Aug. 19–A decision by federal officials to impose a strict interpretation on eligibility requirements for a key federal grant program could cost high-technology and biotechnology startups hundredsof millions of dollars in funding.

The Small Business Innovation Research program, known as SBIR, requires that 10 federal agencies, including the National Institutes of Health, allocate part of their research budgets for grants to small businesses.

Since 1982, more than $10 billion in SBIR grants have been doled out to small businesses to conduct research. This year, the NIH has allocated $525 million for its SBIR grant budget, and awarded 1,259 research grants to biotechs and medical device companies.

Yet early this year, the NIH began to turn down grant applications from biotechs based on a more rigid reading of the eligibility guidelines by the Small Business Administration, which oversees the SBIR program.

Under the administration’s rules, a grant applicant must have fewer than 500 employees and be 51 percent owned by U.S. citizens or permanent resident aliens. In the past, federal agencies interpreted the later requirement loosely, allowing companies controlled by venture capital funds to compete for the grants.

But in 2001, an administrative law judge for the Small Business Administration ruled that the term “majority owned by U.S. citizens” should be interpreted literally, as an individual “natural person” as opposed to an entity a reading that bars venture capital-backed firms from qualifying.

Despite that ruling, the NIH continued to accept and approve grant applications from companies with 51 percent or more venture capital backing, a category in which most biotech startups belong.

Last spring, Salt Lake City biotech Cognetix ran afoul of the Small Business Administration when the agency reviewed its application for a $750,000 SBIR grant.

Citing the company’s majority ownership by venture capital funds, the NIH, at the recommendation of the business administration, denied the grant, though the agency had given several to the company in past years.

The precedent-setting action dismayed the biotech community, and since then several other biotechs have had SBIR grants denied.

The timing could not be worse. Many small startups are already cash-starved, unable to raise money from venture capitalists or through an initial public offering unless they have late-stage products in development.

SBIR funds, which can range from $100,000 to several million dollars, have kept some research programs moving forward despite rough economic times, said Gerald Yakatan, chief executive of San Diego’s Avanir Pharmaceuticals.

“The idea that agencies aren’t going to consider these companies is going to be a disaster,” said Yakatan, who was part of a delegation from the local biotech trade group Biocom that lobbied last month in Washington on the issue.

“There are a lot of companies that were either started with SBIR grants or nurtured by them.”

So far, the policy change hasn’t been applied consistently, and some biotechs that are technically ineligible have received grants.

In July, San Diego’s FeRx, which is developing a drug delivery system, received a $640,000 SBIR grant, though it is majority-owned by venture capital funds.

“We’ve had no problems,” said Richard Keatinge, vice president of corporate development for FeRx, which is using the SBIR grant to develop a radiation therapy for liver cancer. “It is an important source of funding, and it would be a shame if they cut it off.”

It seems likely that the Small Business Administration will do just that in coming months. Maurice Swinton, assistant administrator for technology at the agency, said the administration is working to educate the 10 federal agencies that award SBIR grants about the stance on majority venture capital-backed firms.

“Word has not filtered down, but the SBA is working with SBIR program managers in all the agencies to see the word gets out,” Swinton said. “Companies can have VC capital, but if they are VC majority-owned they are not eligible to participate in the program.”

Several industry trade groups, including the National Venture Capital Association, the Biotechnology Industry Organization and Biocom are lobbying regulators and Congress to ease the restrictions or change the law.

The Small Business Administration is considering a rule change, but the language in the proposed new guidelines won’t solve the issue of majority venture capital ownership, biotech leaders say.

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