By Michael Smigocki

Small Business Innovative Research (SBIR) awards have become an increasingly useful mechanism for the federal government to access the innovative talents of our nation’s small technology companies to provide solutions to some of our nation’s most urgent and pressing needs. These awards have become an important source of revenue for technology companies who have been unable to secure angel or venture financing to further develop their technologies. However, with the benefits of receiving this revenue, there are many land mines that a contractor can encounter. Cost disallowance matters, intrusive audit requirements, possible loss of intellectual property rights, and even civil and/or criminal sanctions are examples of some of the land mines that exist for SBIR contractors. This article is meant to highlight some of these issues and provide useful recommendations to help avoid these land mines.

The SBIR program can provide a contractor with up to $850,000 of “seed capital” and a viable mechanism for commercialization of its technology. The Department of Defense, Homeland Security and other federal agencies have very active SBIR programs. These programs are implemented through a three-phased approach.

Phase I awards are for testing the scientific, technical and commercial merit and feasibility of a particular concept. They are generally fixed-price awards for up to $100,000.

Phase II awards are for development of the concept tested in Phase I, typically to the prototype stage. These awards are for up to $750,000 and are generally cost reimbursable. It is at this phase that many contractors run into problems with their SBIR awards, as will be detailed later.

Phase III awards are for the full-scale commercialization of the technology. It is at this stage that contractors are expected to obtain funding from the private sector and/or non-SBIR government sources in order to develop the concept into a product for sale in the private sector or federal markets.

With winning SBIR awards, the demands placed upon a contractor’s infrastructure can be overwhelming. Many contractors delay making the necessary investments in their infrastructure until it is too late. In order to avoid the early-stage land mines of SBIR awards, the contractor should strongly consider:

•Hiring internally, or developing a relationship with an accounting firm, someone that has intimate knowledge of the Federal Acquisition Regulation, SBIR awards, and government cost accounting.

•Implementing a cost accounting system and developing internal policies and procedures that will ensure compliance with federal regulations.

•Retaining a law firm that has specific expertise in SBIR awards and protection of intellectual property rights.

Since the Phase II award is generally of a cost reimbursable nature, government audit of cost proposals as well as incurred costs will be performed. Most SBIR contractors have never been through these types of audits and are ill-prepared for what may result. Contractors should ensure:

•The cost proposal is based on established cost accounting practices and pricing strategies.

•The incurred cost submission is prepared by, or at a minimum, reviewed by someone knowledgeable of cost allowability and allocability matters under the FAR.

•All contact with government auditors should be handled by this knowledgeable person.

Finally, if the SBIR award happens to be a grant, it could trigger the need for an independent financial statement audit along with a program-specific audit under OMB Circular A-133. This can add significant G&A costs that the com pany did not anticipate.

The old adage of an ounce of prevention being worth a pound of cure is extremely relevant to the SBIR world. The following are examples of the results I have witnessed from SBIR contractors who failed to take these precautionary steps:

•Large cost disallowances and suspension of progress payments that threatened the ongoing viability of the company.

•Significant delays in the awards of new contracts or other SBIR awards.

•Significant legal and accounting fees to address and resolve issues raised by auditors.

•Criminal indictments resulting from fraud investigations.

SBIR awards can be an incredible opportunity for the small, undercapitalized technology company looking to further develop its technology. However, with the award comes a litany of rules and regulations that the contractor must follow. Addressing these matters early and surrounding the company with knowledgeable professionals can help ensure a successful SBIR program for the contractor.

Michael Smigocki, CPA, CVA, is the managing director of the National Government Contractor and Technology Group of American Express Tax & Business Services. The groups provides accounting, tax, regulatory and management consulting, M&A advisory, litigation support and expert testimony to the government contracting and technology industries. He can be reached via e-mail at Michael.A.Smigocki@aexp.com.