The Phase III Protocol: Converting SBIR/STTR Seed Capital into Sole-Source Production Revenue
- Jordan Clayton
- Sep 1
- 5 min read
For the deep-tech executive and the dual-use investor, capital is oxygen. Yet, the two primary sources of liquidity in the defense market are often fundamentally misaligned with the reality of hard-tech development.
Venture capital is fast, but it is expensive (equity dilution) and demands a commercial sales cycle measured in quarters, not years. Traditional government contracts are non-dilutive, but they are slow, bureaucratic, and require a mature, DCAA-compliant back office that early-stage firms do not possess.
What if there was a third option? A "seed fund" backed by the U.S. Treasury that injects non-dilutive capital specifically to de-risk high-technology R&D?
This is the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) program.
It is the largest seed fund in the world. But it is also a trap. Founders who mistake this capital for "revenue" end up building a "science project" company—a petting zoo of cool technology with no path to scale. Founders who understand the statutory architecture see the real prize: a legal "cheat code" that authorizes a direct, sole-source production monopoly.
This is the operational guide to the SBIR/STTR pathway.
The Statutory Architecture: A Congressional Mandate
The SBIR/STTR program is not a discretionary initiative; it is a Congressional mandate. Federal agencies with large R&D budgets (like the DoD) are required by law to set aside a percentage (3.2% for SBIR) specifically for small business innovation.
1. SBIR (Small Business Innovation Research): This is the "solo" play. It funds R&D at the small business level. While partners are allowed, the majority of the work (and the funding) must remain with the small business.
2. STTR (Small Business Technology Transfer): This is the "partnership" play. It requires a formal teaming agreement with a non-profit research institution, such as a university, a University Affiliated Research Center (UARC), or a Federally Funded Research and Development Center (FFRDC). The small business must perform at least 40% of the work, and the research partner 30%. The strategic intent is to transfer technology out of the lab and into the commercial market.
Both programs operate on the same Three-Phase Pathway. Understanding this gated structure is the key to the entire strategy.
The Three-Phase Funnel: Gated Capital Deployment
The program is designed as a funnel to take a high-risk concept and mature it into a fielded capability.
Phase I: The "Feasibility" Play
The Instrument: A small, fast-turn contract (typically $50k-$250k) with a 3-6 month duration.
The Objective: To answer one question: "Is this technically feasible?" It is essentially a paid white paper or proof-of-concept .
The Strategic Goal: The money is negligible—just enough to get you in trouble. The real goal of Phase I is to find your Champion. You must use this 6-month window to identify the end-user and the Program Executive Office (PEO) who will "catch" your technology when the SBIR money runs out.
Phase II: The "Prototype" Play
The Instrument: If you "pass" Phase I, you are invited to bid on Phase II. This is a substantial award (typically $750k-$1.9M) over 12-24 months.
The Objective: This is the real R&D. You are funded to build, test, and demonstrate the prototype you proposed.
The Strategic Goal: Building the tech is only half the battle. The real goal is to use the prototype as a "key" to unlock your Transition Partner. You must get the tech into an exercise, get it "inside the wire," and generate the performance data that proves its value to the PEO.
Phase III: The "Production" Prize (The Holy Grail)
The Definition: This is the most critical, most misunderstood, and most valuable component of the statute. A Phase III is defined as any work that derives from, extends, or completes the R&D performed in Phase I or Phase II.
The Funding: Crucially, Phase III is NOT funded by the SBIR program. It is funded by the customer (the PEO) using Procurement or O&M dollars.
The "Cheat Code": By federal statute, a Phase III award can be granted as a SOLE-SOURCE, NON-COMPETITIVE CONTRACT. Because the competition requirement was satisfied in Phase I, the government can legally bypass the entire Federal Acquisition Regulation (FAR) competition process.
The Strategic Implication: This is the bridge. You have used SBIR RDT&E funds to build a prototype. You have found a PEO with a requirement. That PEO can now award a $100M production contract directly to you, skipping the 2-year delay of a competitive RFP.
The "New" Playbook: Acceleration via AFWERX and DIU
Historically, the SBIR model was too slow for venture-backed startups. Innovation hubs like AFWERX (Air Force), SOFWERX (SOCOM), and NavalX have rewritten the rules to align with commercial velocity.
1. The "Open Topic" Solicitation: Instead of the government dictating a specific technical problem (e.g., "We need a new titanium alloy"), the topic becomes: "What do you have?" This "Open Topic" allows dual-use companies to pitch their existing commercial solutions to the DoD, with the government paying for the adaptation to military needs.
2. Direct-to-Phase-II (D2P2): This is the single most important accelerator for a mature startup. The D2P2 authority recognizes that a venture-backed firm may have already built a prototype with private capital. It allows you to SKIP the Phase I feasibility study and jump directly to a Phase II award (e.g., $1.2M). This allows a SaaS company to secure non-dilutive capital to become "FedRAMP-ready" or build a mission-specific module.
Strategic Failure Modes: The "SBIR Mill" Trap
The ecosystem is littered with the bones of "SBIR Mills"—companies that are rich in Phase I/II awards but bankrupt in real revenue.
Pitfall 1: Mistaking R&D for Revenue Founders become professional "science project" builders. They win dozens of awards but never transition a single one to Phase III. They are a "petting zoo" of cool tech, not a scalable business. When the grant money dries up, the company dies.
Pitfall 2: The Orphaned Prototype This is the definition of the "Valley of Death." A founder builds a flawless Phase II prototype but fails to do the "capture" work of finding a PEO to catch it. The SBIR funding ends. They have a brilliant capability, but no customer, no budget line, and no legal mechanism to continue.
Pitfall 3: Data Rights Naivete SBIR/STTR provides extraordinarily strong SBIR Data Rights—a 20-year government non-disclosure "shield." This is what protects your sole-source Phase III. Many founders forfeit this leverage by signing bad teaming agreements with Primes or failing to properly mark their deliverables.
The DualSight Execution Strategy
An SBIR is not a contract you win; it is a 3-phase, 5-year capture campaign you must execute.
1. Bid with the End in Mind: Never bid on an SBIR (even a D2P2) unless you can identify the Transition Partner. Who is the PEO with the Procurement budget who will fund the Phase III? If you cannot answer this, do not write the proposal.
2. Phase II is a Capture Budget: The $1.2M Phase II award is not just for engineering salaries. It is a non-dilutive Capture Fund. Use that money and the 24-month performance period to travel to the PEO, get your tech into "Battle Labs," and generate the operational data that proves your value.
3. Ghostwrite the Justification: Your job in Phase II is to arm your champion. You must deliver the "Phase III Transition Package"—the artifact of alignment that includes your successful test data, cost-benefit analysis, and the draft language they need to write the Justification & Approval (J&A) that authorizes the sole-source award.
From Seed Fund to Strategic Monopoly
The SBIR/STTR program is not "free money." It is the government's purpose-built mechanism to solve the "Valley of Death." It is a non-dilutive seed investment and a legal "cheat code" for a production monopoly, rolled into one.
But it only works for the executive who has the operational discipline to play the long game.
This is our core playbook. At DualSight, we provide the Strategic Advisory to target the right solicitations, the Capture Strategy to align you with a PEO champion from Day One, and the Execution Discipline to ensure you cross the bridge from an R&D grant to a sustainable Program of Record.
