California is top small tech state; Why? Just follow the money flows

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March 15, 2004 — Small tech companies continued to get a hand financially from federal agencies in 2003, but the recipients and givers varied significantly from the previous year. The startups’ ability to ferret out federal awards is critical for their growth and for that of the emerging small tech industry, especially at a time when venture capital is tight, analysts said.

Small Times identified hundreds of companies selected to receive Small Business Innovation Research (SBIR) grants in 2003 as part of its annual analysis of small tech’s leading states. The SBIR figures are one of handful of criteria used by Small Times to gauge innovative activity in a state. Each state received a score for innovation, as well as for five other categories: research, industry, venture capital, work force and costs. The scores were weighted and tallied for a final ranking.

This year’s final ranking placed California in the lead, followed by Massachusetts, New Mexico, New York, Texas, Illinois, Pennsylvania, Michigan, Connecticut and Ohio, in that order. Innovation proved to be one of the most volatile categories, with newcomers New Mexico, Ohio and Tennessee breaking into its top 10 list compared to last year. Some of that volatility can be traced to SBIRs, highly competitive funding opportunities within the Department of Defense, National Institutes of Health, Department of Energy, NASA and several other federal agencies.

“Follow the money flows,” said Robert Kispert, director of federal programs at the economic development agency Massachusetts Technology Collaborative. Massachusetts ranked second after California in Small Times’ rankings for innovation. “We have a lot of capacity and skill in following the money flows.”

Kispert authored a report in 2004 that found Massachusetts excelled at attracting federal funding for defense research and development. His results, although they covered all high tech, mirrored those of Small Times: Massachusetts’ small tech companies won the most awards from the Department of Defense in 2003, getting almost a quarter of all the 58 small tech-specific defense awards.

Overall, California nabbed the most SBIRs, landing almost 19 percent of the 274 awards identified by Small Times. Massachusetts raked in 12.4 percent of the total, and Texas carved out about 7 percent. Companies qualify for SBIRs if they have less than 500 employees, and the awards are divided into three stages: a feasibility phase with up to $100,000; a development-to-prototype phase with a cap of $750,000, and a final phase where the project shifts into a marketplace without any SBIR money.

SBIR funding is a pittance compared to venture capital investments, but it allows small businesses to test and develop technologies that could blossom into marketable goods and services. Federal SBIR funding totaled about $1.6 billion in 2002, with about half provided by defense, according to the Defense Department. Its SBIR budget grew to about $998 million for fiscal year 2004.

Venture capitalists invested almost that much money in small tech alone in 2003, according to a Small Times analysis of the MoneyTree Survey by PricewaterhouseCoopers, Thomson Venture Economics and the National Venture Capital Association. Small tech investment is only a fraction of the total VC activity, which slowed down drastically after the dot-com crash.

Kispert said SBIR awards help tide companies over during VC droughts. “The good news about the defense industry (awards) is that it does provide an opportunity for new players to move forward with less private equity,” he said. “They’re not having to invest as much of their own money … particularly at a time when private investment is harder to come by.”

The SBIR programs also help launch new businesses and sustain more mature companies. The award of two defense SBIRs in 2003 prompted MEMS veterans Lawrence Muray and James Spallas to pursue their vision of building a tabletop scanning electron microscope through their young startup, NOVELX, according to the two co-founders.

At the other extreme, established small businesses such as Materials and Electrochemical Research (MER) Corp. in Tucson, Ariz., and TPL Inc. in Albuquerque, N.M., include SBIRs among their strategies for success. The 19-year-old MER makes and sells fullerenes, nanotubes and other materials as well as develops fuel cell and battery technologies.

TPL, founded in 1981, lists itself among the top 50 SBIR companies in the nation. It shifted from its roots as a technology company serving the oil drilling industry to a material science-based company because of SBIR opportunities, according to Hap Stoller, TPL founder and president. TPL’s small tech programs are as diverse as nanoscale powders to power supplies for MEMS.

“I decided I’m going to bait as many technology hooks as I can and see what I catch,” said Stoller, referring to efforts to keep the company afloat in lean times with SBIRs. “It was an act of desperation. Most VCs then (in the 1980s and ’90s) and maybe even today would be horrified at the tack I took.”

Flexibility may be an attribute for companies that view SBIRs among their business strategies. Small Times’ analysis found that the number of small tech-related SBIR awards grew modestly between 2002 and 2003. But the numbers fluctuated greatly from one year to the next within individual funding agencies.

For instance, the Department of Defense selected twice as many small tech companies for SBIRs in 2002 than it did in 2003. California won almost 19 percent of 116 defense awards in 2002, with Massachusetts close behind with 17 percent of the total. The National Institutes of Health, conversely, awarded 103 SBIRs to small tech companies in 2003 and only 46 in 2002. California dominated the NIH list in 2003 and tied with Massachusetts for the top slot in 2003.

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