me, Mr. Chairman, Ranking
Member. Jere Glover, executive director of the Small Business
Technology Coalition. I have over 27 years of experience in
small business innovation. I served as chief counsel for
advocacy under President Clinton.
Let me start by saying that prior to enactment of the SBIR
program, small business was virtually excluded from the federal
R&D funding. This is true despite clear evidence that small
businesses were more successful and more efficient at
innovating than large firms.
This program is a magnificent success, widely praised,
yields thousands of patents and billions of dollars in
technology since 1992. It has had nine favorable GAO studies.
SBIR companies are successful in commercializing their
technologies to the extent of 40 percent, much better than even
venture capitalists have been. It has worked so well that in
its 20-plus years of existence, there have been very few and
minor changes made to this legislation. It is not broken, and
this fix is not needed.
The emphasis of the SBIR program is on early stage
innovations and technologies, an area of little interest to the
venture capital community. Less than 2 percent of venture
capital investments last year went to early stage and seed
investments.
There are four facts that are lost in this debate. First,
Phase III specifically is designed to encourage and facilitate
VC partnerships and investment in SBIR companies. Two, small
venture capital companies can today own a majority interest in
an SBIR company and that company remain eligible. Three, large
venture capital companies can own 49 percent of an SBIR company
without it creating a problem. And, finally, SBA is currently
involved in the regulatory process on this very specific issue.
Where SBA has drawn the line is on allowing venture capital
to own and control a majority interest in a small business SBIR
company. This is based on Congress's core definition of a small
business established more than half a century ago. A small
business is one that is independently owned and controlled, 15
U.S.C. 632. There are numerous laws and regulations
that are driven by that phrase and that provision. It is a very
important underpinning of the Small Business Act. To my
knowledge, this is the first time in the history of the SBA
that Congress has been asked to redefine ``small business'' to
include large businesses and companies that are owned and
operated by them.
When this issue first came up, I surveyed the SBTC Board of
Directors. They were unanimously and vehemently opposed to
allowing venture capitalists to own and control SBIR companies.
I later surveyed SBTC's membership, as well as SBIR
participants, in a number of national SBIR meetings, always
with the same results: Small businesses oppose the change in
the definition to allow venture capital-owned and controlled
companies to compete in the SBIR program.
Recently, we surveyed the NIH awardees. We referred them to
BIO, the industry association, Web site where their position
paper was located as well as referred them to ours. We then
asked them the questions. Ninety percent opposed. This was true
even when we asked the question about whether it was owned by
institutions and pension funds.
In SBA's rule-making proceeding, there were a number of
very interesting questions asked. Let me just mention those.
Will the change in allowing venture capital-owned and
controlled companies in the SBIR program shift the program
emphasis to lower-risk technologies that are closer to the
marketplace? Will it increase concentration in states like
California and Massachusetts? Forty-six percent of venture
capital money goes to California. Will it change the profile of
successful and unsuccessful SBIR companies, and will it lead to
calls for other changes to allow universities and large
businesses in the SBIR program? I think the answer to all of
those is yes.
These questions are very important, and I think they must
be answered before Congress goes forward with such a radical
change to a very successful program.
I wonder why SBA was not asked to present its views at this
hearing. They certainly have the expertise, and with thousands
of comments and dozens of field hearings, I think SBA should be
heard.
The SBIR program is extremely competitive. For every
company that receives an SBIR award, there are five to seven
companies that have put in proposals that are not funded. This
is especially true at NIH, where last year they received a
thousand more proposals than the year before. There were 5,000
companies last year that submitted proposals to NIH that were
not funded. Many ranked top, outstanding in science and
technology, but there simply were not sufficient funds at the
NIH to make the awards. Make no mistake: For every VC-owned
company that receives an award, there will be a small business
with outstanding technology that will go unfunded.
I fear that if the Small Business Innovation program is
opened to venture capital-controlled companies, universities
and large firms will try to make the same arguments, thereby
defeating the underlying purpose of the SBIR Act, which is to
make sure that small business has access to federal R&D
funding.
The bill will result in increased geographic concentration
of the SBIR program. As I mentioned, 46 percent of venture
funds go to California. Ten states get 85 percent of venture
funds. Having to compete with ventured-owned companies places
small businesses and other states at a competitive
disadvantage.
We are not unsympathetic to the concerns raised by BIO and
the National Venture Capital Association. We have supported
programs, such as the ATP program and the MEP program, that are
not targeted for small businesses. At the Science Committee, it
was suggested that there needs to be a program for a large VC
and even large businesses to use the remaining 97 and a half
percent of federal R&D to help them commercialize new drugs and
new technologies. We are open to such a proposal. Our objection
is to having funds for large businesses and VC-owned firms come
out of the very limited funds that are available exclusively
for small business. Thank you for allowing me to testify.
[Mr. Glover's testimony may be found in the appendix.]
Chairman Graves. Thank you, Mr. Glover.
I will turn it over to Mr. Barrow to introduce Mr. Cruz.
Mr. Barrow. Thank you, Mr. Chairman. With me today is a
fellow Georgian to testify in today's proceedings. His name is
Tony Cruz. As indicated before, he works for AviGenics, a
company in Athens, Georgia. AviGenics is a biotechnology
company that is developing therapeutic proteins for the
treatment of oncology infections and autoimmune diseases. Mr.
Cruz, thank you for being with us. I look forward to hearing
your testimony.
STATEMENT OF ANTHONY P. CRUZ, AVIGENICS, INC.
Mr. Cruz. Thank you. Chairman Graves, Ranking Member
Velazquez, Ranking Member Barrow, and Committee members, Good
afternoon. My name is Tony Cruz. I am the senior vice president
of finance and administration at AviGenics. Before my
involvement with the biotech industry, I served at active duty
for five years as a captain in the U.S. Air Force, and I am
thrilled to be a part of this democratic process.
On behalf of AviGenics and the biotech industry, I wish to
thank members of this Committee for this opportunity to present
my comments on the recently imposed obstacles which prohibit
small biotechnology companies like AviGenics from participating
in the SBIR program.
AviGenics is an up-and-coming biotechnology company located
in Athens, a small town about 90 minutes from Atlanta. Our main
offices and labs are located on the University of Georgia
campus, and we are well integrated with the university's
efforts to attract technology companies and to generate high-
skilled, high-paying jobs for that area. AviGenics employs
about 50 very highly skilled scientists, technicians, and
specialized farm workers. Currently, Athens is better known for
the university's football program rather than its expanding
base of high-technology companies. We hope that one day Athens,
Georgia, will be recognized as much for its biotech excellence
as the Georgia Bulldogs are for their football prowess.
This is an urgent issue. The SBIR and access to the SBIR
funding can determine the future of this and other companies
within the Athens area, including whether or not we survive in
the near term.
AviGenics is not a subsidiary, nor is it a spinoff of a
large pharmaceutical company. We are an independently owned and
operated technology company dedicated to developing therapies
for infectious diseases and cancer. The company's core
technology is targeted specifically at producing protein-based
therapies which are safer, more effective, and more affordable
than those currently available on the market.
AviGenics's approach is somewhat different from the
majority of the biotechnology industry in that we utilize
modern research tools as well as traditional agricultural
expertise. Specifically, our technology combines state-of-the-
art molecular biology with Georgia's well-established poultry
expertise to produce modern medicines at low cost in using
chicken eggs as the core of our technology.
The value-creation cycle as experienced by the company over
the last few years is very similar to those experienced by
other biotechnology start-ups. Financial support from a
combination of federal grants, including the SBIR program, and
venture capital funding has been critical for the survival and
growth of AviGenics up to date.
In the foreseeable future, SBIR funding will continue to be
critical for technology development and preclinical testing of
our products. SBIR funding and other federal grants make it
possible for the company to establish a proof of concept for
its base technology, and venture funding allows development of
these specific products through very expensive clinical trials
and the regulatory approval process.
Only by demonstrating proof of concept of our technology
were we able to attract VC investment and thus then were able
to hire new employees, pursue activities required for
development of a lead product, and complete human clinical
trials. Future expansion of AviGenics relies heavily on SBIR
and other federal monies being available to develop proof of
concept for the next set of technologies and future product
candidates. This next set of technology validation will
hopefully lead to more VC funding, which, in turn, will further
hiring and completion of other clinical studies.
Early in the company's history, attempts were made to
secure financial backing from industry to develop and validate
the core technology. A cross-section of large pharmaceutical
companies and established biotechnology companies were
approached with an unproven concept of making low-cost and
improved drugs through an unconventional technology, i.e.,
production of therapeutic proteins in chicken eggs.
The message from industry to AviGenics at that time was
loud and clear: Come back when you can show us your technology
works. The industry declined to fund the basic research, even
when the promise of making drugs cheaper, better, faster, and
safer was there. Funding from government research and a few
angel investors was then necessary to reach the initial proof
of concept for our technology. Then and only then was the
company able to attract significant funding from VC firms,
eventually leading us to where we are now, a 50-person company
about to enter Phase II clinical trials.
In 2004, AviGenics completed a U.S. FDA-approved, Phase I
human clinical trial for its lead compound to treat an
insidious infectious disease. The data from the initial study
suggests that our drug performs just as well or better and is
safer than what is currently on the market. Furthermore, this
drug will cost less than half of what it costs for a similar
therapy today. Of course, more extensive human clinical trials
are required for market authorization, but AviGenics's
technology offers a significant promise to millions of patients
who do not benefit from or cannot afford the currently
available therapies.
Advancing our innovative technology to the point where we
were able to initiate clinical evaluation was a path fully
loaded with technical risk. This initial technology development
took over four years as several different technical approaches
had to be utilized without the SBIR grants or other federal
funding.
It is important to note that even with the completion of a
Phase I study for our lead compound, federal funding continues
to be necessary for the company as we must continue to develop
future products for other disease areas. Specifically, federal
research grants are needed for technology-improvement projects,
such as developing more effective and efficient ways to apply
genetic engineering techniques.
According to the recently imposed eligibility standards, a
business must be at least 51 percent owned and controlled by
individuals who are citizens of the U.S., and the company may
not have more than 500 employees, including affiliates. The
SBA's current interpretation of ``individuals'' excludes
venture capital funds. As a result, AviGenics is ineligible for
future SBIR funding.
I believe AviGenics is a case study of what the SBIR
program can do. Like I said, we currently employ close to 50
full-time employees, most of whom are highly educated and
skilled. With SBIR and federal grants early in its history, our
company was able to secure VC funding and thus initiate human
clinical trials. We look forward to the day that our technology
and hard work will result in affordable, effective therapies
for those stricken with hepatitis, AIDS, cancer, or other
ailments.
AviGenics strongly supports BIO's recommendation that the
SBA adopt the rule that addresses the actual ownership
structure of small biotech countries that are owned and
controlled by venture capital companies. Since 1982, when the
SBIR program was created, up until 2003, majority VC-owned,
biotech companies were allowed to compete for SBIR grants.
Specifically, we count on you to support this bill. Thank you.
[Mr. Cruz's testimony may be found in the appendix.]
Chairman Graves. Thank you, Mr. Cruz.
I am now going to recognize Ms. Velazquez, who is the
Ranking Member of the full Committee. It is a pleasure to have
you here. Thank you for coming for a statement.
Ms. Velazquez. Thank you, Mr. Chairman, and I would like to
make an opening statement so that the record reflects my
concerns about the SBIR program and the importance of venture
capital and the role it plays in our economy. So I want to
thank you for allowing me to make my opening remark.
We rely heavily on this nation's technology sector to
advance us forward and to create the next generation of
innovations that will carry us into the next century. Over the
past two decades, small businesses have become the dominant
employer of high-tech innovators, producing 55 percent of all
new technological developments. Clearly, if this nation is
going to continue striving forward in the fields of science,
engineering, and computers, then we must be investing in these
businesses. This is where the SBIR program comes in.
This program plays a critical role in enabling
entrepreneurs with bright, innovative ideas in the technology
field to receive the valuable seed funding they need to start
and grow their businesses. The SBIR program is vital in
empowering high-tech, small firms to obtain their end goal: to
profit from its commercialization. However, the SBIR program
needs some assistance when it comes to providing high-tech,
small firms with the capital they need. That is why venture
capital plays a vital role in turning innovative dreams into
reality.
There is no doubt that the applied research in the high-
tech industry is an expensive one. An example of this is in
biotechnology and drug research where it is estimated to take
$800 million and at least a decade for product development,
testing, and movement to the market. Clearly, this is something
that the SBIR program cannot finance alone. We need to ensure
that there is a balance in getting venture capital to these
aspiring technology firms. It is simply not a valuable option
to limit the ability of small businesses to access one of their
most significant resources: venture capital.
These businesses represent the next wave of innovations,
and placing an arbitrary cap of 49 percent, as SBA proposed, on
the investment they can receive will only hinder their ability
to grow and develop. SBA's proposal simply takes opportunity
away from high-tech, small firms wanting to make their way in
the global marketplace.
There are many ways to ensure that this program truly
maintains its focus on this nation's entrepreneurs without
limiting their ability to access venture capital. These
protections have already proven successful in other SBA
programs. There is no reason why we cannot offer similar
protections to the SBIR program. The issue here is that the
need for venture capital within the technology sector is
greater than ever.
Our nation simply cannot afford to have a policy that
withholds venture capital investment from high-tech, small
firms. The SBIR program clearly plays a vital role in
empowering this nation's small business technology sector.
However, without an adequate public/private partnership, its
capabilities will be severely hindered. That is why it is
important that any change to this program is guaranteed to
maximize technological developments. A proposal that would only
hold small firms back and rob them of available venture capital
investment is simply not a good policy.
Without the resources offered through the SBIR program and
adequate venture capital investment, small businesses will
never have what they need to spur high-tech innovation and
development in order to move this nation forward for
generations to come. Thank you, Mr. Chairman.
Chairman Graves. Thank you, Ms. Velazquez. I appreciate it
very much.
We are going to start with questions, and my questions, I
guess, anyone could answer. I would be interested in hearing
what all sides have to say about it, but one of the concerns
with opening this back up is when a venture capitalist becomes
a majority owner of a business, do they assume day-to-day
control of the business, or--I might even rephrase that
question--can they assume day-to-day control of your business?
We will just start.
Mr. Doerfler. We just completed our first venture capital
financing round, so I am pretty intimately familiar with this
one.
First of all, there was no single venture capitalist that
owned more than 15 percent of our company at any given time. We
put a syndicate together, and I am not aware of any company in
our industry, the biotech industry, that is owner controlled by
a single entity. The VCs came in as a syndicate. We were very
careful, I think as was just mentioned, that we created a board
of directors that was majority controlled by non-VCs to ensure
that the control of the company was not in any group's hands.
Management controls day-to-day operations, the board controls
the company itself, and the shareholders obviously can appoint
the board members.
Now, there is a shareholder agreement that most companies
have--I believe virtually all companies have--that prevents any
single VC from controlling the organization. The other members
of the VC syndicate would not allow that to happen. So there is
an inherent check and balance in our system to ensure that not
one party will control the operations, certainly not control
the day-to-day operations, of an organization.
Mr. Broderick. I would like to respond as well. It
certainly is not what the venture capitalist even wants to do,
is to control the day-to-day operations of a corporation. What
we try to do is we try to find talented management to take care
of that responsibility. They have the skill sets to do that.
They have the experience generally to run the day-to-day
operations of the company. Were we to have to step in to run
the company day to day, it would be a bad situation. It would
be probably a distress situation, and we would probably even
then hire experts to come in and take over the orderly
dissolution of that corporation.
As for controlling the company from the board of directors,
it is our fiduciary responsibility as a member of the board of
directors to act in the best interests of all of the
shareholders involved for the purpose of increasing shareholder
value. In all of the board memberships that I am aware of, each
member has an independent vote. There are no side agreements:
You vote my way. There are no club rules: I will vote for this
if you will vote for that. Each member has a fiduciary
responsibility to vote his own conscience on each issue as an
individual.
Chairman Graves. Mr. Michael?
Mr. Michael. I think that there are times when a VC-
controlled or nearly controlled company is going to be
frustrated about management's desire to take on new projects,
and so although that is not possibly your definition of ``day-
to-day control,'' most energetic, creative scientists will
often want to start new projects, and they will often be
excluded from doing those projects unless they can get access
to an SBIR grant. So that is a form of day-to-day control, and
I think that happens fairly often.
Chairman Graves. Mr. Glover?
Mr. Glover. Most legal, underlying documents do provide the
ability for the venture capitalist to take control if certain
events do not happen or if certain things do not happen. To the
extent the venture capitalist owns over 50 percent,
collectively they have the option at any time to elect a new
board, control that board, and make the decisions.
The SBA's size-determination rules for this and all other
small businesses have always looked at the potential to
exercise that control, whether it has actually been exercised
or not. Legally, they will have the right to exercise that
control, and SBA, to protect small businesses from that
eventuality and to make sure that companies are legitimately
small businesses, do look at the control issue, and they do
look at the underlying documents, and, in most cases, those
documents do provide sufficient opportunities for the majority
holders to exercise those controls.
Chairman Graves. Mr. Cruz?
Mr. Cruz. Just a short addition. In our case, at AviGenics,
we are majority VC controlled; however, there are over 10
different funds that own that majority, and it is very, very
difficult for any one fund to actually exert control over the
company. As was said before, there are underlying legal
documents that provide the distribution of decision-making
throughout all of the funds, as well as the management team and
other common shareholders.
Chairman Graves. Mr. Barrow? Ms. Velazquez?
Ms. Velazquez. Thank you, Mr. Chairman. Thank you, Mr.
Barrow.
Mr. Broderick, I have a question, in particular, about how
we can balance the need to allow increased venture investment
versus protecting small businesses. If we had a structure in
place that would allow venture capital companies to have an
interest of up to 50 percent or more, if necessary, but made it
clear that the day-to-day operations of the company rested with
the small business owner and provided the investor the ability
to step in and assume operations only if the company was in
trouble, do you think this is something you could support?
Mr. Broderick. Thank you for the question. I believe that
that is generally how the companies are operated today. There
is a board of directors that is responsible for the control of
the company, if you will, and we would be happy to work with
you on evaluating that possibility, and, I think, look forward
to doing that.
Ms. Velazquez. Thank you.
Mr. Doerfler, if we limit the amount of venture capital
small biotechs can receive, where will they turn for financing?
Mr. Doerfler. The question is, if we limit the amount of
money we can bring in from venture capital. Well, the venture
capital industry is perfectly suited to support the kind of
work that we are doing because it is very high risk.
Ms. Velazquez. I am referring specifically, if we put a cap
like SBA wants to do.
Mr. Doerfler. Well, we will not be able to participate in
SBIR. We, frankly, will not be able to do that, and investors
will not come into the company unless they can invest as much
as they want to and as much as the company needs to make it
happen. If that cap continues, we will not participate in the
program. It is that simple. It just is not worth our time to
try to get around that.
Ms. Velazquez. So will this cause small businesses to
choose between the SBIR or venture capital?
Mr. Doerfler. Well, it will definitely be venture capital,
not SBIR. We have no alternative. We would have to go with
venture capital because, in my particular instance, our funding
is 98 percent VC funding, and a very small amount is SBIR
funding, and that is what we are doing for additional projects.
Ms. Velazquez. So what will that mean in terms of the
biotech industry regarding development?
Mr. Doerfler. I think that the biotech industry will walk
away completely from the SBIR program. We are not able to
participate.
I think there is another consequence to this. If companies
like ours, like mine, for instance, who have demonstrated the
ability to develop technology, do not participate in the SBIR,
that SBIR program will lose its competitiveness. It will not be
worth what it was before. There is a competitive spirit there.
It raises the level of play, and if you have got a number of
players that cannot participate, it lowers the relevance of
that program and the overall portfolio of companies and
entities that can help NIH.
So I think it is going to have a major effect. It will not
have an effect on the industry as much as it is going to have
an effect on the program and eventually NIH.
Ms. Velazquez. Would you like to comment, Mr. Broderick?
Mr. Broderick. Just one thing. Where would the
biotechnology company go for money if they do not go to the
venture capitalist? And I do not know. I do not think there is
a choice. They would not be funded. They would go out of
business, or they would continue to just get grant after grant
after grant and never commercialize anything.
Ms. Velazquez. Thank you, Mr. Chairman.
Chairman Graves. Mr. Bartlett?
Mr. Bartlett. Thank you very much. For the record, let me
ask, if I am a small business company, and I get an SBIR, and
if, in the process of the work on that, I come up with an
innovation which is patentable, who owns the patent?
Mr. Glover. You would, sir. The SBIR company retains patent
rights under the Small Business Innovation Act.
Mr. Bartlett. Okay. Thank you. If I am a small company, and
I attract venture capital to a project, is that committed to
the project or to my company? Can I separate the project from
the company, or is it given to the company?
Mr. Broderick. It is based on what is given to the company
in general to have the company carry out the business plan,
which includes a product development plan that the company has
come up with, vetted, and otherwise had it reviewed by experts,
and the venture capitalist will put the money inside the
company to support that business plan--
Mr. Bartlett. I understand that under the present rules, if
I am that small business company, and I have an idea that
attracts venture capital money, that if more than half of my
resources are venture capital money, then I cannot now apply
for an SBIR for another idea I have. That is correct?
Mr. Doerfler. That is correct. That is my understanding.
Mr. Bartlett. By the way, I would like to ask Mr. Doerfler,
do you own and control over 50 percent? I think you answered
that. You own and control about 2 percent of it.
Mr. Doerfler. Do I personally?
Mr. Bartlett. Yes.
Mr. Doerfler. Less than 1 percent.
Mr. Bartlett. Less than 1 percent. Okay. I just wanted to
get that on the record.
Mr. Glover, you indicated that there is not now anywhere
near enough money to support the good proposals that come in to
NIH for SBIR funding. Is that correct?
Mr. Glover. That is correct, sir.
Mr. Bartlett. Okay. So we have two things here which appear
to be in tension. One is small companies that have one good
idea or maybe two or three, and they acquire venture capital
funding, which now disqualifies them for SBIR, but, you know,
this engine of creativity is not going to be limited to one or
two.
I, in a former life, ended up with 20 patents, for
instance. If I was pursuing one of those with venture capital
money, then I could get no more SBIR money for one of those
other ideas that I had. So that is on the one hand. We now have
an idea that is going to add something of value to our economy.
It is going to employ people. They cannot get any SBIR money,
and the venture capital people, in spite of their name, are not
really venturous, and they are not going to put any money out
for this, and so now my idea goes begging because I cannot get
any money.
On the other hand, we have legitimate small businesses
where the owner controls more than 51 percent of it, and there
is not even enough money to go around to fund the good SBIR
projects there. Is that correct?
Mr. Glover. That is correct.
Mr. Bartlett. Okay. Well, it seems to me that the solution
to this problem is not to further dilute the effectiveness of
that money by now spreading it over a broader field. It seems
to me we need another program or an additional pot of money to
fund those entrepreneurs who happen to have been successful
enough to attract venture capital money and now have an
additional idea that they want funded. You know, it just does
not seem to me to be productive to go to the same well which
already does not have anywhere near enough money in it to fund
those for whom the program is currently specified. Is that
correct?
Mr. Glover. That is correct, sir.
Mr. Bartlett. Okay. Help me understand why it makes any
sense to try and dilute the effectiveness of that money by
spreading it over a larger field.
Mr. Glover. It does not, but I think, as I said, I
sympathize with the Biotech and Venture Capital Association.
There needs to be a program to take these companies, but it
should not come out of the small business pot. We fought too
hard to establish that small business preference.
Mr. Bartlett. They may still be small businesses, if I
might, but they should not come out of this pot--
Mr. Glover. That is correct.
Mr. Bartlett. --because this is the pot that is designated
for small businesses, just start-up, more than 51 percent owned
by the person. I agree that there needs to be another pot of
money and another program somewhere for these others, but I
cannot see the value of diluting unless we are going to pour a
whole bunch more money into this, and then you could not be
sure it is going to the right place because we have two very
different entities here vying for the money, do we not?
Mr. Glover. We do, indeed.
Mr. Bartlett. Okay. One is an itty-bitty start-up company,
and these other companies that could be not-so-itty-bitty
start-up companies. Thank you very much.
Mr. Doerfler. Dr. Bartlett, may I?
Mr. Bartlett. Yes, sir.
Mr. Doerfler. My company, before we received venture
capital, was 17 employees. We are now 20 employees. So I think,
by any measure, we are still a small company. I do not think it
really made a difference how we got our financing, and the
program worked fine for 21 years.
This change that happened a few years ago changed the
eligibility and forced companies like mine, who had a good
idea, who actually invented something, based on SBIR, put in a
patent application. We are very hopeful we are going to be able
to get that patent, we are ready to go for a Phase II, and we
think it is going to be important, but we cannot participate
now because we have a different form of funding. And we are
still, in my mind, at least my wife's mind, a very itty-bitty
company.
Mr. Bartlett. I am very sympathetic to your dilemma, and
there ought to be a program there for you, and there ought to
be money there for you, but if this present program does not
have enough money for the people who are now in the program, I
am having some trouble understanding how we make the situation
better by making the field larger so that there is going to be
now even a smaller percentage of worthy projects that get
funded.
I think that what our role ought to be, our goal ought to
be, is trying to find more money in another program so that
your second and third and fourth ideas can get the same kind of
SBIR funding that your first one got.
Thank you very much, Mr. Chairman.
Chairman Graves. Mr. Barrow?
Mr. Barrow. Thank you, Mr. Chairman. I want to pick up on
Dr. Bartlett's comments by coming at it from a different route
because, on the one hand, you have got a new definition that
makes the field of eligible participants smaller than it has
been over the last 20 years than commonly understood to be. So
now, all of a sudden, we have got a new order of things in
which a more expansive definition had a larger field of
eligible participants based on their internal organization
structure vying for a piece of the same pie.
I certainly agree with Dr. Bartlett that to the extent we
can provide more resources, we should do so, but unless and
until we are prepared to do that, the question then becomes,
how large should the field of eligible participants be? And the
concern that I have got is that for 20 years we have had an
accepted definition of ``eligible participants'' that has
evolved and been applied consistently over the last 20 years
while something else has been going on at the same time.
Something else that has been going on at the same time has been
the explosion of very capital-intensive ventures that can be
very effectively started up by very small businesses that can
grow into very big enterprises.
I have in mind a growth profile in which an infusion of
$100,000 might be adequate for Phase I, an additional infusion
of $750,000 might be adequate for Phase II, and then the
venture capital folks can get involved at Phase III. But here
we have, over the last 20 years, an explosion in the
biotechnology sector, for example, in which it is possible for
folks to do great things in small companies, but at Phase II
you need a whole lot more than $750,000 to get from Phase I to
Phase III.
So now what we have got, it seems to me, is a new
definition which does not expand the resource pool at all, does
not provide more money, but it does dramatically and all of a
sudden alter the definition of ``eligible participants'' so as
to shrink the pool of eligible people.
Now, in terms of picking winners and losers, I have not got
much to say about that. It is just that it seems to me,
clearly, the burden of proof is on folks who are supporting
this change in definition to say that it is good public policy
to shrink the eligible pool of participants so as to exclude
this very valuable sector of our economy that has grown up in
the last 20 years. The text for my message comes from the Book
of Exodus. There rose up in Egypt a king that knew not Joseph.
Things change, and we have had two patterns going on
simultaneously: this growth in the sector of our economy where
we are going to have explosive growth in very small enterprises
that do not fit the growth profile of the criteria, the amount
of money you can get under this new definition. I sort of feel
like we want to make sure that we continue to make it possible
for folks under the old definition to compete for the same
resources.
Let me follow up on that. Mr. Glover, one of the
explanations that you offered basically in defense of this new
definition which excludes people who have been participating up
until 2003 for Phase II money along with venture capital firms
in their structure is that there is a place for venture capital
firms in Phase III. Well, how do you answer the needs of start-
up firms that need a whole lot more than the $750,000 maximum
you can get in Phase II in order to make the jump, make the
move, from Phase I to Phase III? It is not enough to say that
venture capital firms can come in at Phase III if you cannot
get there from here. So help me understand why this definition
serves that sector of our economy that we want to grow along
with others that fit the more traditional growth profile.
Mr. Glover. Let me first clarify the definition issue
because I think it is important. The Small Business Act and the
rules and regulations at SBA have used the word ``individual''
to mean, in fact, an individual forever, and it is specifically
defined in things like the women's business program, the
minority business program, the 8[a] program, and other
programs.
In 2000, for the first time, that issue came before an
administrative judge at the Small Business Administration to
say what is an individual. It was debated, it was discussed,
and the decision came down in that case that said
``individual'' means individual; it does not mean a corporation
or a trust or anything else. So several people challenged that
decision in subsequent years. Some looked at specifically,
``Well, gee, I am a venture capitalist, and it should not apply
to me,'' and the decision came down, yes, it does. It means
what we said it did in 2000.
So it is not like there was a rule that the SBA changed.
There was an understanding. Now, certainly, some companies
violated what the SBA ruling was in 2000 and 2003, but I am
sure they were innocent and unknowing violations. But clearly,
it is not like SBA suddenly changed something. It was the first
time they were asked to interpret something.
Mr. Barrow. Do not get me wrong on that. My point is that
until that clarification came down, there were firms that fit
that were competing along with those that meet the new
definition who do not meet the new definition as it exists now.
They were competing, and they were participating in the SBIR
program, and they are no longer eligible to do so because of
this clarification. I am not at all being critical or attacking
the means that we got from here to there.
My point is, up until that point, we had the different
folks who qualified under either definition, either the earlier
understanding or the new clarification, participating side by
side and competing for SBIR participation. Now only one can,
and my point is, how do you answer the needs of those folks who
have now been rendered ineligible as a result of the new
clarification?
Mr. Glover. Well, the same way we rendered the needs of
these same companies in whole bunch of areas outside of the
biotech area. By and large, SBIR companies have not had access
to venture capital, with the exception of some biotech areas.
Half of the program goes to defense contracting. You have not
heard any small businesses come in and complain about this rule
from the defense sector. We do not hear noises outside of
anything than really the biotech area.
The challenge to find funding for your technology is the
biggest challenge any small business has. There is no question
that that has been there. It is well documented, and we have
had some programs in the government that tried to work at that.
The advanced technology program, the manufacturing exchange
programs, to varying degrees, have worked at that. There is
some help there. Obviously, getting good funding for your ideas
has always be the biggest challenge in America, and that is
what they have to work hard at, whether they are a venture-
backed fund or not. Some biotech companies actually have
skipped the venture capitals altogether and gone public and
done quite well.
Mr. Barrow. Well, I hear what you are saying, and I want to
work with you to try and make sure that there is enough help to
go around. The concern I got is that we now have folks who are
no longer eligible to participate who were in a sector of the
economy that clearly is an American success story that they
want to nurture and grow. I do not want to penalize other folks
who can compete for opportunities to participate in this
program alongside of folks like that.
But it looks to me like the new clarification is what is
doing the penalizing, and to the extent we can work it out in
such a way that we address the legitimate concerns that big
businesses not be masquerading as small businesses and the
like, and we deal with the problems of effective management and
control being in the hands of the people who are really the
creative inspiration for these enterprises. I think that meets
my concerns without penalizing this sector of the economy.
That makes me want to turn, if I may, Mr. Chairman, to Mr.
Cruz and ask him, but I know that Mr. Michael wants to say
something.
Mr. Michael. May I make a comment, please?
Mr. Barrow. Sure. Go ahead.
Mr. Michael. One thing that is probably helpful for the
Committee to understand is that although we very often talk
about the $800 million needed to develop a drug, the NIH SBIR
programs also support diagnostic products, they support medical
devices, both inside and outside of the body, and many
businesses can get started on much less than the 20, $30
million that might be needed to jump start, and it needs to be
part of our focus.
Mr. Barrow. No question about it.
Mr. Chairman, if I am not trespassing on the Committee's
time, I hear you on that.
Mr. Cruz, you touched briefly, and others have as well, on
the subject of internal management and control, and I think you
just passed on it. Can you help us understand a little bit
better what sorts of things are actually at work in order to
make sure that large venture capital firms are really not able
to control the management of companies such as yours?
Mr. Cruz. There is, as was said, the legal documentation
that determines sort of the voting of each of the classes of
shareholders, and for anything large enough that would impact
the direction of the company, there are votes necessary across
the different classes of shareholders. So there are, as the
company progresses, different shareholders, different venture
capital that invest throughout the life of the company. So
inherent in that is the check and balance of different
shareholders or different funds having control or a portion of
the control for changing the direction of the country. So that
is one level.
Another level, the board of directors is usually defined in
the bylaws of the company, and that usually takes into account,
again, the different classes of ownership,--preferred
shareholders, common shareholders, and management--and that is
usually negotiated between the VCs and the management team and
the previous angel shareholders to make sure that there is not
one single party, one person, controlling, you know, the
direction of the company.
Mr. Barrow. Thank you.
Chairman Graves. Mr. Bartlett?
Mr. Bartlett. Thank you very much. I just wanted to clarify
for the record. We really never changed the rules, did we?
Didn't we just interpret the rules?
Mr. Glover. That is my review of the case law. That is
correct. There is no change in the rule.
Mr. Bartlett. It is still the same rule; it is just that
before, the definition of ``individual'' was not clearly
understood, and now that it has been defined, that precludes
firms that have more than 51 percent venture capital funding
from participating in this program. That is, in fact, where we
are, isn't it?
Mr. Glover. Yes, sir, with the exception that it can be a
small venture capital firm and still be eligible at even over
51 percent.
Mr. Bartlett. Okay. For the record, I would just like to
note again that there is now not enough SBIR money for the good
SBIR proposals, as the participants are now determined by the
interpretation of what an ``individual'' is. If NIH had more
money, they could give it to more good proposals. Is that
correct?
Mr. Glover. Yes, sir.
Mr. Bartlett. Okay. And it is primarily NIH money we are
talking about.
Mr. Glover. Yes, sir.
Mr. Bartlett. Okay. If you are looking at these two
different groups of companies,--one is the really small guy who
started out, has no meaningful venture capital funding, and the
other firm that has had a successful project, successful to the
extent that they have now got venture capital funding--there
are two of them now, and each one of them has a new proposal
they are coming in with, this is not quite a level playing
field because the firm that has already had enough success to
get venture capital funding, they now have a group of investors
who have confidence in them. They have already indicated that
they have an idea good enough that they can fund.
Now, if they cannot convince those people that this next
idea is also good enough to fund, I do not think we have quite
the level playing field with the new firm that has no prior
history and no venture capital funding. And again, I am very
sympathetic to that firm that has more than one good idea. What
the heck are they going to do with the second and the third and
the fourth good idea? They ought to be able to get funding for
that.
But I think, Mr. Glover, you are kind of where I am. They
may need funding but not from this pot because this well is not
even deep enough to fund the good proposals that come in. Is
that correct?
Mr. Glover. That is correct.
Mr. Bartlett. Okay. So I think that what the Committee
ought to be about is finding additional funds, perhaps under an
additional program, so that you do not have these two not quite
on the same playing field, so that you do not have these two
groups of companies competing with each other. But I agree
completely that if we are not able to fund small companies that
have more than 51 percent of venture capital money and a
second, a third, and a fourth good idea, that we are limiting
the opportunities for entrepreneurship and creativity in this
country. But I also agree that if we simply open up this
program to that, that there is not enough money to go around
now. So why would we want to spread this money thinner over a
broader field?
I think that we have a really great argument here for a
specific program and additional funding, and this is the kind
of thing that the Americans and the Congress can support
because you can show a very good return for the taxpayer's
dollar in these programs. Thank you, Mr. Chairman.
Ms. Velazquez. Mr. Chairman, I just would like to work with
you and the Committee and the people here, and maybe what we
could do, expanding on what you were just talking about, the
pot. What we could do is expand the amount of money, instead of
going from 2.5 to 5 percent, that 2.5 is the ceiling. It is the
base. It is the floor. It is not the ceiling. So why can't we
expand the program and then have more people participating?
Mr. Bartlett. My preference would be 2.5 for this program
and 2.5 for another program because they are not quite the same
population of companies. They are just not quite the same. You
would reach the same goal you want to reach, but now you do not
have these little guys competing with the company that is
already bigger, with venture capital and maybe more consultants
and so forth that puts them on a different playing field.
Chairman Graves. Mr. Doerfler?
Mr. Doerfler. I am not sure how long this would take, but I
think there is a tremendous amount of urgency around this
issue. I mentioned a letter that we put into the record by Dr.
Zerhouni, who said that right now it ``undermines NIH's ability
to award SBIR funds to those applicants whom we believe are
most likely to improve human health....'' I think that there is
a concern--at least, I have a concern--that the level of the
applicants today--the applications are not what they were a
year ago or two years ago or three years ago, and it is
affecting public health, and that is something we have got to
address immediately.
I also believe that there will be more data coming in from
analyses at NIH and NCI that we can put more empirical
information around this issue so it is not something that is
subject to opinion, but it is actually subject to someone who
actually is looking at these applications to see if the level
of the quality of the application is actually going up, staying
the same, or going down. That is, I believe, a critical element
of what we need to do with this program.
Chairman Graves. Real quick, Mr. Glover.
Mr. Glover. I have not seen this particular letter, but I
can tell you, on 20 years' experience with the NIH on SBIR
programs, they have been against it from the very beginning.
They fought it. They have announced surveys and data which
looked at universities and rated them on a five scale and rated
small businesses on a four scale and announced we were lower.
Only after we found out, did they have to apologize and say
they were wrong.
They have never been strongly supportive of small business
at the National Institutes of Health, and I would look with
interest at whatever they did based on this long-term history,
not what the current people are doing. They may be doing a fine
job, but I do know this long history, and it has been a very
embarrassing situation, and they have not done their homework.
Chairman Graves. Yes, real quick.
Mr. Michael. One very quick comment. Public policy should
not be based on just what is happening today, I think. Today,
there are many, many people who cannot get venture capital
funding. The flow of money, certainly in the Mid-Atlantic, is
not supporting a lot of companies, so you are left without an
option. It is very impressive to meet people who have those
venture capital alliances, but that is not the norm certainly
in the Mid-Atlantic right now. So SBIR has become increasingly
important.
Chairman Graves. I want to thank all of the witnesses for
being here today. We do have another series of votes. But this
is obviously a very important issue. I appreciate hearing both
sides. We have exposed some very good ideas. You know,
America's technology and innovation is world renowned, and we
certainly want to do everything we can to promote that and push
it forward and provide as much resources as we possibly can
from all sectors. But I do appreciate all of the witnesses
being here. This was a great hearing. Thank you very much.
[Whereupon, at 4:20 p.m., the Subcommittee was adjourned.]
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