You can be on Entrepreneur’s cover!

Why the SBIR Program Is Worth Funding By overcoming market failure in the development and financing of early-stage technology, the SBIR program makes possible commercial activity that would not otherwise have occurred.

By Scott Shane

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

Conservative economists often criticize government involvement in private markets, arguing that at best it is inefficient and at worst is counterproductive. However, even the great conservative economist Milton Friedman often pointed out that government intervention is necessary when markets fail to allocate resources efficiently.

Even the most conservative economists should support the Small Business Innovation Research (SBIR) program – a scheme in which 11 federal agencies with external research and development budgets of more than $100 million must allocate 2.8 percent of those budgets to grants or contracts with small businesses undertaking projects that both have commercial potential and meet the R&D goals of the funding agency. The SBIR program overcomes the failure of private markets to fund innovation when the benefit to society exceeds the benefits to the private firms undertaking it. By overcoming this market failure, the SBIR program makes all of us better off, facilitating the allocation of resources to the development of new materials, medical technologies, software, and the like.

Private businesses fail to allocate resources for early-stage technological innovation at the level society desires because new technologies are often too uncertain for their future prospects to be judged and because they are too far from commercialization for companies to capture the benefits of providing them.

Moreover, private capital markets are often reluctant to fund companies that undertake early-stage technological innovation. New and small firms conduct much of the breakthrough technological innovation that occurs in this country because the incentive of ownership (which is much easier to provide in young and small businesses) is generally necessary to get people to put in the effort and take the risks necessary to develop fundamentally new ideas. But private capital markets often fail to provide sufficient financing to the new and young companies trying to develop early-stage technologies because venture capitalists and business angels find it difficult to assess their potential financial returns and the time horizon necessary to produce those returns. As a result, new and young firms frequently fail to obtain the capital they need to undertake early-stage innovations, leading to less innovation than what society desires.

Related: How to Build a Two-Sided Platform

In the absence of schemes like the SBIR program, the federal government's R&D needs would not be met. Often the government itself lacks the capability to develop new technologies on its own. Moreover, the private sector generally does not find the government's R&D problems to be a worthwhile investment because the solutions to those problems frequently cannot be turned directly into commercial products in the marketplace.

SBIR grants mitigate these market failures by providing small business owners with a source of capital that does not depend on private-market allocation. Analysis by both academics and policymakers shows that the scheme works. Numerous studies show that the SBIR program makes possible innovations that would not have been developed in the absence of government intercession.

While the SBIR program involves policy makers' intervention in private markets, it's the type of intercession that should satisfy even conservative economists. The economic benefits of funding SBIR projects greatly exceed the costs of doing so because the program allows new and small businesses to use government funding to develop early stage technologies to the point that they can be evaluated and supported by private capital markets. By overcoming market failure in the development and financing of early stage technology, the SBIR program makes possible commercial activity that would not otherwise have occurred, helping to produce otherwise absent innovations that benefit society.

Related: Why Rates of Entrepreneurship Remain Depressed

Scott Shane

Professor at Case Western Reserve University

Scott Shane is the A. Malachi Mixon III professor of entrepreneurial studies at Case Western Reserve University. His books include Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live by (Yale University Press, 2008) and Finding Fertile Ground: Identifying Extraordinary Opportunities for New Businesses (Pearson Prentice Hall, 2005).

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Editor's Pick

Business Ideas

63 Small Business Ideas to Start in 2024

We put together a list of the best, most profitable small business ideas for entrepreneurs to pursue in 2024.

Business News

This Highly-Debated Piece of Cinematic History Just Sold For Over $700,000 at Auction

The wood panel from "Titanic" is often mistaken as a door. Either way, he couldn't have fit. (Sorry.)

Business News

From Tom Brady to Kevin O'Leary – See Who Lost Big in the Wake of the FTX Crypto Collapse

The crash exposed an $8 billion hole in FTX's accounts, leaving investors and customers scrambling to recoup their funds.

Starting a Business

How to Find the Right Programmers: A Brief Guideline for Startup Founders

For startup founders under a plethora of challenges like timing, investors and changing market demand, it is extremely hard to hire programmers who can deliver.