Enterprise and Small Business Principles

Innovation and public policy in the US

The federal government has played an active role in financing new high-technology firms since the Soviet Union launched the Sputnik satellite in the late 1950s. In recent years, European and Asian nations, and many US states, have adopted similar incen­tives. While these programmes’ precise structures have differed, the efforts have been predicated on two shared assumptions: that the private sector provides insufficient capital to NTBFs and that the government can identify firms where investments will ultimately yield high social and/or private returns.

Since 1980, the federal government has instituted active policies in support of these dynamic NTBFs. Building on experiences in the states, Congress and the execu­tive branch created new programmes in which government and the private sector are partners in developing and deploying new technologies. These programmes include the Small Business Innovation Research (SBIR) programme, the Small Business Technology Transfer (STTR) programme, the Advanced Technology Program (ATP), the Manufacturing Extension Partnership (MEP) programme, and several financing programmes for high-technology companies administered by the US Small Business Administration.

These programmes stress commercialisation potential, non-financial assistance and better intellectual property rights protection. They represent only a small fraction of America’s total investment in research and development (R&D), but in leveraging money to the public and private sectors they have an economic impact far greater than that suggested by the programme budget alone. Taken together, the programmes rep­resent an important commitment to the process that allows small technology-based businesses to use their unique competencies to address federal research needs, create new products and processes, and bring them to commercial markets.

In addition to providing basic management, technical and research assistance to pre-venture entrepreneurs and existing small businesses, a number of SBDCs are emphasising assistance to technology companies. Specialised services include commer­cialisation help, assistance to inventors and manufacturers, SBIR application assist­ance and services to NTBFs. The SBA has also established an agreement with the US Department of Commerce to establish SBDC field offices at manufacturing extension centres to improve the competitiveness of small and medium-sized manufacturers by providing management and marketing consulting and guidance.

5.8.1 Financial support for NTBFs

The US Small Business Administration (SBA) has several loan programmes that assist small businesses whose primary activity is in the high-technology industry. Two pro­grammes that currently assist some 2,000 high technology businesses annually are the Section 7(a) and 504 loan. The Section 7(a) loan programme authorises the SBA to guarantee loans made by lenders to small businesses that cannot obtain financing on reasonable terms through normal lending channels. The SBA can guarantee 75% of the loan amount up to $750,000. For loans of $100,000 or less, the guarantee rate is 80%. The interest rate is not to exceed 2.75% over the prime-lending rate.

Through certified development companies (CDCs), the 504-loan programme pro­vides long-term, fixed-rate financing to small businesses to acquire or construct facil­ities for their operations or to purchase machinery and equipment with a useful life of ten or more years. Typically, project proceeds are provided as follows: 50% of the pro­ject cost is financed by an non-guaranteed bank loan, 40% by an SBA-guaranteed debenture that is sold to investors at a fixed rate, and 10% by the small business. The maximum SBA debenture is $750,000, except under certain circumstances when it can be up to $1m. Job creation and retention is the main purpose of the programme.

In addition to these established loan programmes, the two-year pilot capital access programme was conceived to help direct the SBA’s limited loan resources to busi­nesses that may have a greater impact on the nation’s overall economic well-being. It is based in part on a proprietary computer-based market segmentation programme developed by Citibank that identifies and targets businesses involved in the development and utilisation of newer technologies, potential job creators and prospective exporters. Minority-, women - and veteran-owned firms are also targeted under this programme. The programme includes a mutually agreed set of credit standards and a streamlined loan application process. So far, nine loans for a total of $1,663,000 have been made to high-technology firms under the programme.

5.8.2 Angel Capital Electronic Network

A series of nine focus groups sponsored by the SBA’s Office of Advocacy between September 1995 and March 1996 confirmed the existence of a significant gap in equity capital for rapidly growing firms needing between $500,000 and $1.5m. Entrepreneurs can often raise amounts under $500,000 from their personal resources (investments, second mortgages, credit cards, families, friends and colleagues). For amounts up to $1.5m, however, it is very difficult to raise the third-party equity capital so essential to the success of rapidly growing high-technology businesses.

Popular mythology has it that the organised venture capital industry has sufficient capital to meet the needs of high-potential small businesses, that the shortage is not of capital but of ‘good deals’. The myth is both popular and false: the organised ven­ture capital industry has always been a limited market. Fewer than 1,000 deals are consummated in a year and fewer than 100 are starting or seed deals. As the amount of funding flowing into the industry has increased, the number of deals has remained essentially static. The average size of a deal has increased dramatically: organised ven­ture capitalists rarely fund deals under $3m.

Many of the NTBFs with promising technologies, products and markets need rela­tively small amounts of equity capital to commercialise and produce their products. These firms have traditionally turned to the informal private equity capital that goes under the name ‘angel capital’. This market has been estimated at 30 times the size of the venture capital market. Because angel capital is both informal and private, know­ledge about the nature and extent of the market is limited. The Office of Advocacy’s nine focus groups examined the problems associated with angel capital and its poten­tial to meet the needs of rapidly growing small businesses. The focus groups confirmed that despite the essential role angel financing plays, the market has inefficiencies asso­ciated with a lack of organisation and high transaction costs.

SBA’s Office of Advocacy, in cooperation with the University of New Hampshire’s Center for Venture Research, recently examined how the process could be improved. Clearly, the market would work better if the angel investors had access to more poten­tial deals and the entrepreneurs had exposure to more potential investors. The trick was to design a system that would provide greater dissemination of information without notably increasing the potential for fraud and abuse. The new system, unveiled in October 1996, is ACE-Net, the Angel Capital Electronic Network. ACE-Net covers eight of the most successful regional angel capital networks with a password-controlled, secure Internet network. The network will serve as a locator for serious investors and entrepreneurs interested in finding each other. A series of carefully crafted security mechanisms will help protect the process from fraud and abuse.

ACE-Net addresses the problem of high transaction costs by introducing a set of standard terms to reduce the time and cost involved in each transaction. The primarily university-based regional networks are ideally positioned to provide education and information about the angel financing process to potential angels and entrepreneurs. As the network begins to operate, it should increase the number of angels, the poten­tial amount of angel financing available, and the efficiency of the process.

5.8.3 Small Business Innovation Research programme

Federal research and development that strengthens the national defence, promotes health and safety, and improves the nation’s highways and airports is vital to the long­term interests of the United States and its citizens. The SBA, through the Small Business Innovation Research (SBIR) programme and its smaller companion programme, the Small Business Technology Transfer (STTR) programme, helps ensure that innovative ideas developed by quality small businesses are a part of these efforts. These programmes ensure that some $1bn in federal R&D projects goes to small businesses each year. SBIR is an integral component of a national technology strategy and the primary access point for NTBFs to participate in federal R&D efforts.

In 1982 Congress passed the Small Business Innovation Development Act, author­ising the SBIR programme. The nation had just undergone a long period of economic stagnation and policymakers were looking for new economic answers. International competition, particularly in producing and marketing technology, was growing more intense. The US had the largest R&D effort in the world - a scale of scientific enter­prise unequalled in history - and America’s international competitors were becoming more successful at producing and marketing innovations derived from that research.

The SBIR programme was designed to address these perceived problems in several ways. It increased the competition for federal R&D work by opening it to small busi­nesses. The scope and funding of each project was designed to attract talented entre­preneurs. Projects were chosen to fulfill each government agency’s requirements for innovative solutions to their technology-oriented problems. To improve the nation’s economic competitiveness, the programme was designed to encourage entrepreneurs to bring innovations derived from federal R&D into the marketplace.

Today’s SBIR programme is a competitive procurement activity designed to meet the R&D needs of the federal government. Each federal agency with an extramural R&D budget in excess of $100m must designate a certain percentage of this budget for small business. Ten federal agencies currently participate in the programme: the Depart­ments of Defense, Agriculture, Commerce, Education, Health and Human Services, Transportation and Energy, the Environmental Protection Agency, the National Air and Space Administration and the National Science Foundation.

In the three-step SBIR process, small businesses can earn awards up to $100,000 for phase I and up to $750,000 for phase II. Phase III looks to the private sector for fund­ing. Successful bidders can be awarded up to $100,000 to perform a feasibility study as phase I. If the small firm and the agency then agree, the firm can be awarded a phase II contract or grant for actual R&D resulting in a model or prototype. In the third phase - commercialisation - the small firm is encouraged to bring the innovation to market.

At the completion of the second phase the government has the rights to the innova­tion for its own use only; that is, the government will never pay the firm a royalty. But the small firm keeps all other rights to the innovation and is encouraged to patent, copyright or take other measures to protect its position. The firm can then bring the innovation to the marketplace, producing the product or service directly or working out co-venturing or licensing arrangements.

By some measures the SBIR programme has been highly successful. Since its incep­tion in the 1983 financial year, small high-technology firms have submitted more than

220,0 proposals resulting in more than 33,000 awards. Although the programme’s primary purpose is to meet the government’s R&D requirements, the incidental benefit is substantial: more than 25% of SBIR projects have become products or services sold in the marketplace. The public reaps the benefits of the government research and the business participants improve their competitive positions and profitability. The SBIR programme is meeting not only the research goals of the funding agencies, but also a special need for high-risk seed and start-up capital. The current level of almost $1bn in SBIR funding each year is more than ten times the funding provided by the institu­tional venture capital organisations to these small technology firms.

5.8.4 Small Business Technology Transfer programme

The Small Business Technology Transfer (STTR) programme is a three-year pilot pro­gramme, funded in 1994 through a small allocation from five federal agencies’ extra­mural R&D budgets. The purpose of STTR is to tap research institutions for the enormous reservoir of ideas that have not yet been deployed effectively for the nation’s economic benefit. These research institutions employ one in four R&D scientists and engineers in the US and are involved in more than $40bn in R&D each year. They have helped position the US as undisputed world leader in basic research and many areas of applied research. The one-quarter million scientists and engineers in these institutions often recognise that their research has important commercial applications, but few have efficient mechanisms to pursue these applications.

STTR is an important step toward harnessing this research for America’s economic advancement. By merging the innovative ideas of the researcher at the research insti­tution with the entrepreneurial skills of a small technology company, STTR creates an efficient vehicle for moving the ideas to market. University collaboration with new technology-based firms has the potential to stimulate innovation more than R&D performed solely in a company lab. Route 128 in Massachusetts and Silicon Valley in California are centres of high-tech economic development precisely because of univer­sity interaction with small, innovative companies.

Both STTR and SBIR programmes serve the purpose of transforming innovative research into commercial reality. STTR uses the approach established in the SBIR pro­gramme, which has proven remarkably efficient in stimulating technological innovation. But whereas SBIR funds R&D projects at small firms and limits the participation of research institutions to a subcontracting or consulting role, STTR funds cooperative R&D projects between an NTBF and a research institution. STTR enables a researcher at a university to spin off a commercially promising idea by joining forces with a small technology company. Thus, STTR is a mechanism for small businesses to tap into the vast reservoir of ideas in the nation’s research institutions.

5.8.5 Advanced Technology Program

Small firms are thriving in the rigorous, hard-fought competitions of the Advanced Technology Program (ATP), which is managed by the US Department of Commerce’s National Institute of Standards and Technology (NIST). Of the 280 awards made by the ATP from 1990 to 1996, nearly half went to individual NTBFs or to joint ventures led by a small business. The awards are valued at $970m in ATP funds and more than $1bn in industry cost-share. Many more NTBFs are participating in or benefiting from the programme as members of ATP-funded joint ventures, and as subcontractors, sup­pliers and customers of ATP awardees. And small means small in the ATP. Many of the awardees have been start-ups or still in the early development stages. More than half of the 100 small, single-company awardees had fewer than 25 employees and more than 85 had fewer than 100 employees at the time they received the ATP award.

In partnership with the ATP, these NTBFs are developing high-risk, enabling tech­nologies that they can translate into new business opportunities, new industrial pro­cesses to improve their productivity and the productivity of other US producers, and new products and services for the world’s markets. Some of these technologies are path breaking in that they will revolutionise existing ways of doing things or create whole new industry sectors. Some provide the technical infrastructure critical to productivity advances within an industry sector. And some have many different uses across a variety of industry sectors.

Although most of the ATP-funded projects are still in their early stages, the parti­cipants, including the small companies, have begun to report promising results. The ATP awards are enabling these companies to pursue challenging research projects that otherwise would have been delayed, scaled down or not done at all. As a result, many of the companies now have important new technical capabilities that enable them to attract other sources of capital and pursue new commercial opportunities. Some are growing rapidly. New and improved processes, products and services are emerging that benefit not just the award-recipient companies but also other researchers, producers, consumers and, ultimately, the nation.

5.8.6 Manufacturing Extension Partnership

The Manufacturing Extension Partnership (MEP) is a growing nationwide system that gives smaller manufacturers unprecedented access to new technologies, resources and expertise. At the heart of the system is a network of affiliated, locally based manufacturing extension centres. Each centre is a partnership, typically involving federal, state and local governments; industry; educational institutions; and other sources of expertise, information and funding support.

Centres are private, non-profit organisations rather than offices of the federal gov­ernment. The programme began with three extension centres in 1989. Today, nearly all states and Puerto Rico already have or are planning centres affiliated with MEP, linking firms with engineers and other specialists with manufacturing or business experi­ence to address specific needs. Through this network, MEP is putting hard-to-find tech­nical assistance and the newest business practices within the reach of the nation’s

381,0 small and medium-sized manufacturing establishments.