The National Defense Authorization Act (“NDAA”) for Fiscal Year 2012 extended the Small Business Innovation Research (“SBIR”) and Small Business Technology Transfer (“STTR”) programs through September 30, 2017. Also, for the first time, the NDAA allowed SBIR and STTR small businesses to be majority-owned by Venture Capital Operating Companies (“VCOC”), hedge funds or private equity firms (collectively “investment firms”), without regard to whether or not the investment funds themselves were small or large businesses. This is a game-changer for high tech small businesses that have been chronically hampered by restrictions on outside investment.
To implement this dramatic change, on May 15, 2012, the Small Business Administration (“SBA”) issued proposed regulations to identify the ownership and control limitations applicable to investment firms and to take exception to some of the SBA’s traditional affiliation rules where investment firms owned SBIR and STTR companies.
Ownership and Control:
To be eligible for the SBA’s SBIR and STTR programs, a small business applicant must be:
- A “domestic business concern,” defined as:
- Created for profit;
- Having a place of business located in the United States;
- Operated primarily within the United States; or makes a significant contribution to the U.S. economy through payment of taxes or use of American products, materials or labor; and
- Created or organized in the United States or under U.S. or any State law.
- More than 50% owned and controlled by U.S. citizens, permanent resident aliens, or domestic business concerns; or
- Majority-owned by multiple domestic investment firms; and
- Registered with the SBA on or before the date they submit a response to an SBIR solicitation.
What a SBIR or STTR can’t have is more than 50% ownership by one, single, domestic investment firm.
- Stock Ownership Control: The SBA’s current affiliation rules provide that if a small business’ stock is widely held, with no single block of stock being large (as compared to others), then the small business is not ‘controlled’ by any large business shareholder. Conversely, general principles of affiliation also provide that if 2 or more persons own, control, or have the power to control less than 50% of the concern’s voting stock, but the blocks of stock are equal in size, then the stockholders, not the company, are in control – and should any of these stockholders be large, the small and the large businesses will be considered affiliated.
The SBA proposes to exempt SBIR and STTR companies from these specific affiliation rules when the SBIR’s or STTR’s voting stock is widely held, or when there are two or more persons holding large blocks of voting stock, but no one person owns more than 50% of the stock. Notwithstanding the general rule, for SBIR and STTR companies with a majority interest held by investment companies, this situation will not create an affiliation or control issue.
- Identity of Interest: The SBA’s current regulations presume an affiliation based on identity of interest between family members with identical or substantially identical business or economic interests or when the small business is economically dependent based upon contracts, loans or other arrangements with its large business investors.
At this time, the SBA is allowing only one only clear exception to the identity of interest affiliation and that is because the NDAA specifically stated that the SBA cannot find an investment company to be affiliated with an SBIR or STTR applicant solely because the two have shared investors. So, for the time being, overlapping investors in both the SBIR/STTR and its investment firm shareholders will not, by itself, establish such an identity of interest to create an affiliation.
The SBA is seeking public comment on the rule, which will be considered by SBA before publishing a final rule which is due on or before July 16, 2012. 77 Red. Reg. 28520 (May 15, 2012).