The U.S. Small Business Administration (SBA) seeks public comments on whether it should provide an exclusion from affiliation for venture capital companies (VCC) in size determinations for eligibility for the SBIR Program. Under such a policy, VCCs that invest in SBIR participants would not be considered affiliates of the SBIR participant and their size would therefore not be included in determining the size of the participant.

On June 4, 2003, SBA proposed in the Federal Register, 68 FR 33412, to modify §121.702 of its Small Business Size Regulations (13 CFR part 121) to allow a small business that is owned and controlled by another business concern to be eligible for funding agreements under the SBIR Program. The size standard for the SBIR Program requires that an eligible small business concern, with its affiliates, have no more than 500 employees. The proposed rule did not propose to change this 500 employee size standard for the SBIR Program. The rule proposed only to modify the small business eligibility requirements so that the SBIR awardee must meet one of the two following additional criteria: (1) it must either be a for-profit business concern that is at least 51% owned and controlled by one or more individuals who are citizens of, or permanent resident aliens in, the United States (as the regulations currently require); or (2) it must be a for-profit business concern that is 100% owned and controlled by another for-profit business concern that is itself at least 51% owned and controlled by one or more individuals who are citizens of, or permanent resident aliens in, the United States. Comments on the proposed rule were due to SBA by July 7, 2003. SBA received 164 comments to the proposed rule. SBA has not yet issued its final rule, but expects to do so in the very near future.

Sixty commenters addressed an issue related to VCCs that was not a subject of the proposed rule. Forty commenters stated that a concern should be allowed to participate in the SBIR Program if one or more VCCs have majority ownership or control of the concern. In addition, most of these 40 commenters believed that if one or more VCCs owned or controlled a concern, the VCC should not be deemed affiliated with the concern. The justification offered was that VCC investment is crucial to startups in the biotech industry and that SBIR funds are needed to reduce the private risk of these investments. The remaining 20 commenters, however, were opposed to any proposal that would allow a concern to participate in the SBIR Program if one or more VCCs have majority ownership or control of the concern. These commenters expressed their concern that because VCC firms often represent and are established by large corporate interests, allowing their subsidiaries to receive SBIR awards could result in SBIR funds, which are reserved for small business concerns, being used to subsidize research projects of large corporations.

The relationship of a VCC or other investment vehicle to an SBIR participant is a broader policy question than SBA sought to address with the June 4, 2003, proposed rule. Under current regulations (§121.103, "What is affiliation?"), when VCCs have control of a firm in which they invest, they are considered affiliated with that firm, just as any other business entity would be if it had ownership or control.

SBA’s Small Business Size Regulations in 13 CFR §121.103 provide a small number of exclusions from affiliation. Concerns owned in whole or substantial part by Small Business Investment Companies (SBICs) or development companies licensed under the Small Business Investment Act are not considered affiliated with the SBIC or development company. Also, concerns owned and controlled by Indian Tribes, Alaska Regional or Village Corporations, Native Hawaiian Organizations and Community Development Corporations are not considered affiliates of these entities solely because of their common ownership and common management. Further, the regulation excludes VCCs, as defined in U.S. Department of Labor regulations (29 CFR §§2510.3-101(d)), from affiliation with concerns receiving assistance under the Small Business Investment Act. (The SBIR Program is established under the Small Business Innovation Development Act, not under the Small Business Investment Act.)

SBA believes that determining whether VCCs should be excluded from affiliation under §121.103, assuming the small business concern meets the ownership and control criteria established by the SBA, requires a separate rulemaking action, affording the public an opportunity to comment directly on SBA’s proposal. Although SBA’s June 4, 2003, proposed rule did not address this issue, substantial public interest has persuaded SBA to seek additional comments directly on this question. SBA has not determined at this time if it will propose to exclude VCCs from affiliation or to provide some other type of exemption for VCC investments, but is seeking public comment on whether it should propose such a change to its affiliation rule.

SBA requests comments on the issue of whether it should propose a change to the size affiliation regulation for SBIR Program purposes by allowing business concerns that are majority owned or controlled by one or more VCCs to be eligible for SBIR awards, regardless of the ownership and control of the VCCs. SBA is seeking information on how such a change is likely to impact the program and its participants, and how such a change could be implemented while at the same time ensuring that the SBIR Program remains a program that benefits small business entrepreneurs.

Specific issues that SBA is seeking information on include the following:

1. The role of VCC financing on SBIR projects during Phases I and II.
2. The impact of such a change in eligibility requirements on the composition of SBIR participants. For example, would the program shift towards lower-risk technologies closer to market, or become more geographically concentrated following industries and areas of venture capital focus?
3. The types of firms and projects that would benefit most from such a change, and those that would benefit the least.
4. Whether an exclusion from affiliation for VCCs would require justifying limiting the exclusion to VCCs and not including other entities such as not-for-profit organizations.
5. Whether or not granting VCC exclusion from affiliation would adversely affect the ability of small business concerns without such access to private capital to compete for SBIR awards.
6. Whether the participation of firms owned and controlled by VCC firms would ultimately create an environment of multiple repeat award winners.
7. Alternative approaches that may assist small business concerns in obtaining and utilizing VCC funding while participating in the SBIR Program, aside from a policy that requires an exclusion from affiliation for VCC majority-owned small business concerns.

If SBA ultimately determines that it is necessary to develop a proposed rule on this issue, then it will perform an analysis mandated by the Regulatory Flexibility Act (RFA). As part of an RFA analysis, SBA must determine whether the rule will have a significant economic impact on a substantial number of small entities. The RFA defines small entities as small business concerns, small not-for profit organizations, and small governmental jurisdictions. Thus, SBA is seeking comments to determine the number and type of small entities that would be affected by a rule that would provide an exclusion from affiliation for VCC companies in size determinations for eligibility for the SBIR Program. In addition, SBA is seeking comments on the number of small business concerns competing for SBIR awards that have received venture capital funding and the number of VCC majority-owned small business concerns that potentially may be interested in participating in the SBIR Program.

As part of an RFA analysis, SBA must also determine whether the rule will have a significant economic impact on these small entities. To make this determination, agencies seek information about the percentage of revenues or profits affected by the rule. Therefore, SBA is also seeking comments on the costs to small entities if SBA implements a rule that would provide an exclusion from affiliation for VCC companies in size determinations for eligibility for the SBIR Program. Such costs include implementation costs and the effect the rule would have on profits or revenues, i.e., whether it would it reduce profits or raise or lower revenues.

Comments on any other aspect of the SBIR Program that might directly affect whether or not SBA should propose excluding VCCs from affiliation for purposes of the SBIR Program are also welcome.

Dated: September 15, 2004.

SMALL BUSINESS ADMINISTRATION
13 CFR Part 121
RIN 3245-AF22
Small Business Size Standards; Selected Size Standards Issues
AGENCY: U.S. Small Business Administration.