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Why Grants are Good for Business

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If your company is struggling to win state or federal R&D grants right now, you’re not alone. The poor investment climate has spawned intense competition for grant money.

Take NIST’s Advanced Technology Program: In 2002, applications reached a record high and the agency has thus far funded only four percent of them; that’s one-fourth what it usually awards.

Despite the decreasing odds of winning, going for grants is still worth the effort. It’s hard to overstate the benefits of getting grant money. Grants support work too risky for private capital, create bid-advantaged contracting opportunities, and, if used properly, reduce the dilution founders and employees experience on their way to liquidity.

The chart below shows a new biotech company going through six rounds of investments before being sold for $400 million. In this case, founders and employees own just 17.8 percent of the company by the time it reaches liquidity.

If, instead of so much investment capital, the founders had been able to win some grant money, they would have maintained greater ownership as long as the company had maintained the same valuation trajectory.

As the next table shows, if the company had won a half-million-dollar grant instead of taking its first round of investment capital, the founders’ share at liquidity would have been 23.7 percent instead of 17.8 percent. If they had won grants in place of their first two rounds, they would have owned 31.6 percent of the company at liquidity. That’s between $23 million and $96 million more that the founders and employees could have held at liquidity had they financed their early research and development efforts through grants.

For maturing companies, the reduction of dilution also benefits early-round investors. In this example, an angel investor nearly doubles his return should the company replace the second and third rounds with grants.

To be sure, there are reasons why you wouldn’t want to rely on grants as your sole source of funding. Consider a few:

Cost Sharing. Many awards programs require cost sharing. The NIST Advanced Technology Program, for example, requires a minimum cost sharing of indirect expenses. You cannot cost-share with funds from other federal grants or credibly claim that you have no indirect expenses.

Restricted Uses. Grants typically prohibit the use of funding for business development, marketing, or sales. You might be able to fund your product’s development with grants, but you will be unlikely to sell your final products or reach liquidity without investing in other critical business functions.

Funding Variability. Grants are not stable, recurrent sources of capital. A company can receive $5 million in one cycle and come up empty for the next several years. In other words, diversify your funding with venture capital, partnerships, or early product sales.

It’s also important to remember to stay focused on your business while pursuing grants. Winning grant funding for research that is not part of your overall strategy may be worse than receiving none at all. The valuation and dilution benefits cited here assume that a company’s valuation remains the same whether capitalization is provided by private investments or grant funding. However, valuations aren’t driven by the dollars put into the company. Instead, valuations are driven by the company’s progress in meeting its objectives and milestones. If a grant does not help your progress on your chosen path, it will not increase the firm’s valuation. Instead, it delays real progress.

 

Randy Grimes is the founder and principal of The Randall Group, a consultancy that helps small-to-medium-sized biotech companies find and win government grants. Contact him at www.the-randall-group.com or at (480) 206-6954.

 


What Founders Get From Investor-Funded Startups

Round

Premoney Valuation
($, millions)

Investment
($, millions)
Founders’ Stake (%)
Investors’ Stake (%)

1

1.5
0.5
75.0
25.0
2
7.5
2.5
56.3
43.7
3
15.0
5.0
42.2
57.8
4
30.0
10.0
31.6
68.4
5
75.0
25.0
23.7
76.3

6

150.0
50.0
17.8
82.2

 

What A Difference Some Grants Make

Grant Funding
($, millions)

Founders’
Stake (%)

Investors’
Stake (%)

Founders’ Value
($, millions)
Investors’ Value
($, millions)
0.0
17.8
82.2
71
328
0.5
23.7
76.3
94
305
3.0
31.6
68.4
126
273

8.0

42.2
57.8
168
231

 

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