SBIR Budgeting Basics: Direct Costs, Indirect Costs, and the Small Business Fee
A breakdown of the three major budget categories that can make or break your SBIR proposal.
Written by Scout Editorial Team
At Scout, we’ve built and reviewed hundreds of SBIR budgets across agencies like NIH, NSF, DOE, and DoD. And time and again, we see the same pattern: many otherwise strong proposals fail not because of weak science, but because of poorly structured or non-compliant budgets. Federal reviewers expect financials that are clear, realistic, and audit-ready. A sloppy budget can sink your application before reviewers even read your Specific Aims page.
In this post, we’ll break down the three major components of an SBIR budget so you can avoid common mistakes and build a proposal that stands up to both reviewers and auditors:
- Direct Costs
- Indirect Costs (Overhead & Fringe)
- Small Business Fee (Profit/Fee)
By understanding these categories—and how agencies expect them to be allocated—you’ll put your application on stronger footing, demonstrate fiscal discipline, and increase your chances of success.
SBIR Budgeting at a Glance
Category | What It Covers | Typical Range/Notes |
|---|---|---|
Direct Costs | Salaries, consultants, equipment, materials, travel | Usually ~60–70% of Phase I budget |
Indirect Costs | Overhead, fringe benefits, admin support, facilities | Negotiated or estimated rate; ~20–40% of direct costs |
Small Business Fee | Profit/fee charged by the company | Capped at 7% of total costs (direct + indirect) |
1. Direct Costs: The Heart of the SBIR Budget
Direct costs are the line items directly tied to the research and development (R&D) proposed in your SBIR project. These are the most closely scrutinized expenses—by both scientific reviewers and Grants Management Officers—because they demonstrate how you plan to execute your work.
Examples of Direct Costs
Personnel
- Includes the Principal Investigator (PI), research staff, technicians, and postdocs.
- Must align with the stated level of effort (% effort)—a key compliance requirement.
Fringe Benefits
- Covers costs like health insurance, retirement contributions, payroll taxes, and other benefits tied to salaries.
Consultants and Subcontractors
- Used for specialized expertise not available in-house.
- Must remain within subcontracting limits (e.g., ≤33% of Phase I effort for most SBIRs).
Equipment and Supplies
- Includes scientific instruments, software licenses, reagents, and prototyping materials.
- Must be essential to the proposed R&D—not general-purpose lab furniture or office equipment.
Travel
- Covers costs for agency-required meetings, conferences, or research site visits.
- Must be justified as necessary to the project.
Key Compliance Notes
Personnel costs must reflect reasonable market rates and align with company payroll records. Inflated salaries are a red flag.
Travel and equipment must be tied directly to project activities—general business development or fundraising trips are not allowable costs.
Subcontracts require detailed budgets and letters of commitment from the partner institution. Missing documentation is a common reason for budget rejection.
Your direct costs tell the story of how your research will be executed. A well-structured budget shows reviewers that your startup can manage federal funds responsibly and deliver on the technical objectives of your SBIR project.
2. Indirect Costs: Overhead and Administrative Expenses
Indirect costs (IDC) represent the overhead and administrative expenses that keep your startup running but can’t be tied to a single R&D activity. While they don’t show up in the lab, they are critical to sustaining the infrastructure needed to execute federally funded research.
Examples of Indirect Costs
Administrative salaries – CEO, finance, operations, or HR support staff
Facilities – Rent, utilities, internet, and shared office resources
Professional services – General accounting, bookkeeping, and legal support
Depreciation – Costs tied to shared equipment used across multiple projects
IT and cybersecurity – Systems, licensing, and compliance infrastructure
How to Calculate Indirect Costs
NIH / NSF – Applicants without a negotiated rate may use a 40% Total Direct Costs (TDC) de minimis rate (NIH Grants Policy Statement).
DoD / DOE – Often allow startups to propose a provisional indirect rate, subject to future audit and adjustment.
If your startup anticipates significant overhead costs, it may be worth negotiating a formal rate agreement with your cognizant federal agency. This provides flexibility and stability for future SBIR/STTR proposals.
Common Mistakes to Avoid
Double-counting expenses (e.g., charging rent as both a direct and indirect cost).
Overstating fringe or overhead rates without proper documentation.
Inconsistent cost treatment across projects—agencies expect uniform application of accounting practices.
Indirect costs aren’t just a compliance requirement—they’re a lifeline for your startup’s operations. Managing them correctly ensures that you can support your team, facilities, and infrastructure without raising red flags during audits.
3. The Small Business Fee: The Often Overlooked Profit Margin
One of the most overlooked features of the SBIR budget is the Small Business Fee—sometimes referred to as the profit or fee. Unlike direct or indirect costs, this allocation is essentially a profit margin for your company. It isn’t tied to specific cost categories, giving founders one of the few areas of true financial flexibility within a federal grant.
Rules for the Small Business Fee
Capped at 7% of total project costs (direct + indirect)
Not tied to line items—you decide how it’s spent
Common uses include:
- Business development activities
- Investor relations or fundraising support
- Unallowable expenses (e.g., patent filing, marketing, lobbying)
- General growth initiatives that strengthen your company
Many first-time applicants skip requesting the Small Business Fee, often out of fear it will be seen as excessive. This is a mistake. Agencies expect you to include it—and in fact, leaving it out can signal inexperience. Since it’s one of the only flexible pools of funding in an SBIR award, failing to claim it means walking away from dollars you can use to strengthen your company beyond the lab.
Example SBIR Phase I Budget Breakdown
Category | Amount | % of Total |
|---|---|---|
Direct Costs | $160,000 | 64% |
Indirect Costs | $70,000 | 28% |
Small Business Fee | $20,000 | 8% |
Total | $250,000 | 100% |
Budget Compliance Across Agencies
NIH – Requires detailed personnel justifications and often uses a modular budget format. Precision in effort allocation is heavily scrutinized.
NSF – Offers more flexibility, but demands consistent treatment of fringe benefits and indirect costs across all submissions.
DoD – Expects fully itemized subcontractor budgets with letters of commitment and clear justifications.
DOE – Places strong emphasis on indirect rate justification and may require cost-sharing in Phase II awards.
Each agency has its own budget templates and compliance requirements, but the underlying structure remains the same. Mastering these nuances ensures your proposal is not only competitive scientifically but also audit-ready financially.
Common Pitfalls in SBIR Budgets
Overloading Personnel Costs – Reviewers expect a balanced budget. If too much of the award goes toward salaries, it may signal weak planning for equipment, materials, or other research needs.
Ignoring Subcontract Caps – Subcontracting more than 33% in Phase I or 50% in Phase II can result in automatic rejection. These thresholds are non-negotiable.
Skipping the Small Business Fee – Many first-time applicants fail to request it, leaving up to 7% of the award unclaimed. Agencies expect you to include it.
Charging Unallowable Costs – Expenses like business dinners, entertainment, or lobbying are prohibited and can trigger budget cuts—or worse, audit findings.
Weak Budget Justification – A budget without strong explanations raises red flags. Every line item should clearly tie back to your R&D milestones and technical objectives.
Think of your budget as more than numbers—it’s part of your proposal narrative. A clear, compliant, and well-justified budget shows reviewers that your startup can execute federal research responsibly and maximize the impact of taxpayer dollars.
How Scout’s Approach to SBIR Budgeting
Compliance-Ready Financials – Budgets tailored to the specific templates and requirements of NIH, NSF, DoD, DOE, and other agencies.
Indirect Rate Strategy – Advising whether to use safe/de minimis rates or negotiate a formal indirect cost agreement.
Subcontracting Guidance – Ensuring consultant and subcontractor allocations stay within federal caps (≤33% in Phase I, ≤50% in Phase II).
Milestone-Driven Structure – Aligning budget categories directly with your R&D objectives and deliverables, so reviewers see how dollars translate into progress.
We’ve seen firsthand how a well-justified budget not only ensures compliance but also boosts reviewer confidence—increasing the likelihood your proposal is funded.