Act Seeks to Cut Strings Between U.S. Small Businesses and China, Russia, and Other Countries of Concern
Small businesses that rely on the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs to fund their research and development projects were left on the edge of their seats this September as the reauthorization of those programs hung in the balance. Fortunately, on September 30, 2022—the date on which the programs were set to expire—President Biden signed the SBIR and STTR Extension Act of 2022 (the Act). The Act, which reauthorizes the SBIR and STTR programs until September 30, 2025, is the result of several months of protracted negotiations in which Congress questioned whether the programs provide enough protection against ties between China and other foreign countries of concern and program awardees. These concerns were amplified following reports that state-sponsored Chinese firms were targeting companies funded by the programs and, in some cases, that China was the true beneficiary of the awards, not the United States. This prompted intense scrutiny of the programs, which are intended to fund US startups and small businesses to stimulate technological innovation and meet federal research and development needs, and placed the reauthorization of these programs in jeopardy. Ultimately, however, Congress was able to reach an agreement to reauthorize the programs, but not without some major national security reforms to ensure that American intellectual property remains protected from foreign influence.
The SBIR/STTR programs are intended to encourage small businesses that might otherwise be deterred from pursuing innovation due to the uncertain return on investment to engage in research and development activities that will result in new, cutting-edge technology that will benefit both the federal government and the commercial marketplace. The programs are structured in three phases:
- Phase I – In Phase I, small businesses seek to establish the technical merit, feasibility, and commercial potential of the proposed R&D efforts and to demonstrate their capabilities in order to qualify for further federal funding in Phase II. SBIR/STTR Phase I awards are generally $50,000–$250,000 for six months (SBIR) or one year (STTR).
- Phase II – In Phase II, small businesses continue the efforts started in Phase I, and funding is based on the results achieved in Phase I as well as the scientific and technical merit and commercial potential of the project proposed in Phase II. SBIR/STTR Phase II awards are generally $750,000 for two years.
- Phase III – In Phase III, small businesses pursue commercialization of the results of the Phase I/II activities. SBIR/STTR programs do not fund Phase III; rather, small businesses use non-federal capital to commercialize the results, and/or agencies may award follow-on non-SBIR/STTR-funded R&D or production contracts.
In order to be eligible for SBIR/STTR funding, the current regulations require that an entity must be (1) a for-profit concern, with a place of business located in the United States; (2) more than 50 percent directly owned and controlled by one or more individuals who are citizens or permanent resident aliens of the United States (or by other small business concerns, each of which must be more than 50 percent directly owned and controlled by individuals who are citizens or permanent resident aliens of the United States); and (3) no more than 500 employees, including affiliates. Additionally, in the STTR program, the small business must formally collaborate with a nonprofit research institution in Phase I and Phase II.
The Act imposes new obligations on federal agencies that are required to establish SBIR/STTR programs, amending the Small Business Act (15 U.S.C. 638) to mitigate the risks posed by foreign influence in the SBIR/STTR programs. Specifically, Section 4 of the Act requires agencies to establish and implement a due diligence program designed to assess the security risks presented by small business concerns seeking a federally funded award. These programs will assess the “cybersecurity practices, patent analysis, employee analysis, and foreign ownership of a small business concern seeking an award, including any financial ties and obligations…of the small business concern and employees of the small business concern to a foreign country, foreign person, or foreign entity.” Agencies will also be required to annually report on these due diligence activities, and, not later than 30 days after enactment of the Act and periodically until implementation is complete (the Act requires the establishment of these programs no later than June 27, 2023), agencies must brief Congress on the implementation of these due diligence programs.
Section 4 of the Act also imposes broad new disclosure obligations on small businesses seeking funding through these programs. Each small business concern submitting a proposal or application for an SBIR/STTR award must now disclose its connections to any “foreign country of concern,” which the Act defines as China, North Korea, Iran, Russia, or any other country determined to be a “country of concern” by the Secretary of State. Specifically, small business concerns must disclose:
- The identity of all owners and covered individuals of the small business concern who are a party to any foreign talent recruitment program of any foreign country of concern;
- The existence of any joint venture or subsidiary of the small business concern that is based in, funded by, or has a foreign affiliation with any foreign country of concern;
- Any current or pending contractual or financial obligation or other agreement specific to a business arrangement or joint venture-like arrangement with an enterprise owned by a foreign state or any foreign entity;
- Whether the small business concern is wholly owned in a foreign country of concern;
- The percentage, if any, of venture capital or institutional investment by an entity that has a general partner or individual holding a leadership role in such entity who has a foreign affiliation with any foreign country of concern;
- Any technology licensing or intellectual property sales to a foreign country of concern during the five-year period preceding submission of the proposal; and
- Any foreign business entity, offshore entity, or entity outside the United States related to the small business concern.
The Act restricts agencies from awarding SBIR/STTR funding in some instances to those concerns that have such connections.
These new disclosure obligations come with a bite—Section 5 of the Act permits agencies to claw back funding from those small business concerns that are found to have made a material misstatement to the federal agency that the federal agency determines poses a risk to national security, or if there is a change in ownership, structure, or other circumstances of the small business that the federal agency determines to be a risk to national security. Awardees that are found to have made a material misstatement or have a change in circumstances implicating national security will be required to repay “all amounts received from the Federal agency under the award.” This means that awardees should be especially vigilant in uncovering and disclosing any and all connections with foreign countries of concern, as outlined above, or risk potentially severe financial consequences. Moreover, awardees will be required to regularly report to agencies throughout the duration of the award on any change to their disclosure responses, as well as any discovery of a material misstatement or a change in circumstances implicating national security.
In addition to these significant national security requirements, Section 8 of the Act also imposes increased minimum performance standards for SBIR/STTR awardees, and limits the amount of awards that may be received by recipients that are not meeting the minimum performance standards. Section 8 also requires that, no later than July 1, 2023, and annually thereafter, the Small Business Administration must provide to Congress a list of small business concerns that did not meet the applicable performance standard. Notably, these lists will be kept confidential and will not be subject to disclosure under the Freedom of Information Act.
Small business concerns that rely on the SBIR/STTR programs for funding should rightfully celebrate the renewal of these programs, but they will also need to take steps now to identify any connections to China or other countries of concern that could imperil their ability to take advantage of these programs. As in all things Government contracting, it will be important to ensure that disclosures to the Government of connections with foreign countries of concern are timely and accurate, and that companies are ever vigilant to changes in circumstances that may warrant further disclosure. Small businesses with numerous Phase I/II awards should also ensure that they are prepared to meet the increased performance standards set forth in the Act, or risk limitations on their ability to receive future awards.