Have A Moonshot Idea? The NSF is the investor for you!

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From sending a man to the moon to putting a portable computer in everyone’s pocket, today’s technological and scientific renaissance is the product of great innovators — people who push boundaries and test the limits of science and technology as we know it.

But the brightest minds must first be allowed to experiment and grow.
The National Science Foundation’s (NSF) Small Business Innovation Research (SBIR) program lets America’s innovators take those chances. Ben Schrag, a senior program director for the NSF’s Small Business Innovation Research program, and his colleagues are working with startup companies that are exploring new frontiers.

From growing energy-efficient bricks with biology to harvesting synthetic spider silk to make more durable clothing, the companies on their radar are exploring new frontiers. Schrag and his colleagues take pride in funding some of the most technically risky small businesses and startups in the United States.

Schrag recently spoke to Propel(x) about how NSF’s small grants are encouraging innovation, some of the exciting technologies that are being supported, and how they’re raising funding for the innovations that possibly will build the great companies of tomorrow.

Swati: How does Small Business Innovation Research (SBIR) work? How do you interact with the private sector, find companies, evaluate them, and fund them?

Schrag: 11 government agencies have Small Business Innovation Research programs, and what they all have in common is that the government is giving either a grant or a contract to a small business to support the research and development of some new product or service that the agency thinks is valuable.

Swati: And I understand you look at all of these deals from the NSF lens. What is your charter at the NSF?

Schrag: The National Science Foundation as a whole mostly supports ‘blue-sky’ scientific discovery – science for the sake of science. The Small Business Innovation Research program, on the other hand, is a small piece of NSF that helps move that scientific discovery out of the lab and into the marketplace by funding small businesses to do R&D for eventual commercialization.

In the NSF SBIR Phase, we are looking at a very early stage, risky, innovative technologies, and our goal is to support technologies as early as possible, usually before any other private funder or agency is willing to jump in because the technology risk is too high. We try to do that across a very broad set of technologies, with very few exceptions; almost any technology with innovation, technical risk, and commercial potential is a candidate for support by NSF.

Swati: And how do you source these companies, and how are you finding them so early?

Schrag: We use a lot of traditional tools of entrepreneurs, so word of mouth is the most powerful thing we have. We have about 500 companies we touch every year, and we try to use those folks as ambassadors.

We are trying to also do a lot of outreach to like-minded organizations, such as Propel(x), as well as to colleges and universities–where we have a pretty high brand recognition–and the program directors such as myself do a lot of outreach events anywhere there are concentrations of entrepreneurs. Every week there’s at least one or two of us who are out in the community talking to entrepreneurs and innovators.

Swati: How many of these companies do you fund a year?

Schrag: At any given time we are actively funding something like 400 to 500 different projects. And most of the companies we fund have a single project with NSF. So the number of different small businesses that we support is almost as high: something like 400 that are getting NSF support at any given time.

Swati: So in a year, how many do you think you award?

Schrag: The total budget for the full federal government in the last fiscal year was about two and a half billion for SBIR and STTR. The NSF last year was about $170 million. And the number of awards we made last year was something like 400.

Swati: As a funding source, how are you different? How does the Small Business Innovation Research differ from VCs, Angels, or other private investors?

Schrag: One big, important advantage for entrepreneurs is that we’re non-dilutive – we don’t take a share. Plus, we’re willing to take a risk and fund a company that hasn’t had earnings or fully proven its technology.

We want the most innovative ideas that could have the biggest payoff for society. We hope that the companies we fund can overcome the technical risks through more R&D funding and hit a home run in the market. We call it ‘seed funding’ and we ultimately hope the companies grow large enough to create jobs and generate income for the United States in the form of taxes.

The government does not take an equity position in our grantees, and we don’t require repayment of our funds. In some agencies, there may be agency-driven deliverables as part of a contract, but at the NSF, we use a more flexible NSF small grant funding mechanism.

However, we do strongly push, motivate, and mentor our awardee companies to aggressively commercialize because that’s the outcome that we’re looking for. As far as differentiators specific to NSF, I think something that sets us apart is that we do not have a topical focus. So there’s no technology area we’re particularly interested in or trying to focus on.

You can imagine that the Department of Energy is looking for energy-related companies and NASA is looking for companies that have some technology that is useful in space. The National Science Foundation is unique in that we don’t have that silo, and so we’re able to support an even broader set of entrepreneurs without significant topic or sector restrictions.

Swati: Help us understand what the NSF SBIR Phases — e.g. ‘Phase I grant’, ‘Phase II grant’ — are when you bring a new company on board and what they indicate in terms of the maturation of the technology that you’re investing in.

Schrag: Sure. While this differs from company to company, ‘Phase I’ is generally what we call the feasibility demonstration. The goal here is to show that the underlying technology could be made to work in a way such that the market would be interested in it–so it’s proof of concept in some sense. At NSF SBIR Phase, our Phase I awards are generally for $225,000.

The ‘phase II’ project is considered research and development toward a prototype.
Again, there’s some variability in these stages because some technologies and markets move faster. For example, we fund some software projects that are very likely already in the market by the end of phase II.

In contrast, new biomedical technologies or new materials technologies may take five to seven years to bring to market, and in these cases, phase II may not even get you to a true prototype. We’re trying to be flexible about supporting a lot of different entrepreneurs with different markets and different technical areas.

The Phase II funding ranges from as low as $300,000 at some agencies to as high as $1,000,000 at others. At NSF SBIR Phase, our Phase II funding level is $750,000, with the potential for significant additional matching funding in certain cases.

Swati: Now obviously you’re a part of a wide funding community, and I’m interested in understanding how you encourage your companies to work with Angels or VCs and what kind of programs exist to bridge from grant to investment.

Schrag: First and foremost, having an NSF grant signals to the investment community that a company has sound science. It’s a stamp of approval. And, the NSF Small Business Innovation Research program doesn’t just give small business money and then move on to the next grant. We work closely with all of our grantees to help them succeed.

We encourage our companies to think about third-party investment from the very beginning. It’s almost impossible to start thinking about investment too early, in our experience. This is very important to us because external investment not only helps our grantees to have the funding to keep moving forward even after our project is over, but it also signals to new potential applicants that NSF SBIR can set up a company for additional private-sector support.

As far as the kind of programs we have — we do a lot of old-fashioned entrepreneurial education. We bring in folks to help our grantees understand how to engage VCs and Angels and what they look for. We have networks of our own that we sometimes can plug our entrepreneurs into. We also have a couple of programs of our own.

The most prominent and powerful is Phase 2B, which is another funding opportunity where companies that are Phase II awardees at NSF can have third-party investment, sales, or some kind of validating revenue from a third party, matched by NSF. We’ll potentially match 50 cents of every third-party dollar, up to an additional half million dollars under this program.

So, on top of the phase two award which is three-quarters of a million, if they can bring in a validating investment or product sale that shows that the NSF funding has led to these dollars coming in, they’re in a position to get up to an additional half million from NSF. And almost half of our Phase II companies can successfully raise some kind of funding like that.

Swati: And then for those entrepreneurs who are seeking grants from you, what are your suggestions for how to approach Small Business Innovation Research and what you are looking for, how they can stand out in their application?

Schrag: There are two important criteria we look for in terms of trying to understand if you are a good fit.

One is, again, innovative, deep science or technology. The hallmarks of this are the potential for strong technical differentiation of the company in the market, and also the existence of risky, unproven technology aspects.

Because of this, high technology risk is something that is required for our companies at the Phase I level. It’s ironic, of course, that many investors out there tend to avoid funding companies with significant technical risk. At NSF, not only do we tolerate this, we require it.

In other words, we want to see that the technology has the potential to still fail, and even to potentially bring down the company in the case that it cannot be successfully developed.

We’re looking for things like new drug delivery methods and medical devices, new kinds of materials, and chemical technologies that have never been developed. We’re looking for new kinds of energy harvesting technologies that require systems and innovations that nobody has ever really made work before. And lots and lots of other things on top of those.

That’s the first piece, the innovative technology piece. The second thing we look for is a commercial story that makes us think “If the technology works, the market is going to feel an impact.” Those are the same things that most early-stage investors look for.

We’re looking for a team that’s got the skills and the passion to bring it to market. We’re looking for a competitive advantage. We’re looking for market traction and close ties and engagement with stakeholders. We’re looking for protection through intellectual property or some other unfair competitive advantage. These are a lot of the same things that private investors are looking for in scalable start-ups.

My recommendation for how people should approach the program is: to send us an email or give us a call; and just ask questions. You don’t need a warm intro, in the same way you do with a lot of traditional investors. We have more straightforward channels of communication–a warm intro can’t hurt. But in general, people can just reach out by calling us or shooting us an email. Our website has contact info for all the Program Directors, who make the funding recommendations, and those are the people you’re going to want to talk to.

Swati: Are there any restrictions in terms of what other funding they can seek?

Schrag: There are a couple of legal restrictions about the kinds of organizations we can fund. We only fund small businesses. There are two main legal restrictions associated with this.

One is that the companies can’t have more than 500 employees. The other is that the companies have to be owned and operated in the US with a majority of ownership and control in the hands of US-based individuals (citizens or permanent residents).

What that means is that companies that are majority owned by institutions–which usually includes institutional investors like Venture Capitalists–are generally not eligible.

Swati: What is your background? How did you become involved with NSF and SBIR?

Schrag: I am trained as a physicist. I did my graduate work at Brown University, finishing in 2003. During the last year of grad school, I was helping to start a small business with one of my colleagues and my graduate adviser.

I worked for six years right out of grad school at that company, working on a couple of new technologies. One was a kind of magnetic sensor and the other was a semiconductor instrument for identifying and diagnosing faults in computer chips. Our company got early funding from the National Science Foundation through this program, so I’ve been on the receiving end of the Small Business Innovation Research program as a principal investigator before I came to NSF.

And in our case, it gave the company the ability to get started before we were able to raise private funding and get a jump on testing out our technology and building relationships. And that was invaluable to us. And because of that, I always understood the power of the program. So I jumped when I got the opportunity to work at NSF. It was a no-brainer. In 2009, I came to Washington and I started in my role here at the NSF.

Swati: Having that entrepreneur’s perspective must be so valuable for you. Would you say most of the directors have a similar background?

Schrag: Yes. All the SBIR program directors at NSF have relevant business and entrepreneurial experience. I think there are something like ten start-ups between the team here, all pretty much in deep technology areas. And all of us also have technical backgrounds in our fields.

When we hire Program Directors, we look for that dual role of people who understand science and technology and people who have been involved in building businesses from the ground up, and in bringing technology to market. This combination of skills is invaluable in giving us the ability to dive deep and understand the program and the grantees, and to let us focus our attention on supporting great companies and helping to make our grantees successful.

Swati: Can you tell me a little more about your focus at Small Business Innovation Research and the sectors and technologies you look at?

Schrag: My portfolio area is in advanced materials and instrumentation, both of which are very broad areas. I wouldn’t call these sectors because new materials can end up in a variety of market verticals including energy, healthcare, life science, transportation, and many others.

The way that the Program Directors here divide up the work is based on technical focus. We fund companies that are in many different industry sectors, but to do deep technical diligence, which we feel is critical, it’s best to divide and conquer based on technical focus areas.

Swati: What does your deep technical diligence involve?

Schrag: The NSF as a whole relies on an external peer review process to help guide funding decisions. The Small Business Innovation Research program is no different, but in our case, the external experts we bring in include both technical experts in the areas we fund, as well as commercial experts.

The technical experts are often academic or industrial scientists or engineers, while the commercial experts are entrepreneurs, investors, or other people who have experience in taking new technologies to market. The Program Directors discuss each proposal with these experts and ask them questions, to try to arrive at funding decisions.

After this external review, the Program Directors also do their investigation and diligence, by putting a variety of questions and requests to every company we end up funding (and some that we don’t).

Swati: Now, when you look at companies, what gets you most excited about?

Schrag: As one of nine Program Directors, I’m obviously only seeing a small section of the technology, and only at the very early stages. But almost all of the companies I work with are exciting to me. They’re incredible entrepreneurs who have huge ambitions, and they’re uniformly talented and hard-working.

While we don’t push any one thing at NSF SBIR Phase, one of the things that seems prominent these days in the area that I fund is the growing market demand for more sustainable materials.

Ten years ago, there wasn’t nearly as much interest from consumers or businesses in the market in terms of where materials come from or what happens to them after their useful life is over. Today, it feels like there’s a huge amount of opportunity for companies who can create new materials that are not only better-performing, or more inexpensive, but also that are better for the world, that are better for human health, and the environment – that don’t consume scarce or non-renewable resources.

So, these days we’re seeing some really exciting material technologies that are being pushed forward by teams who are thinking hard about how this material’s production and use is going to affect the planet. It’s great to see those entrepreneurs who have, in addition to great business ideas, a passion for making the world better.

It’s great to see them be able to get even more traction because of the increased interest in sustainability. Because of that, they seem to be having much more success, and more quickly, than they would have even five or seven years ago. So that’s very exciting, and we have had some great stories that have emerged as part of this broader trend.

Swati: Could you name a few of those?

Schrag: Sure. One of the companies that has gotten a lot of press lately is called Ecovative Design. They have developed a replacement for Styrofoam and other petroleum-based materials by using agricultural waste as a feedstock, combined with the use of a fungal root structure called mycelium.

So they grow what people call “mushroom packaging.” This material is based on feedstocks that are currently considered waste streams, and the end product performs the same as Styrofoam. In addition to not requiring petroleum as an ingredient, these materials degrade in the environment and therefore don’t sit around in landfills for long periods the way that Styrofoam does.

Based on this, the company has grown dramatically in the past six years or so. I think that they had three employees when they first got funding in 2009 time frame, and they’re at over 70 employees now and they’re doing great business. They have built some strong partnerships and they’re dynamic.

We also have a couple of other companies in the same vein. There’s a current grantee company called Biomason that’s figured out a way to grow bricks. The traditional brick masonry that you typically see works well, but it takes a lot of energy to create. The bricks usually have to be heated to a very high temperature, and there are a lot of greenhouse gas emissions associated with that. Biomason has figured out a way to use new cement to make brick without any heating or almost any embodied energy at all. And so their technology has the potential to get rid of all the greenhouse gas emissions associated with masonry, which is a significant amount.

One more company we’ve funded which is a little different from those two is a company called Bolt Threads. They’ve figured out a new way to create spider silk, which is a fascinating material with attractive properties that a lot of people want to make things out of, but is hard to harvest because you can’t farm spiders – they kill each other in close quarters.

Bolt Threads has built its business on deep expertise in synthetic biology, which is a newly emerging area of scientific research that NSF has supported on the fundamental side and that my colleague, Ruth Shuman, has supported with NSF SBIR funding in her biology portfolio for many years. Based on this, Bolt Threads has developed a way to grow spider silk using engineered bacteria so they don’t need a spider at all.

As a result, they can create this silk on an industrial scale. And once you have that industrial scale of spider silk, you can create all kinds of new materials, from breathable fabrics to better bullet-proof vests. There’s a lot of potential for these materials, and they’ve raised about $90 million in private capital since we helped them get started in the early days of 2010. They have a real potential to disrupt the textiles market.

Swati: Will we be wearing this material?

Schrag: They just announced a partnership with Patagonia, so I think if you want to wear spider silk, that might be one of the first ways to do so. But I don’t know when, how much, or what the initial embodiment of these materials will be. Stay tuned!

Swati: So this company now has raised $90 million, and now their VCs will likely be looking to some kind of exit, and that’s how success is measured in the private world. How do you measure the success of the Small Business Innovation Research program in terms of where your grantees end up?

Schrag: We want them to make an impact in the market. We want them to create new products and services that enhance human health, help make the environment cleaner, reduce carbon emissions, and make education technologies more effective so students can learn. We understand that we only provide funding very early on, but our goal is for those companies to be able to find enough funding and support to have a chance to get to market.

The ones that create a lot of jobs and revenues and have a large economic impact are great. That’s one way that we can see significant benefits. Other companies aren’t as big in terms of dollars, but they are just as important because they enable really powerful social benefits.

We have a company right now in Phase II called VocalID, which is developing technology to create a new kind of voice prosthetic that allows people who can’t speak, or who don’t have any really good options to express themselves vocally, to receive a customized voice profile.

So a seven-year-old girl has a different prosthetic voice than a 60-year-old man. It’s been a moving and powerful story to see how the users of these voice prosthetics can fundamentally change their relationship with the world when they get their personalized voice.

The company is doing very well, and from NSF’s perspective, the big win is the potential of this new technology to improve lives. So for the NSF SBIR Phase program, we have a lot of different ways that our grantees can be successful and have an impact on the world.

Swati: For an Angel investor who is kind of on the fence or is interested in investing in science, but does not know this world, what tips would you give them in terms of starting in evaluating investments in deep tech and this kind of innovation?

Schrag: Just like any other investor, I would say to try to talk to some people who know the technology aspects, or to look for other signs of technology validation. Just like the NSF looks for validation from customers or follow-on investors to understand whether to invest Phase IIB funds in awardees.

For people who are interested in these types of investments, I’d also look to see if government agencies with deep science expertise have supported a company. We find a lot of our companies get traction based on the NSF Small Business Innovation Research funding because then the external investors see that experts have looked at the technology and feel like it’s solid.

Even though we’re the National Science Foundation, we bring in hundreds of external technical experts every year to help us do our diligence on the SBIR/STTR proposals we receive. Just like we bring in people who understand these technology areas to give us advice and to help us make decisions, I recommend that Angels tap into their network to find the same types of people. Alternatively, they should look to partner with private organizations that have the same focus on deep technology and deep science start-ups.

Disclosure: This content is for informational use only and is not a recommendation of a particular investment or investment strategy. Past performance does not guarantee future success. Private Investments are highly risky and illiquid and are not suitable for all investors. There is no guarantee that an investment will be profitable.

All investments bear the risk of partial or complete loss of capital. Projections have been created by the companies themselves, and they are based on several different variables. They are not a guarantee of the actual results the company will produce.

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