How SBIR Grants Attract Venture Capital

Across the United States, in industries from biotechnology to aerospace, entrepreneurs are discovering an unlikely edge in the race for venture capital: a decades-old federal grant program. New research shows that start-ups receiving Small Business Innovation Research (SBIR) awards – competitive government R&D grants – go on to attract private investors at dramatically higher rates than otherwise similar companies that don’t(**). The finding suggests that this infusion of public funding, which comes with no equity strings attached, is acting as a powerful catalyst for young tech companies.

A recent study by the National Academies of Sciences, Engineering, and Medicine compared hundreds of SBIR-funded firms with a matched set of peer companies that never received SBIR grants. The results were striking. SBIR-backed firms were more than five times as likely to secure venture capital or angel investment and over three times as likely to reach a successful exit – via an initial public offering or acquisition – than the non-SBIR firms. In raw terms, 144 out of 901 SBIR awardees eventually obtained follow-on private financing, versus just 26 of 901 in the control group. That “larger proportion of awardee firms” getting funded underscores how an SBIR grant can vault a start-up from obscurity into the sights of venture capitalists.

“Startups often catch the eye of venture capital investors after they land [SBIR] funding from America’s Seed Fund,” observed David Timm, an analyst writing for Crunchbase(**). Indeed, the SBIR program is frequently described as public venture capital – essentially government seed money that helps nascent companies mature to a point where private investors will jump in(**). By injecting early, non-dilutive dollars into high-risk, high-reward ideas, SBIR bridges the notorious “valley of death” between a lab discovery and a commercially viable product – a stage at which traditional investors often balk(**). SBIR grants provide the needed R&D runway and a vote of confidence, so that by the time a project shows proof-of-concept, venture capitalists see a de-risked opportunity rather than a science experiment.

Notably, the National Academies study found that SBIR recipients had raised far less outside capital prior to their grant than the comparison group – in fact, only about one-seventh as much on average. This indicates SBIR is reaching companies that likely couldn’t have funded their research otherwise. “The programs are providing early capital to firms that lack significant sources of support,” the report concluded. In other words, SBIR isn’t just picking winners that were already poised to succeed – it’s making a decisive difference for startups that might have been starved of funds. Many of those startups, once fueled by an SBIR Phase I or II award to develop their prototype or gather data, emerge with a technology validated enough to attract venture funding. Far from crowding out private investment, the federal dollars appear to be crowding it in – effectively priming the pump for VCs by shouldering the initial risk.

Entrepreneurs and investors alike say one key advantage of SBIR money is that it’s non-dilutive – Uncle Sam takes no equity stake. “Many investors love SBIR funding because it is non-dilutive,” notes Kevin Christopher, a startup attorney, meaning it boosts the company’s prospects without shrinking anyone’s ownership share(**). An SBIR grant might pay for a critical round of experiments or a prototype build-out, so the startup can hit technical milestones without giving up a chunk of equity. For venture capital firms, that nondilutive boost is highly attractive: by the time they invest, the company is further along and more valuable, yet the founders (and thus future investors) still retain full ownership of the progress funded by SBIR. Early federal grants can effectively make subsequent investments more rewarding. “Investors often ask, ‘Have you gotten any grants or awards?’,” says Bryce DelGrande, a vice president at Fidelity Private Shares, emphasizing that grants de-risk a startup’s story in the eyes of VCs(**).

Beyond the balance sheet, SBIR awards carry a prestige that money alone can’t buy. Winning one means surviving a rigorous scientific peer review and proving that the idea has technical merit and commercial promise. This confers a stamp of approval that resonates with partners and funders. “An NIH SBIR grant is much more than just a check,” explains a guide for grant-seekers. “Getting through the tough peer-review process is a huge stamp of approval. It tells private investors, potential partners, and future customers that your technology is the real deal”. The sentiment echoes earlier findings by the National Research Council that SBIR awards serve as a “certifier of promising new technologies,” encouraging follow-on private investment in those firms. In effect, the U.S. government’s endorsement reduces uncertainty – reassuring venture capitalists that a startup’s science has been vetted by experts. That credibility can “make a big difference when negotiating equity deals” later on.

The federal SBIR program, launched in 1982 amid a push to spur innovation, now spans 11 agencies and pumps out over $3 billion annually in research grants to small businesses. In 2012, for example, SBIR agencies together awarded about $2.4 billion for very early-stage projects – nearly triple the mere $820 million that all U.S. venture capital firms put into seed-stage investments that year. This little-known fact reflects how venture capital has increasingly shifted toward later, less risky deals, while SBIR consistently funds true seed research. From defense drones to cancer therapeutics, SBIR grants have seeded startups in virtually every high-tech sector, often targeting nascent markets or cutting-edge fields that VCs hesitate to touch initially. Even some of today’s headline-making companies took advantage of SBIR support in their early days, underscoring the program’s broad impact. (The consumer DNA testing firm 23andMe, for instance, received SBIR funding as a young startup(**).)

For would-be founders, the implications are clear. Securing an SBIR grant can dramatically amplify a startup’s trajectory – providing cash, credibility and connections that make private investors more willing to come on board. “Grants and awards act as third-party validation, showing equity investors that others believe in your business’s potential,” observes Thuy Cusato, a J.P. Morgan startup banking vice president. Venture capitalists, for their part, are increasingly aware that an SBIR-backed company may be a better bet. After all, by the time an SBIR Phase II project is complete, much of the technical risk has been retired on the government’s dime, not the VC’s. As one startup CEO quipped, the best investor is a customer – and the federal government is essentially a paying customer for your R&D. Little surprise, then, that startups with SBIR funding have become magnets for venture capital in recent years.

There are, of course, important caveats. SBIR grants come with strings in the form of reporting requirements and, in some cases, limitations on majority ownership by venture firms (rules intended to ensure awards go to bona fide small businesses). Some founders find the application process cumbersome or worry that chasing government funds could distract from market execution. Yet experienced SBIR veterans say these hurdles can be managed – especially given what’s at stake. “With proper guidance…the SBIR process, from application to closeout, can be quite focused,” Christopher writes, pushing back on the notion that startups can’t handle both grant work and growth. In fact, many incubators and regional programs now help companies navigate SBIR paperwork precisely because the payoff can be so high.Ultimately, what the data now validates is a scenario long suspected in the start-up ecosystem: when the government acts as an early investor – effectively providing public venture capital – it boosts the likelihood that private venture capital will follow. The SBIR program’s outsized success in translating research grants into commercial wins suggests a synergistic relationship rather than a zero-sum game.

For entrepreneurs, an SBIR award can be a golden ticket to later investment. And for society, it hints at a virtuous cycle in which public funding for innovation draws in even greater private funding, accelerating the journey from lab bench to marketplace. In the high-stakes world of start-up financing, that partnership between Uncle Sam and Sand Hill Road may be turning out to be one of the most potent combinations of all.