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Amid federal funding cuts, an analysis of 10,000 companies by Kyle Myers shows how small business grants fill unique government needs. But how will AI change the game?
From engineering the robotic arm of the Mars Perseverance rover to developing a testing tool for the F-35 fighter jet, the US government has long relied on small businesses to produce new technology.
The government’s Small Business Innovation Research (SBIR) program has been so successful at unleashing fresh ideas that it’s often compared to venture capital firms. As debates the program’s future, research by Harvard Business School’s Kyle R. Myers finds that startups participating in the program produce 20% more breakthrough patents than VC-backed efforts.
Myers’ study illustrates how government investment in the private sector can meet critical needs. At a time when government spending is under scrutiny, the findings suggest that cuts might come with significant tradeoffs.
The SBIR can focus on funding small businesses that are tackling important problems and produce innovations that may not appeal to private investors, but may create large social value.
“Private-sector venture capitalists have a clear objective, and that is to find innovative companies that can generate large private returns,” says Myers, an associate professor. “In contrast, the SBIR can focus on funding small businesses that are tackling important problems and produce innovations that may not appeal to private investors, but may create large social value.”
Myers and colleagues crunched 20 years' worth of data on more than 10,000 small businesses to understand the ways these two channels stimulate innovation. The working paper “Small Business Innovation Applied to National Needs,” shows how venture capital and the government seed fund differ, from their strategic goals to the patents and citations each produce.
Myers coauthored the study, released in June, with Lauren Lanahan, an associate professor at the Lundquist College of Business at the University of Oregon, and Evan E. Johnson, a researcher at the University of North Carolina at Chapel Hill.
Their study comes at a sensitive time for SBIR. The House of Representatives recently passed a bill to reauthorize the program for another year. However, before the government shutdown, senators had only debated potential changes to the program. Some congressional Republicans have pushed for the program to adopt the incentives and timelines of a VC firm.
Congress created the program in 1982, inspired by the observation that small businesses produce a disproportionate share of cutting-edge innovation.
Under the SBIR statute, any federal agency with an extramural research budget larger than $100 million must allocate 3.2 percent to the SBIR program, bringing SBIR’s annual funding to nearly $3.5 billion.
Grant recipients are limited to small businesses with 500 or fewer employees, many of them are regular subcontractors for larger private contractors. They’re typically tasked with developing innovative solutions to well-defined, small-scale technological challenges confronting federal agencies.
Not surprisingly, some of the federal government’s most research-focused agencies—such as the Department of Defense, , Health and Human Services, and the —are among the largest participants in the SBIR program.
Among many other technologies, SBIR grants have led to the development of innovative air-monitoring equipment for the Department of Energy and wearable sensors for patients taking part in -required clinical trials.
The authors compiled data on more than 10,000 businesses from 2000 to 2021. They combed SBIR grants, government patent and procurement records, and private datasets.
Roughly 20% of these businesses received seed investments from VCs but no SBIR awards, while the rest benefited from SBIR grants. Compared with VC-funded startups, they found that SBIR-backed firms produced:
Roughly 3 times more patents
Twice as many citations
20% more breakthrough patents
The most likely reason: VC-backed firms focus on private growth opportunities, which may not often involve the pursuit of patents or federal contracts. In contrast, SBIR-backed small firms develop unique, smaller-scale innovations that federal agencies need, says Myers.
To compare VC firms and SBIR recipients, Myers and fellow researchers mined data from the Small Business Administration, the National Establishment Time Series, Crunchbase, and government patent and procurement records. Compared with VCs, SBIR-backed businesses had:
“These firms are inventing technologies that fill unique niches, and the nature of these technologies makes it very difficult to capture a lot of the value they create,” Myers says of SBIR firms’ innovations.
The firms’ cultures differ as well. Many of the smaller SBIR-backed firms, though not all, tended to focus on pure scientific pursuits. VC-backed firms exhibited more aggressive, growth-oriented cultures, full of entrepreneurial zeal.
The rise of generative AI could enable large companies and contractors to invent and experiment more efficiently, helping them expand without hiring more people. At the same time, small businesses could benefit from AI’s firepower, performing “orders-of-magnitude more operations,” the authors write.
AI will likely influence the government’s relationship with small businesses by:
Raising opportunity costs of government engagement. AI adoption could result in more lucrative private sector opportunities for small businesses, making niche government contracts less appealing, the paper says.
Raising questions about digital versus physical solutions. Software won’t be able to solve every problem, and some national innovation needs will require analog tools and human expertise. However, with AI, will small business capabilities remain aligned with those needs?
Shifting the pace and source of ideas. While national priorities have historically set the innovation agenda, AI might result in more consumer-focused inventions. The government might need a more structured effort to keep pace with technology.
Myers hopes the SBIR program will continue, due to its track record of producing innovative results and past bipartisan support for its mission.
“If the SBIR program is run successfully and continues to find ways to improve itself, it can continue to play an important role in the US innovation ecosystem,” says Myers.
Image: Ariana Cohen-Halberstam with asset from Unsplash.
Small Business Innovation Applied to National Needs
Myers, Kyle, Lauren Lanahan, and Evan E. Johnson. "Small Business Innovation Applied to National Needs." Harvard Business School Working Paper, No. 25-062, June 2025.
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