SBIR and STTR companies rarely work on only one thing at a time.

 

A founder may spend the morning reviewing prototype data, the afternoon speaking with potential customers, and the evening preparing investor materials. Engineers may work on federally funded R&D while also supporting non-award product development. Leadership may manage payroll, hire employees, meet with partners, respond to agency questions, and prepare for commercialization.

 

That is normal for an early-stage company.

 

But when federal funding is involved, not all startup activity belongs on the award.

 

SBIR/STTR awardees need to separate federally funded R&D from commercialization, fundraising, sales, general business operations, and unallowable or non-award activity. Without that separation, companies may mischarge costs, distort indirect rates, weaken documentation, or create problems during reporting, invoicing, drawdowns, closeout, or audit review.

 

At Peter Witts CPA PC, we help SBIR/STTR companies clean up cost structures so project work, commercialization activity, general business costs, and unallowable costs are tracked clearly.

 

Why Cost Separation Matters

 

Federal awards are not general-purpose startup funding.

 

They support specific approved work, during a specific period, under specific award terms. Even when a company is building toward commercialization, the award usually funds the work described in the approved scope, budget, and agency instructions.

 

Cost separation helps the company answer:

• Which costs directly support the funded R&D project?
• Which costs support the business generally?
• Which costs relate to commercialization?
• Which costs are fundraising, sales, or investor activity?
• Which costs are unallowable or outside the award?
• Which costs belong in an indirect cost pool?
• Which costs should be excluded from drawdowns, invoices, or reimbursement requests?
• Which costs should be tracked for management purposes only?

The company should be able to explain why each major cost belongs where it was charged.

 

Start With the Approved Statement of Work

 

The approved statement of work is the starting point.

 

Before deciding whether a cost belongs on an SBIR/STTR award, ask whether the cost supports the work the agency approved.

 

A cost is easier to support when it connects to:

• A project task
• A technical milestone
• A research objective
• A prototype activity
• A testing plan
• A data collection activity
• An approved consultant or subcontractor scope
• An approved budget category
• The period of performance

If the activity does not support the approved work, it may need to be tracked outside the award or treated differently.

 

The key question is not whether the activity helps the company. The question is whether the activity supports the funded award.

 

Federally Funded R&D Costs

 

Federally funded R&D costs are costs that directly support the approved SBIR/STTR project.

 

These may include:

• Founder or employee time spent on approved technical work
• Scientist, engineer, or developer labor tied to project tasks
• Prototype development
• Experiments
• Testing and validation
• Project-specific materials and supplies
• Approved consultant support
• Approved subcontractor or research partner work
• Lab services tied to the project
• Project-specific software or data services
• Technical reporting required by the award

These costs should be coded to the award or project in the accounting system and supported by documentation.

 

For labor, the company should also maintain timekeeping records that show who worked on the project, when they worked, and what activity they performed.

 

Commercialization Costs

 

Commercialization activity helps move the technology toward the market.

 

That may include customer discovery, sales conversations, market research, investor presentations, business development, pricing strategy, channel development, manufacturing planning, regulatory planning, licensing discussions, or go-to-market work.

 

Commercialization is important. But that does not mean all commercialization activity can be charged to the SBIR/STTR award.

 

NIH’s SBIR/STTR budget instructions state that, regardless of when the costs are incurred, no SBIR/STTR funds can be used to support commercialization activities except for Technical and Business Assistance or Commercialization Readiness Pilot funding. Other agencies may have their own specific rules, so awardees should review the current solicitation and award terms before charging commercialization-related costs.

 

The practical takeaway is simple: commercialization activity should be identified separately and reviewed carefully before being charged to the award.

 

General Business Costs

 

General business costs support the company as a whole.

 

These may include:

• Accounting and payroll support
• General management
• Rent and utilities
• Insurance
• Administrative software
• HR and recruiting
• Company-wide legal support
• General office expenses
• Finance and compliance support
• Leadership meetings
• Internal operations

Some general business costs may be allowable indirect costs if they support multiple cost objectives and are treated properly in the company’s indirect rate structure. Others may be unallowable, non-award, or outside the funding scope.

 

NIH explains that F&A or indirect costs are necessary costs incurred for a common or joint purpose that benefit more than one cost objective and are not readily assignable to a specific cost objective without disproportionate effort.

 

This is why general business costs should not automatically be charged directly to the award. They need to be classified and allocated properly.

 

Fundraising and Investor Activity

 

Fundraising and investor activity are common in SBIR/STTR companies, especially between phases or during commercialization planning.

 

Founders may spend time on:

• Investor meetings
• Pitch decks
• Due diligence calls
• Term sheet discussions
• Board updates
• Fundraising strategy
• Capital raise planning
• Investor reporting

These activities may be important to the company’s growth, but they should not be treated as federally funded R&D.

 

Founder time spent fundraising should be separated from direct project labor. If it is not separated, the company may overcharge the award, distort labor distribution, and weaken support for payroll charged to the project.

 

Sales and Business Development Activity

 

Sales and business development activity should also be separated from federally funded R&D.

 

This may include:

• Sales calls
• General customer outreach
• Proposal activity for non-federal customers
• Marketing campaigns
• Website development
• Trade show activity
• Distribution discussions
• Channel partner meetings
• Pricing strategy
• Commercial contracts
• Customer demos not tied to the approved award scope

Some customer discovery or commercialization activities may be allowed only under specific agency programs, budget categories, or award terms. Others may need to be tracked outside the award.

 

The company should not assume that because commercialization is part of the long-term SBIR/STTR mission, all sales-related costs belong on the award.

 

Internal R&D Outside the Award

 

Many SBIR/STTR companies perform internal R&D in addition to federally funded R&D.

 

That internal work may support future product development, commercial features, technical improvements, or new applications that are not part of the approved federal award.

 

Internal R&D should be separated from the award when it does not support the approved statement of work.

 

Examples may include:

• Features outside the funded prototype
• Product development for a different customer segment
• Research for a future proposal
• Improvements not included in the approved scope
• Technical exploration unrelated to the award
• Commercial product work beyond the federally funded task

If employees work on both award R&D and internal R&D, timekeeping should separate those activities.

 

Direct, Indirect, and Unallowable Cost Categories

 

To separate costs properly, the company should understand three core categories.

 

Direct costs are costs tied specifically to the funded project. These are usually charged directly to the award.

 

Indirect costs support the business or multiple projects. These may be allocated through fringe, overhead, or G&A rates when allowable and properly supported.

 

Unallowable costs should not be charged to the federal award and may need to be excluded from indirect cost pools, billings, claims, or proposals.

 

SBIR.gov explains that a good accounting system differentiates direct from indirect costs and isolates unallowable costs. It also identifies timekeeping and labor distribution as key accounting system expectations for SBIR/STTR companies.

 

A clean cost structure helps the company manage all three categories.

 

Unallowable Costs Need Visibility

 

Unallowable costs should not disappear from the books.

 

The company may still incur costs that are legitimate business expenses but not allowable for federal award purposes. Those costs should be recorded in the accounting system and clearly identified so they are not charged to the award or included improperly in indirect rates.

 

FAR requires expressly unallowable costs and mutually agreed unallowable costs, including certain directly associated unallowable costs, to be identified and excluded from billings, claims, and proposals applicable to a government contract.

 

For SBIR/STTR companies, this means costs such as certain fundraising, lobbying, entertainment, or non-award commercialization activity should be reviewed carefully and coded appropriately.

 

Timekeeping Is the Control Point

 

Timekeeping is one of the most important controls for separating R&D, commercialization, and general business activity.

 

A founder or employee may work on several activities in the same week. Without timekeeping, it is difficult to prove which time belonged to the award and which time did not.

 

Timekeeping should separate:

• Direct award R&D
• Indirect business activity
• Internal R&D outside the award
• Commercialization activity
• Fundraising or investor activity
• Sales and business development
• Administrative work
• Unallowable or non-award activity

This matters because labor is often the largest SBIR/STTR cost category. If labor is not tracked correctly, the company’s project costs, indirect rates, drawdowns, invoices, and budget-to-actual reports may all be affected.

 

Founder Time Requires Extra Care

 

Founder time is one of the most common gray areas.

 

A founder may be the principal investigator, technical lead, CEO, fundraiser, commercialization lead, and operations manager at the same time.

 

That means founder time should be divided based on actual activity.

 

For example:

• Time spent performing approved technical work may be direct project labor.
• Time spent managing company-wide operations may be indirect.
• Time spent pitching investors may be fundraising activity outside the award.
• Time spent selling to commercial customers may be sales or business development.
• Time spent on non-award product features may be internal R&D outside the award.

The founder’s title does not determine the cost treatment. The activity does.

 

Use Project Codes and Activity Codes

 

The accounting system should make cost separation practical.

 

At a minimum, SBIR/STTR companies should consider project or activity codes for:

• Federal award R&D
• Internal R&D
• Commercialization
• Fundraising
• Sales and marketing
• General administration
• Unallowable costs
• Cost share or matching funds, if applicable
• Other customer-funded work
• Other federal awards

These codes help leadership see where time and money are going.

 

They also make it easier to prepare budget-to-actual reports, indirect rate schedules, drawdown support, invoices, and closeout documentation.

 

Separate Commercialization from Award-Funded Technical Work

 

Commercialization and R&D can be closely connected, but they should still be tracked separately.

 

For example, a prototype test required by the approved statement of work may be award-funded R&D. A sales demo for a potential commercial customer may be commercialization or business development. A technical adjustment needed to meet the approved award milestone may be award activity. A product feature requested by a future customer but not included in the approved award scope may be internal or commercial activity.

 

The company should document why costs are charged to the award when commercialization and R&D overlap.

 

Helpful support may include:

• Approved statement of work
• Technical milestone records
• Project meeting notes
• Budget narrative
• Timekeeping descriptions
• Agency correspondence
• Consultant or subcontractor scope
• Internal approval notes

Documentation helps show the difference between federally funded R&D and broader commercialization work.

 

Review Costs Before Drawdowns or Invoices

 

Before drawing funds, invoicing, or requesting reimbursement, the company should review whether costs are properly classified.

 

Ask:

• Are these costs tied to the approved award?
• Are they within the period of performance?
• Are they direct, indirect, or unallowable?
• Are commercialization costs excluded unless specifically allowed?
• Are fundraising and investor activities excluded?
• Are sales and marketing costs excluded where required?
• Do payroll charges tie to timekeeping?
• Do vendor costs tie to the project?
• Are indirect costs calculated properly?
• Are supporting records organized?

This review should happen before payment requests are submitted, not after questions arise.

 

Budget-to-Actual Reports Should Show Cost Separation

 

Budget-to-actual reporting should help leadership see more than total award spending.

 

A useful report should show whether costs are being charged to the right categories and whether non-award activity is being separated.

 

Review:

• Award direct costs
• Indirect costs
• Unallowable costs
• Internal R&D
• Commercialization spending
• Fundraising activity
• Sales and marketing costs
• Cost share, if applicable
• Remaining award budget
• Cash flow impact

This gives leadership a clearer picture of both award performance and company operations.

 

Policies Help Keep the Team Consistent

 

Cost separation is easier when the company has written policies and practical training.

 

Policies may cover:

• Direct and indirect cost classification
• Unallowable costs
• Timekeeping
• Labor distribution
• Expense approvals
• Commercialization activity
• Fundraising and investor activity
• Sales and marketing costs
• Internal R&D
• Drawdown or invoice review
• Document retention

Employees do not need a long compliance manual. They need clear guidance on how to code time and expenses correctly.

 

Common Cost Separation Mistakes

 

SBIR/STTR companies often run into problems when they treat the federal award like general startup funding.

 

Common mistakes include:

• Charging all founder time to the award
• Treating investor meetings as project labor
• Mixing federally funded R&D with internal product development
• Charging general sales activity to the award
• Not separating commercialization costs
• Recording all payroll as direct labor
• Not using project codes
• Not tracking unallowable costs separately
• Including unallowable costs in indirect rate pools
• Drawing funds based on total expenses instead of award costs
• Not documenting why a cost supports the award
• Waiting until closeout to separate costs

These issues are easier to prevent with the right accounting setup.

 

Questions to Ask When Classifying Costs

 

Before charging time or expenses to an SBIR/STTR award, ask:

• Does this cost support the approved statement of work?
• Is it within the period of performance?
• Is it tied to a specific project task or milestone?
• Is it direct, indirect, or unallowable?
• Is it commercialization, fundraising, sales, or general business activity?
• Does the award specifically allow this cost?
• Is documentation available?
• Does the accounting system code it correctly?
• Does timekeeping support the labor?
• Should agency guidance or approval be reviewed?

These questions help prevent misclassification before it becomes a reporting issue.

 

Monthly Cost Structure Review Checklist

 

Each month, SBIR/STTR awardees should review:

• Direct award costs
• Indirect costs
• Unallowable costs
• Founder time
• Employee time by project
• Commercialization activity
• Fundraising and investor activity
• Sales and business development activity
• Internal R&D outside the award
• Vendor and consultant coding
• Indirect rate impact
• Drawdown or invoice support
• Documentation gaps

This monthly review helps keep the award records clean and helps leadership understand the company’s true cost structure.

 

Final Thoughts: Federal Funding Requires Clear Cost Boundaries

 

SBIR/STTR companies are often building the science, the product, the company, the customer pipeline, and the investor story at the same time.

 

That is exactly why cost separation matters.

 

Federally funded R&D, commercialization activity, fundraising, sales, internal R&D, and general business operations may all happen in the same month, or even the same day. But they should not all be charged the same way.

 

At Peter Witts CPA PC, we help SBIR/STTR companies clean up cost structures so award costs, indirect costs, unallowable costs, commercialization activity, and general business expenses are tracked clearly and supported by records.

 

Need Help Cleaning Up Your Cost Structure?

 

If your company is managing SBIR/STTR funding while also working on commercialization, fundraising, sales, internal R&D, or general operations, Peter Witts CPA PC can help review your cost structure, project codes, timekeeping, indirect rates, unallowable cost tracking, drawdown support, and documentation process.

 

Backed by 35+ years of government contract accounting experience and first-hand DCAA knowledge, our team helps innovators separate award activity from broader startup activity so federal funding is managed with clarity, compliance, and confidence.

 

Schedule a strategic consultation with Peter Witts CPA PC to clean up your cost structure.