Negotiating an SBIR/STTR Phase II Budget

When negotiating an SBIR/STTR Phase II budget, grant, and/or contract, it is critical that a small business prepare themselves by understanding the process, doing their research, having the proper justification and documentation, and even knowing when to get professional support from contracts & grants management consultants and/or their govcon accounting firm. That’s because while the basics of budgeting, grant and contract formation are generally the same across all agencies, individual agency nuances widely vary, and can substantially impact your small business’s bottom line.

Phase II Proposals and Budgets

A successful negotiation starts with a solid budget, one that conforms to the agency’s particular request for proposal. This is the first challenge. Pricing instructions are often found in more than one place or in other referenced documents. Even the most diligent understanding of pricing requirements won’t catch every nuance. It may take a couple or more rounds of budgets to understand all the pricing requirements.

A variety of factors contribute to this confusion as every agency applies their specific budget requirements.

Budget Input Platforms/Worksheets

Budget input platforms are notorious for being frustrating to sign up for and operate. This includes the DoD (DSIP) and Grants.gov for grant agencies. Applicants should be proactive in keeping their SAM registration active and submitting proposals well before it is due in case of platform malfunctions, holidays, and potential government shutdowns.

Be wary of online budget worksheets or others sent by the agency to produce your budget. You will need to understand how to portray your indirect rate structure appropriately. In fact, you may have an indirect rate structure that isn’t represented by the agency’s template. In this case, you’ll have to modify the template – not a trivial task.

*If you need help with this, or simply developing an indirect rate structure—even if you are a new startup lacking any historical financial data—a consulting firm like ReliAscent can help with this task in a matter of hours (there is no need to pay a govcon accounting firm to setup and operate a DCAA compliant accounting system prior to winning an award, just to be able to propose a rate, despite what some firms may tell you). Contact us today to learn more.

Budget Limitations for Labor

Here are some examples of how certain agencies either cap or limit project (direct) labor:

• Salary is capped by the NIH with the cap updated annually.
• Many agencies use the Department of Labor/Bureau of Labor Statistics (DOL/BLS) data to evaluate labor rates.
• Labor rate escalation is typically limited to 2-5% annually.
• Principle Investigators are required to dedicate a minimum amount of time to the project.

A negotiation point in favor of an SBIR/STTR firm is many R&D jobs today aren’t listed in the DOL/BLS, such as Robotics Engineer, or AI Specialist. Also, the DOL/BLS data lags about two years, so it’s not a clear representation of the current job market which can vary widely at times. To justify labor rates, a point can be made that a small firm is competing for similar talent with universities and larger firms in the area.

Almost every firm is owned or headed by a Ph.D who is either the Principle Investigator (PI) or other contributor to the project. Whereas the DOL/BLS data portrays a mean salary, a premium can surely be added to represent the educational level and years worked for an individual.

Another issue may arise when a non-technical corporate officer or employee is listed as direct labor. This is acceptable in the case where there is an outreach element to a certain research topic.

Compensating labor in the form of equity does not easily fit the government’s cost-based approach to estimating labor, and therefore should be avoided. In addition, each employee should have only one hourly rate. If an employee performs activities across a broad range of duties, a “blended” pay rate may be used.

Other Direct Cost Limitations

Many agencies resist or prohibit purchasing of equipment (tangible property over $5,000 per unit). Be aware that if the government agrees to finance equipment, title of the equipment remains with the government unless otherwise dispositioned at a later date. American-made equipment is preferred.

Most agencies also prohibit foreign travel unless well-justified.

Grey areas may emerge where the government might deem project costs as indirect costs. Prime examples being computers and servers, which is acceptable as long as they are dedicated solely to the project.

Travel costs are limited to lowest available non-refundable airfare (with few exceptions), per diem meals and lodging, and other “reasonable” travel costs.

Subcontract, Subaward, Consultant Limitations (Workshare)

All phase II SBIRs are limited to 50% of the work being performed by subcontractors or subawardees. For STTRs, the limitation rises to 60%, however, the STTR partner has to perform at least 30% of the work.

Different agencies have different methods of scoring this workshare, which can be a frustrating trap to fall into.

Consultant costs should be defendable with the only specific limitation coming from the NSF which states costs should, “not … exceed the NSF maximum of $600 per day (NSF defines a day as 8 hours)”. That’s equivalent to $75 an hour. It’s debatable if this is NSF’s intent. One could then argue you could pay a consultant $600/hr as long as they only work one hour a day.

Indirect Cost Limitations

Contract agencies cite FAR Part 31 cost principles when pricing proposals. Grant agencies, as well, refer to FAR 31 in this manner. All agencies also include additions or alternatives to the general cost rules in the form of their FAR or CFR supplements.

These cost rules not only address direct project costs, but also indirect cost and indirect rates.

For fringe costs, there are few limitations beyond the general guideline of what’s “fair and reasonable”. This goes for many of the other administrative costs a firm may incur during normal business operation. The FAR, however, also expressly prohibits business costs such as interest, contributions, alcohol, entertainment, and private patent costs.

Some grant agencies (NSF/NIH) go way beyond FAR limitations by prohibiting Internal Research and Development (IR&D) costs, Sales and Marketing efforts including commercialization, and patent costs (but see TABA below).

Indirect Rate Limitations and “Safe Rates”

While there are no stated limitations from contract agencies on indirect rates, limitations from the grant world are numerous:

• NSF limitations: The indirect rate is limited to 150% of salary and wages.
• DOE soft limitation: Documentation justifying the rate is only required if the budgeted fringe costs plus indirect costs are higher than 50% of the budgeted labor. No other limitation if the rate is higher.
• NSF “safe rate” meaning no negotiating indirect rates: If the budgeted fringe costs plus indirect costs are higher than 50% of the budgeted labor.
• NIH “safe rate”: No cap on fringe rates, but limits the Finance and Administration rate to 40%. Higher rates will require justification and negotiation.

Even if you have negotiated rates with another government agency, indirect rates may have to be renegotiated to accommodate any one of these limitations.

Technical and Business Assistance (TABA)

The government in recent years recognized the struggle small businesses face moving technology from the lab to commercialization. Congress has added funding to assist with this effort with TABA allowances focused on assisting firms with a variety of business needs. For example, the DOE Phase II TABA funding can cover what otherwise are unallowable patent costs (for discoveries made during the grant period) as direct project costs. TABA funding rules should be carefully examined which could make otherwise unallowable costs (such as marketing and patents) an allowable TABA expense.

Fee Limitations

The general rule of thumb for SBIR/STTRs is fee should be no more than 7% of total proposed costs. Some grant agencies may allude to this as a limitation, however, there is no regulatory requirement stating so.

For contract agencies, fee is limited by regulation to 15% of costs for cost-plus type contracts. There are no stated limitations for fixed-price or Other Transaction contracts.

Fee is customarily applied as a percentage to total costs. Some agencies are clever by half by disallowing fee on selected direct costs such as travel, material, or equipment.

(Clever by half = clever in a manner that is unproductive and annoying)

Negotiations

Since the SBIR/STTR winner is based on technical evaluation, there’s not much to negotiate beyond that from a technical standpoint. The focus then turns to evaluating the cost volume.

Government pricing experts, having complete knowledge of all cost principles and agency limitations, will scrutinize the cost volume and send comments to the agency’s contract or grant manager who will then pass any comments on to the SBIR/STTR firm. This may involve minor rebudgeting. Contract/grant managers typically allow any reduction in the total proposed price to be offset by an increase in another area of the budget, as long as the original price is not exceeded.

Perhaps the most impact an SBIR/STTR firm will face with a Phase II contract or grant is the type of contract or grant that is negotiated.

Contract and grants are typically cost-reimbursable with a fixed fee amount (CPFF), meaning the government will pay for actual project expenses, including indirect costs. The contract or grant will specify a “target cost”. Costs that overrun this target in rare cases can be reimbursed.

In this pre-award negotiation phase, the agency may ask if your accounting system is adequate, or in the case of DoD, will send an auditor from the Defense Contract Audit Agency (DCAA) to inspect your accounting system. This can be a major hurdle to receiving the contract or grant. Designing a timekeeping and accounting system to meet these strict compliance standards are discussed in additional articles linked below.

It should be noted that the NSF CAP (Cost Analysis and Pre-Award) review is as data-intense as a DCAA Pre-Award accounting system survey.

Set-up and continuous scrutiny of an approved accounting system can be avoided only in the case where contract agencies agree to contracts that are Firm Fixed-Price (FFP). A prime example is NASA, where all SBIR/STTR contracts are fixed-price. Some DoD agencies may allow fixed-price contracts whereas others only use CPFF contracts as a matter of policy.

Another contract vehicle used by some contract agencies is the Other Transactional Authority (OTA). This contract may act like an FFP contract but with fewer regulatory strings attached.

Financing

The process for getting paid varies depending on the agency and contract or grant type. For DoD contracts, you will be allowed to bill on a cost-plus-fee basis (for cost reimbursement contracts), or by accomplishing performance milestones (reports and product delivery) for fixed-price contracts.

The value of each performance milestone can be negotiated so as to provide the SBIR/STTR firm positive or at least neutral cashflow throughout the project.

Grants typically are financed through a “drawdown” method directly from the U.S Treasury, again based on costs incurred. The NSF is the exception, where the Phase II grant is considered a “fixed” grant. Grantees can draw down certain percentages of the total grant amount at certain times.

Negotiating for a Win

Putting your SBIR/STTR in the best position for negotiating a Phase II contract or grant may take some time due to learning all the limitations and other nuances for a particular agency. Seeking funding from multiple agencies makes proposal preparation, negotiating, and contract/grant administration that much more complex. ReliAscent has experience across a broad range of agencies offering SBIR/STTR funding and can actively guide you through the regulatory and compliance maze.