Startups that secure Small Business Innovation Research (SBIR) funding from America’s Seed Fund often attract the attention of venture capital (VC) investors. However, before jumping into a deal, it’s essential for both startup founders and investors to fully understand how SBIR rules work—especially regarding ownership, affiliations, and acquisitions.

If you’re a venture investor interested in SBIR-backed startups, here’s what you need to know about eligibility, affiliation concerns, and how acquisitions could impact valuable government grants.

SBIR Eligibility and Affiliation Rules

To qualify for an SBIR award, businesses must meet the following criteria:

• At least 51% of the business must be owned by U.S. citizens or permanent residents.
• The business must have fewer than 500 employees, including affiliates.

The tricky part arises from the U.S. Small Business Administration’s (SBA) strict affiliation rules. If two companies are closely connected—whether through shared management, employees, or even an address—the SBA might consider them a single entity. This could be problematic for VC firms that control multiple startups. For example, if one startup has 200 employees and another has 300, the SBA could consider them a 500-employee company, making them ineligible for SBIR funding.

What does “control” mean in this context? The SBA looks at ownership stakes, board influence, and business dependencies. If a VC firm holds too much control over an SBIR recipient, that company may lose its eligibility for SBIR funding.

What This Means for VC-Backed Companies

Venture Capital Operating Companies (VCOCs) can avoid affiliation issues if they maintain a minority stake and do not exert control over the SBIR recipient. VCOCs also have the advantage of being able to back companies with parent firms that exceed 500 employees, unlike traditional SBIR startups.

However, there are limitations:

• No single VC, hedge fund, or private equity firm can own a majority stake in the startup.
• Foreign ownership is permitted, but only if the foreign entity has a U.S. presence and complies with U.S. incorporation laws.

Moreover, not all federal agencies award SBIR grants to VC-backed companies. In 2022, the Government Accountability Office found that only the Department of Defense and the Department of Health and Human Services regularly awarded SBIR grants to VC-backed firms. This means that while VCOCs offer flexibility, they also face a smaller pool of government contracts.

How Acquisitions Affect SBIR Status

Acquisitions and mergers can affect a company’s ownership and employee count, potentially violating the 500-employee limit and triggering affiliation issues.

The good news? A company that already holds an SBIR award can still maintain eligibility for that specific contract, even if it surpasses the small business threshold after the acquisition. Agencies can extend or renew the award without revoking the small business status.

The bad news? Future SBIR funding may be at risk. If an acquisition changes ownership in a way that violates SBIR eligibility rules, the startup could lose its chance to secure new SBIR awards.

Planning Ahead to Avoid Issues

Founders and investors must plan carefully before making acquisitions that could jeopardize SBIR funding. Here are a few steps to take:

• Review how any potential ownership changes might impact SBIR eligibility.
• Develop a five-year growth plan that accounts for acquisitions and changes in ownership.
• Consult with legal and compliance experts who specialize in SBIR funding to stay ahead of potential issues.

By understanding the rules and planning accordingly, venture investors and SBIR-backed startups can work together successfully—without risking valuable government funding.