Thornberry is proposing legislation that would make it easier for startups like Capella Space to continue to get private funding and compete for DoD small business awards.

Updated May 20 with new total funding raised by Capella Space

WASHINGTON — Capella Space, a San Francisco-based startup that launched the first U.S. commercial radar imaging satellite in December, submitted a bid earlier this year for a Defense Department Small Business Innovation Research contract.

The company previously worked with the Pentagon’s technology outreach group in Silicon Valley and knew the military was interested in Capella’s technology. The company is building a constellation of 36 radar satellites to scan any spot on the planet once every hour and identify objects like small vehicles in any weather conditions.

So it came as a surprise when Capella officials heard their bid had been rejected because the SBIR program excludes companies that are majority-owned by venture capitalists.

“We were shocked,” Dan Brophy, the company’s vice president of government services told SpaceNews on Friday. “Despite all the interest in what we’re doing, we were excluded.”

DoD’s decision to deny Capella an SBIR award based on the source of its capital came to the attention of House Armed Services Committee Ranking Member Mac Thornberry (R-Texas), a longtime advocate of Pentagon reforms to lower barriers to small businesses that develop technologies with military utility. He saw Capella’s situation as a textbook case of bureaucratic hurdles getting in the way of innovation. He is now proposing legislation that simplifies the process for obtaining a waiver to the SBIR restrictions so companies can continue to get private funding and still compete for DoD awards.

The SBIR program was created in 1983. In 2003 the courts ruled that companies with over 50 percent venture capital ownership are ineligible for SBIR grants. In 2011 Congress recognized that this ruling was problematic and created a waiver for small businesses. The waiver requires congressional notification and Small Business Administration approval. While other government agencies that use the SBIR program have sought waivers, DoD has not requested one in seven years, according to a fact sheet provided by Thornberry’s staff.

SBIR awards are small compared to what a company like Capella can raise in the private markets. But winning a contract can be hugely valuable because of the potential long-term opportunities and access to DoD buyers.

Thornberry told reporters on Thursday that he is concerned innovative small businesses are being barred from the SBIR program precisely for being successful as their technologies are attracting private sector investment. A company that develops technology with both commercial and military applications is appealing to investors but that should not be an obstacle to DoD having access to that technology, Thornberry said. The message DoD is sending now is that “if you are successful, you’re thrown out.”

Thornberry on May 16 released a series of proposed measures to reform how the Department of Defense does business, the SBIR provision being one of them. This is the fifth year that he has offered reform proposals for inclusion in the National Defense Authorization Act. The HASC will mark up the NDAA next month. Thornberry said these reforms have bipartisan support although he could not be certain that Committee Chairman Adam Smith (D-Wash.) will include this proposal in the chairman’s mark.

The restrictions on SBIR funding to companies that are majority owned by venture capital were put in place to prevent corporate malfeasance, such as large companies creating a shell company that they declare as a small business.

Brophy said Capella Space has raised $51 million in private funds. The SBIR award it bid for was for a $50,000 study contract on how the company could provide the government data gathered by its radar satellites. If a proposal is selected to advance to the next phase, it can compete for a $750,000 award. The money is helpful but the more significant value of SBIR is that it’s “one of the best ways to connect innovative commercial companies with the government, and it’s one of the few channels to do that,” he said.

Venture-backed startups have won SBIR awards from agencies like the National Institutes of Health, the Energy Department and the National Science Foundation. “They asked for waivers but DoD never asked for a waiver,” Brophy said. “It’s a case where a well intended policy has gone awry.”

In the commercial space sector, investors have poured more than $8 billion into startups over the past two years, said Brophy. Many of these technologies are of interest to DoD. “VC’s swing for the fence to try to hit home runs. That’s exactly the kind of work the government wants to be able to explore,” he said. “It has a huge multiplier effect for DoD: They can spend a million dollars and take advantage of $30 million to $40 million of private capital.”

Capella Space is one of a handful of global startups building satellites and sensors to do Earth observation from space using synthetic aperture radar. It launched its first satellite in December and plans to build a constellation of 36 40-kilogram satellites by 2022. Unlike the electro-optical cameras used by most remote sensing satellites, synthetic aperture radar can see at night, through clouds and in any weather conditions.

If the company is shut out of the SBIR program, it does not see other avenues right now to work with DoD. “We’d have a hard time in a traditional acquisition,” Brophy said. Contractors tend to be selected based on past performance, he said. “That would pretty much rule out any type of venture-backed companies.” For startups, the government contracting process is unattractive, he said. “It doesn’t align very well with commercial companies. It takes a very long time.”

The SBIR program is much more appealing, said Brophy. “It is a way for the commercial small business community to connect with the government. And if there’s a real match, it can lead to more opportunities.”

By turning away venture-backed firms, DoD is limiting participation to “bootstrapping” small business that don’t get venture capital and might not have the resources to advance and commercialize technology, Brophy said.

A HASC staff member who briefed reporters on Thursday said Thornberry found it disappointing that DoD has not used the waiver program and instead has “blocked and prohibited these companies from participating at all rather than deal with the bureaucracy on the back end.”

Thornberry’s proposed legislation creates a pilot program with a modified SBIR waiver that DoD “can actually use,” the staffer said. “This reform bill pushes waiver authority down to the service acquisition executives and tries to be more inclusive,” he said. The larger point of the bill is to make sure that companies are not be selected based on the source of their investment but on the merits of the technology itself.

The committee fact sheet notes that Capella Space was born in 2016 out of a DoD-funded program called Hacking4Defense that is run at several major U.S. universities. It was created to give students the opportunity to learn how to work with DoD and the intelligence community to address security challenges. One of the H4D teams at Stanford University became Capella Space and quickly raised funding following the class.

“Capella Space’s work was so promising that major venture capitalists chose to invest in them,” says the fact sheet. “However, when Capella Space applied for a SBIR grant, the very confidence the marketplace was showing in their work was also the reason they were excluded from the program.”