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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 (DoD) Small Business Innovation Research contract.

Capella Space is one of the few global startups building satellites and sensors to do Earth observation from space using synthetic aperture radar. 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. 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.

However, Capella’s bid was rejected because the SBIR program excludes companies that are majority-owned by venture capitalists.

In 2003 the courts ruled that companies with over 50 percent venture capital ownership are ineligible for SBIR grants. Then, in 2011 Congress created a waiver for small businesses.

However, unlike other government agencies, the DoD has not requested any waiver in seven years, according to a fact sheet provided by a staff of House Armed Services Committee (HASC) Ranking Member Mac Thornberry (R-Texas). Thornberry, a longtime advocate of Pentagon reforms to lower barriers to small businesses is now proposing legislation that simplifies the process for obtaining a waiver to the SBIR restrictions.

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 that he is concerned innovative small businesses are being barred from the SBIR program precisely for being successful enough to attract private sector investment.

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.

Dan Brophy, Capella Space vice president of government services said that 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.”

If the company is shut out of the SBIR program, it does not see other avenues right now to work with DoD. Contractors tend to be selected based on past performance, which “pretty much rule out any type of venture-backed companies,” Brody said.

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.

On May 16, Thornberry released a series of proposed measures to reform how the Department of Defense does business, including the SBIR provisions.  

Thornberry proposed legislation that would make it easier for startups like Capella Space to continue to get private funding and compete for DoD small business awards. The bill aims to make sure that companies are not selected based on the source of their investment but on the merits of the technology itself.

“Capella Space’s work was so promising that major venture capitalists chose to invest in them,” says the House committee fact sheet. However, the confidence the marketplace was showing in their work was also the reason they were rejected from the SBIR program.