Indirect costs are one of the most confusing parts of an SBIR/STTR proposal budget. Many applicants understand the direct costs of the project, such as personnel, materials, consultants, and subcontractors, but they are less certain about how to recover the general business costs needed to support the work.

 

That uncertainty can lead to budget mistakes. Some companies use a rate that is too low and underfund their operations. Others use a rate that is difficult to support, creating questions during review or challenges after award.

 

At Peter Witts CPA PC, we help SBIR/STTR applicants and awardees understand the financial structure behind indirect costs so their proposal budgets are realistic, defensible, and aligned with future award management.

 

Why Indirect Costs Matter in SBIR/STTR Proposals

Indirect costs help cover the expenses that support your business but are not tied to one specific project. These may include rent, utilities, administrative labor, accounting, insurance, software, and other operating costs necessary to keep the company running.

 

For SBIR/STTR companies, indirect costs matter because they can affect:

• Proposal competitiveness
• Cost recovery
• Cash flow during award performance
• Accounting system readiness
• Phase II financial planning
• Billing, drawdowns, and reporting
• Future audits or agency reviews

A strong indirect cost strategy is not just about choosing a number. It is about understanding how your company operates, what costs are needed to support the award, and how those costs will be tracked after funding is received.

 

The Three Common Approaches: NICRA, De Minimis, or Custom Rate

SBIR/STTR applicants generally encounter three common approaches to indirect costs:

• A negotiated indirect cost rate agreement, often called a NICRA
• A de minimis indirect cost rate
• A custom or proposed indirect cost rate

Each option has a different purpose, level of documentation, and strategic impact.

 

Choosing the right approach depends on your agency, solicitation, award type, cost structure, accounting system, and growth plans.

 

Option 1: NICRA

A NICRA is a Negotiated Indirect Cost Rate Agreement. It is an approved indirect cost rate negotiated with a federal cognizant agency.

 

For companies that already have a NICRA, the proposal budget will typically use the approved rate unless the solicitation or award terms say otherwise. A NICRA can give reviewers and agencies more confidence because the rate has already gone through a formal review process.

 

A NICRA may be helpful when your company:

• Has prior federal awards
• Has a more mature accounting system
• Has recurring federal funding activity
• Needs a documented rate for larger awards
• Is managing multiple contracts or grants
• Wants consistency across federal proposals and awards

However, many early-stage SBIR/STTR applicants do not have a NICRA yet. That does not automatically mean they cannot include indirect costs. It simply means they need to understand the other available approaches and the documentation required to support the rate they use.

 

Option 2: De Minimis Rate

A de minimis rate is a simplified indirect cost rate that certain applicants or awardees may be allowed to use when they do not have a negotiated rate.

 

This option can be attractive to early-stage companies because it is simpler than building a fully customized indirect rate structure. It may reduce the documentation burden and make budgeting easier for companies that are still developing their accounting systems.

 

A de minimis rate may be appropriate when:

• The company does not have a NICRA
• The business has a simple cost structure
• The solicitation allows the de minimis approach
• The company wants a simplified budgeting method
• The indirect costs are modest or still developing
• The award does not require a more detailed rate structure

However, the de minimis approach is not always the best financial strategy. If your actual indirect costs are higher than the allowed de minimis rate, your company may under-recover the true cost of performing the work. That can create cash flow pressure, especially during Phase II or as the team grows.

 

Applicants should always review the specific solicitation and agency guidance before assuming that a de minimis rate is available or appropriate.

 

Option 3: Custom or Proposed Indirect Rate

A custom or proposed indirect rate is built around your company’s actual or projected cost structure. This approach may be useful when the de minimis rate does not reflect the true cost of supporting the project, but the company does not yet have a NICRA.

 

A custom rate may include:

• Fringe benefits
• Overhead costs
• General and administrative costs
• Facilities costs
• Administrative labor
• Accounting and compliance support
• Software and operating expenses
• Other allowable business costs

This approach usually requires more documentation. The company should be able to explain what costs are included in the indirect pool, what base the rate is applied to, and why the rate is reasonable.

 

A custom rate may be appropriate when:

• The company has meaningful operating costs
• The award will require a larger internal team
• The company is preparing for Phase II
• The de minimis rate would understate actual costs
• The business expects more federal funding in the future
• The accounting system can support cost pool tracking
• Leadership wants a rate strategy that supports growth

A custom rate should not be guessed. It should be built from financial records, reasonable projections, and a clear understanding of how the company will track costs after award.

 

How to Decide Which Rate Approach Makes Sense

There is no single right answer for every SBIR/STTR company. The right indirect cost approach depends on the company’s stage, agency, proposal budget, and financial infrastructure.

 

Before choosing a rate, ask:

• Does the solicitation allow indirect costs?
• Does the agency provide specific instructions for indirect rates?
• Do we already have a NICRA?
• Are we eligible to use a de minimis rate?
• Would the de minimis rate cover our actual operating costs?
• Do we have enough documentation to support a custom rate?
• Can our accounting system separate direct, indirect, and unallowable costs?
• Will this rate still make sense during award performance?
• How will this rate affect future Phase II or follow-on funding?

The best rate strategy should support both the proposal and the company’s ability to manage the award responsibly after funding is received.

 

Do Not Copy Another Company’s Rate

One common mistake among SBIR/STTR applicants is using a rate they heard from another founder, advisor, or applicant.

That can create problems.

 

Indirect rates should reflect your company’s actual cost structure, not another company’s operations. A biotech startup with lab space, specialized equipment, and compliance needs may have a very different cost structure from a software company with a small remote team.

 

Using another company’s rate may make the budget easier to complete, but it can also make the proposal less defensible and create financial issues later.

 

Your indirect rate should be based on your own costs, your own business model, and your own award strategy.

 

Connect the Indirect Rate to the Accounting System

Your proposal rate should not live only inside the budget spreadsheet. After award, the company needs to track costs in a way that supports the rate.

 

That means your accounting system should be able to:

• Separate direct costs from indirect costs
• Identify unallowable costs
• Track labor by project or funding source
• Support fringe, overhead, or G&A cost pools if used
• Reconcile actual costs against the proposed budget
• Produce reports for billing, drawdowns, or agency review
• Maintain documentation for future questions

This is especially important for companies preparing for larger awards, Phase II funding, or cost-reimbursable contracts.

 

If the accounting system cannot support the rate strategy, the company may face challenges after award even if the proposal is accepted.

 

Avoid Underfunding the Business

Some applicants choose the lowest possible indirect rate because they want the proposal to look more competitive. While that may reduce the budget on paper, it can create problems during performance.

 

If the company does not recover enough of its allowable operating costs, it may need to fund administrative, facilities, accounting, compliance, or management expenses from other sources.

 

That can lead to cash flow strain and make it harder to perform the work successfully.

 

A competitive budget should still be financially realistic. The goal is not to make the budget as low as possible. The goal is to build a budget that supports the work, follows agency rules, and gives the company a sustainable financial path through award performance.

 

Avoid Overstating Costs Without Support

The opposite mistake is using an indirect rate that is too high or not well supported.

 

If the rate cannot be explained, documented, or connected to the company’s financial records, it may raise questions during review. It may also create challenges later if the company cannot track costs consistently with the proposed structure.

 

A defensible rate should show:

• What costs are included
• What costs are excluded
• What base the rate is applied to
• How the rate was calculated
• Whether the rate is based on actuals, projections, or both
• How the company will monitor the rate after award

The more complex the rate, the more important the documentation becomes.

 

Think Beyond Phase I

Many SBIR/STTR companies build their first budget only around Phase I. But the rate strategy should also consider what may happen next.

 

If the company expects to pursue Phase II, hire staff, lease space, add subcontractors, or pursue multiple federal awards, the indirect cost approach should be able to grow with the business.

 

A rate that works for a small Phase I project may not be enough for a larger Phase II award. Likewise, a very simple accounting system may need to become more structured as the company’s federal funding grows.

 

Before submitting, consider:

• Will this rate still make sense if we receive Phase II?
• Will we need a more formal accounting system later?
• Are we building a cost structure that supports future awards?
• Could our current approach limit cost recovery?
• Are we prepared to explain the rate to an agency or auditor?

Indirect cost planning is not only about the current application. It is part of a longer federal funding strategy.

 

Common Indirect Cost Mistakes in SBIR/STTR Proposals

SBIR/STTR applicants often run into issues when indirect costs are not planned carefully.

 

Common mistakes include:

• Using another company’s indirect rate
• Choosing a de minimis rate without checking agency rules
• Using a custom rate without enough support
• Including unallowable costs in the indirect pool
• Mixing direct and indirect costs inconsistently
• Forgetting fringe benefits or administrative labor
• Failing to connect the proposal rate to the accounting system
• Underestimating the cost of managing the award
• Not planning for Phase II or future awards
• Waiting until after award to build the financial structure

These issues can make the proposal harder to defend and the award harder to manage.

 

Final Thoughts: Your Indirect Rate Is a Strategy Decision

Indirect costs are not just a budget line. They are part of the financial strategy behind your SBIR/STTR proposal.

 

The right approach should help your company recover allowable costs, support the proposed work, stay aligned with agency expectations, and build a foundation for future funding.

Whether your company uses a NICRA, a de minimis rate, or a custom proposed rate, the key is to make sure the rate is realistic, documented, and connected to how the award will actually be managed.

 

At Peter Witts CPA PC, we help SBIR/STTR applicants and awardees build indirect rate strategies that support proposal credibility, award management, audit readiness, and long-term growth.

 

Need Help Choosing the Right Indirect Cost Strategy?

If you are preparing an SBIR/STTR proposal, Peter Witts CPA PC can help you evaluate whether a NICRA, de minimis rate, or custom proposed rate makes sense for your company.

Backed by 35+ years of government contract accounting experience and first-hand DCAA knowledge, our team helps innovators build the financial foundation to pursue funding, manage awards, and grow with confidence.

 

Schedule a strategic consultation with Peter Witts CPA PC to strengthen your SBIR/STTR indirect cost strategy.