Note: This is a fictionalized version of real-world clients’ experiences.

The Audit That Ended Everything

I was sipping coffee, basking in the glow of our research progress, which was funded by a $1,295,000 NIH SBIR Phase II grant, when the audit notice arrived. My materials science startup was on the cusp of a breakthrough.

The auditors arrived the following week. They uncovered a major non-compliance issue, beginning with false claims in our proposal (overstated labor rates and unsupported direct and indirect costs), written in collaboration with a grant writer. Other violations identified included the misuse of funds (paying the grant writer a contingent fee) and treating grant money like a personal piggy bank to cover working capital needs.

Within a week of the audit report, the awarding agency sent a termination-for-cause letter. Our grant was gone! The agency also issued a repayment demand and terminated eligibility for future grants. Our dreams crumbled. That disaster taught me that these mistakes aren’t just errors—they’re a recipe for ruin. What if a few honest choices could keep your grant safe?

The Traps That Trigger Audit Failure

Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) grants provide valuable, non-dilutive, early-stage funding. But they come with strict requirements and oversight. Overstating labor rates in proposals, claiming unsupported indirect costs, misspending funds on non-project expenses, or using grant money as working capital to pay all bills are all too common missteps. These aren’t just sloppy accounting. They are false claims, fraud, and violations that invite audit failure, funding clawbacks, or even criminal charges. The US Department of Health and Human Services Office of Inspector General and other oversight agencies have documented fraud from application through award closeout. (Note: In 2025, Progeny Systems, LLC (acquired by General Dynamics), settled a False Claims Act, paying $600,000, and Vianair, Inc. paid $524,947 to settle a similar claim.)

My Road to Ruin

When we applied for the SBIR grant, the grant writer guided us to use the maximum NIH Salary Cap amounts for our key personnel. I didn’t understand the (actual) Cost Plus Fixed Fee grant. Our indirect cost rates, including fringe, overhead, and general and administrative (G&A) expenses, were not supported by sufficient data. We used the rates that the grant writer said he typically used.

Unfortunately, after winning the grant, we spent the funds freely, using them to purchase new office furniture, settle unpaid vendor bills, and even cover unrelated projects. Grant funds became our working capital. Our logic was that since this is our only project and funding source, it should receive 100% of the business expenses. We were wrong, so wrong. When the agency conducted the audit, we were unable to justify our rates, prove our costs, or demonstrate that the funds were spent appropriately on the project. The agency didn’t care about our innovation once they saw mismanagement, and we paid the price.

Ignorance Isn’t a Defense

Why would anyone make these choices? Ignorance? Laziness? Naivete? All of these.

First, we placed too much trust in the grant writer. We focused on the company’s success rate in securing grant awards. We didn’t do our homework and understand the SBIR program and its rules.

Second, we failed to exercise common sense when we overstated labor rates and used unsupported indirect costs. These mistakes misrepresented our budget, thereby violating the integrity of the proposal. In our case, our grant writer advised that we could use the NIH salary cap rates for our labor costs. As he put it, the agency says you can charge up to that amount. We overlooked the fact that we weren’t planning to pay those amounts and couldn’t afford to do so. Agencies like the NIH expect rates grounded in actual salaries and documented indirect costs.

Third, misspending funds by using grant money for non-approved expenses breaks federal regulations. Understand that even if your government-funded project is your only project, you cannot charge 100% of your business expenses to the project.   There are several reasons, including, but not limited to, cost allowability rules and costs that exceed award maximums.

Fourth, treating grant funds as working capital is just wrong.

A Simple Path to Stay Honest

Avoiding these traps starts with integrity and systems. In proposals, base labor rates on actual payroll records or well-thought-out budgets for future periods. We should have used W-2 wages for existing employees and benchmarked rates using sites like Salary.com for planned positions. When dealing with our indirect rates, we should have calculated them using real data and estimates based on third-party sources (quotes, etc.).

The mistakes we made after the award were completely avoidable. We should have spent only on approved project tasks—labor, materials, or subcontractors tied to milestones. Furthermore, we should have kept grant funds in a separate account, never mixing them with general expenses. It’s the little things done consistently, day after day, that keep you compliant.

Overcoming the “We Need the Money” Mindset

You might think, “Inflating rates or dipping into funds is harmless—we need to survive!” It’s not worth it. Ignoring my responsibility to understand the SBIR rules cost me everything. I sabotaged my company. Imagine losing your grant, your reputation, and facing legal action because you lied in your proposal and failed to spend funds appropriately. Now imagine the pride of a clean audit, earning trust for bigger awards. Honesty isn’t a burden—it’s your edge.

Your First Step to Audit-Proof Grants

Here’s your challenge: today, take one step toward compliance.

If you haven’t received an award:

• Verify your proposal’s labor rates against your payroll records.
• Develop a company budget using historical costs and estimates based on third-party data.
• Review the claims and representations in your proposal. Confirm that your PI meets the requirements. Analyze the level of effort requirements for the company and key personnel.
• Determine if the project proposal and budget submitted are sufficient to complete the deliverables. Does the company need additional funding from non-government sources to cover indirect costs or potential direct cost overruns?

If you have active SBIR/STTR and other projects:

• Review proposal budgets.
• Compare labor costs in the budget to the actual costs. Are you invoicing based on the budget or actual costs?
• Compare expenditures to budget amounts.
• Calculate actual indirect rates and compare them to your provisional rates used in the proposal/award.
• Confirm that you have documents to support all expenditures.
• Identify non-compliant costs charged to projects. Correct these overcharges on the next invoice or drawdown for the project.
• Implement internal controls, processes, and tools to comply going forward.

From Wreckage to Wisdom

That audit didn’t just take my grant and my business. It took my confidence. But it gave me wisdom: make the effort to understand program requirements. Use honest labor rates, supported costs, disciplined spending, and separate funds. Following the rules isn’t just a good idea, it’s the law. Start today, and learn from my experience. What’s the first honest step you’ll take?