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Private investment attraction (or not) to start-ups that have accepted government funding?

What (in general) is private investment's attitude about start-ups that have used government funding to develop their products? For example, a start-up applies for and wins an SBIR or STTR grant and uses the funds, in part, to develop a product they wish to commercialize for a worldwide market. The government gets their limited data rights to whatever they funded, but the company has the opportunity to commercialize, but they need further investment to do so. Now they offer a pitch to a private investor.

Questions for you:
Do investors see prior government funding as an entanglement (or any other "negative" in deciding whether or not to fund)?
Does the fact that the company doesn't need to pay back those funds any part of the decision equation? (a "positive"?)
How would an investor address the government funding issue in the deal to fund? Or would they?
Are there concerns regarding IP and who owns it?

I'm mainly interested in federal funding, but I'd be interested in any experiences with any type of government funding.

Thanks for your replies!

SBIR = small business innovation research
STTR = small business technology transfer

17 Replies

Ken Anderson
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Ken Anderson Advisor
Director, Entrepreneurial and Small Business Development, Delaware Economic Development Office
This requires a much more expanded response than what I will give here, but there is one aspect of this question I have found to be consistent. That is that private investors generally believe, rightly or wrongly, that state and federal funders, which are few and far between outside of the SBIR and STTR highly competitive process, are rarely the"first to fund." As a result, private funders perceive that entities that receive early state or federal "seed" funding, have been thoroughly vetted, financially and technically and as a result, makes the entity more appealing to external investors. Of course, this is not always actually true.
Martin Omansky
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Martin Omansky Entrepreneur
Independent Venture Capital & Private Equity Professional
We have seen a lot of this. Here is my response: (1) Since 1980, IP belongs to the recipient of government funds. Government has data rights Nd royalty-free pricing. but neither is a big deal. (2) Investors usually like government funds in advance of equity funds be as of credibility and non-dilutive financing at the highest risk stage. (3) some state-based incentive funds are more likely to contain provisions that make investors nervous, so I recommend reading the fine print. (4) Some federal programs, such as SBA loans, impose certain restrictions and requirements. I would fully understand the SBA rules and depend upon independent counsel to advise you on the desire ability of accessing from this source. Sent from my iPhone
Franklin Madison
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Franklin Madison Entrepreneur
Founder & Managing Director: Chimera Capital & Finance LLC, Gaia Ventures
*Rudy, I was Regional Director for SBIR for the State of NY for 6 years. I have an intimate knowledge of how investors see it. Its positive because it provides "proof of concept" for the technology that you have developed.* What (in general) is private investment's attitude about start-ups that have used government funding to develop their products? For example, a start-up applies for and wins an SBIR or STTR grant and uses the funds, in part, to develop a product they wish to commercialize for a worldwide market. *The SBIR money is good, the capital goes to your side of the valuation in the company, or your side of the table. So any savvy investor? willl know you have proven your business model (presale) with the SBIR. Dont assume however that all investors know what SBIR is,* The government gets their limited data rights to whatever they funded, but the company has the opportunity to commercialize, but they need further investment to do so. Now they offer a pitch to a private investor. *It depends on the SBIR and the agency. In some instances if its a contracting agency they may pay you for the rights to use the technology that you developed.* Questions for you: Do investors see prior government funding as an entanglement (or any other "negative" in deciding whether or not to fund)? *Not in the case of SBIR, again if they know what it is.* Does the fact that the company doesn't need to pay back those funds any part of the decision equation? (a "positive"?) *Its good business sense, it should excite the investor....you found another source for early stage capital* How would an investor address the government funding issue in the deal to fund? Or would they? *They will, it goes to your higher valuation of the company* Are there concerns regarding IP and who owns it? *You own it, even in SBIR....the govt has the right to use the IP. You own the IP and decide who to license it too* I'm mainly interested in federal funding, but I'd be interested in any experiences with any type of government funding. *SBIR is your best bet....* Thanks for your replies! SBIR = small business innovation research STTR = small business technology transfer *Franklin Madison* *[removed to protect privacy] T: [removed to protect privacy] * *Skype: blacqlock Twitter: NapoleonSolo* *about.me/frankmadison * *linkedin.com/pub/franklin-madison/0/5a/914 * *plus.google.com/+FrankMadison/posts/p/pub *
Scott Davison
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Scott Davison Advisor
Accomplished Entrepreneur & Executive
I think the answer is: it depends...

As both an investor, and a former advanced tech start-up founder (where we raised about $25m in Fed. funding), private investorslook at government funding from two perspectives:

1) Non-dillutive capital: Government grants, especially SBIR and STTR type grants, do not come with a whole lot of strings attached. There is really no significant IP or commercialization entanglement with this type of funding. The Feds are investing this grant money specifically because they want to see you develop and commercialize your idea. The only issue that arises with regard to government rights comes up if you cannot or will not commercialize IP that the government has helped fund. So in this sense, government funding helps you invest in early state research and development on the government's dime. This is good for you in terms of retention of equity in your idea, but is also good for your investor, because you are not burning his or her $$ on early stage R&D.

2) The other perspective that investors should have on this type of funding relates to how much it will cost the company to pursue and execute the grants. Government funding mechanisms, especially phase I grants, can take a lot of resources to go after and they rarely ever materialize very quickly. Unless you are pretty wired with the group that will administer the grants, you can burn a lot of time writing grant applications that will never be successful. Even when you are successful, the money will take time to wrestle into place, and then there is a certain amount of overhead to administering the grant effort.

Summary: as an investor, I'd be thrilled if a company had already been awarded government grants and spent it as non-dilutive capital on R&D. I'd be ok with ongoing funding as long as it doesn't diminish the company's ability to move quickly and pivot when necessary. But, if an idea is truly appealing, I would prefer to put private capital to work instead of leashing the company to a slow government process for evaluating applications and granting relatively small amounts of money in the early phases.

Good luck to you.
Richard Alcott
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Richard Alcott Entrepreneur
Marketing and Communications
Rudy - it seems you are addressing a Phase 3 scenario. If that is the case, you have successfully delivered on Phase 1 & Phase 2 requirements which validate the research. Moving to a commercialization Phase presents its own risk depending upon the application, IP, market maturity and competition. Do investors see prior government funding as an entanglement (or any other "negative" in deciding whether or not to fund)? In my experience grant funding is not a negative because there is no dilutive investment attached to funding that allows development of a proof of concept. Does the fact that the company doesn't need to pay back those funds any part of the decision equation? (a "positive"?) Generally speaking the positive is the company has a validated concept with a rigorous methodology to support results. Essentially it was seed money with no dilution. How would an investor address the government funding issue in the deal to fund? Or would they? In my experience investors won't address grant funding except where there is a requirement to supply the government a favored nation cost of goods/services that is at a stipulated discount that must be maintained and not offered to any other customer. If the business plan is driven by private and government market place opportunities then I view the government model as cashflow and private segment as growth and long term profitability. The business plan needs to reflect market opportunity and financial risk. Are there concerns regarding IP and who owns it? IP clarification is crucial. Ideally the Company owns the IP or has an exclusive unencumbered license ideally for the life of the IP. Many times the exclusive license allows Founders to continue their work with IP they developed with a University/Institution in which the University/Institution owns and maintains the IP. The only challenge I have seen is soliciting foreign investment. Many times, foreign investors will ask that the Company and IP be transferred into a foreign entity. Universities may not find that acceptable. Richard
Robert Levin
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Robert Levin Entrepreneur
General Counsel at Cybis LLC
Rudy: I've been the general Counsel of several companies whose business model included using government R&D funding to develop technology for commercialization, either directly or via spin off or sell off. In my experience investors are very comfortable with the model. Many commercial innovations were developed with govt money from DARPA, NRL, AFRL, ARL, etc. For example, Siri was developed under a DARPA program called CALO. To answer your questions: 1. Investors are comfortable with the model. 2. Not having "debt" is obviously a positive 3. The investor will do due diligence on the issue, reviewing the government contracts under which the funding was made, focusing on the data rights clauses, but also looking at other issues. For example, some funding comes with restrictions on export, sale to foreign entities etc. There is no issue with IP ownership because under the federal funding structure the awardee owns the IP and the government gets various forms of license rights. Robert J. Levin, Esq., LLC 201 Washington Road Princeton, NJ 08543 [removed to protect privacy] [removed to protect privacy] www.levin-lawfirm.com
Rudy Darken
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Rudy Darken Entrepreneur
Professor at Naval Postgraduate School
First, thanks for all your excellent responses. Extremely helpful. To summarize what I think I heard all of you say:
  1. You generally feel that federal grants are viewed positively by private investors because:
    a. It's non-dilutive capital and
    b. It generally results in a proof-of-concept that is helpful in risk assessment
  2. But read the fine print and understand any restrictions that may have been applied especially ITAR controls and foreign sales and investment issues.
It could be that what I have seen some of (i.e. hesitance to commit when federal funding is involved) is related to Franklin's point that not all investors are comfortable and knowledgable about SBIR and other federal grant programs.

I also think Scott's and Richard's comments complement each other nicely. Scott said that if government funding precedes private investment, that's good for the reasons stated above. But by the time the start-up is seeking private investment, it may be best to stop pursuing federal grants because the speed of government funding is nowhere near the speed of private investment and expectation. Federal funding is also way too speculative and unpredictable. Richard views government funds as cashflow and private investment as the means to growth and future profitability. That makes perfect sense.

So if I were advising a start-up on this topic, I might say, [Phase 1] look for federal grants when your ideas are immature and federal support will help to get them ready for prime-time. In parallel, develop a commercialization strategy. [Phase 2] probably stop competing for federal grants (unless it is low effort with reasonable reward, like if you have a good working relationship with a program sponsor) and focus on private investment on a much shorter timeline to get your product to market. As a sidebar, I'd want to know any and all ITAR or IP restrictions way ahead of time so investors are never surprised.

Does that seem to capture it? By the way, large part of why I'm asking about this is that I have yet to find an entrepreneur or incubator program that talks about any of this (not that there aren't any, I just haven't seen them yet). And I think it's important. There are too many instances, in my opinion, of companies that use federal grants and the SBIR program or similar as a more or less permanent revenue source with little to no expectation of commercialization. In my experience, our national track record of transitioning government R&D to private commercialization is not very good. Would you agree with that assessment? I'm not saying there haven't been some big wins. There certainly have been. But in my experience, the success rate of government R&D (i.e. Did the project meet its goals?) is very good. The success rate of commercialization (i.e. Did the company productize the results?) is very poor. I would be interested to hear your thoughts on that.

Thanks again for the excellent discussion.
Martin Omansky
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Martin Omansky Entrepreneur
Independent Venture Capital & Private Equity Professional
Feds are lousy at funding commercialization. Projects in the life sciences are particularly vulnerable. Indeed there have been some high profile exceptions (microprocessors from NASA to general use, for example) but generally tech transfer is not a strength of the federal government. Sent from my iPhone
Franklin Madison
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Franklin Madison Entrepreneur
Founder & Managing Director: Chimera Capital & Finance LLC, Gaia Ventures
Martin, tech transfer isn't the job of the Feds. The RFP that they issue in SBIR is designed to answer a problem that the govt wants to have solved. So you are right
Rudy Darken
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Rudy Darken Entrepreneur
Professor at Naval Postgraduate School
Then who "owns" the tech transfer problem? The feds clearly want it (or there wouldn't be the Bayh-Dole Act among other things) but as you say, it isn't their job. So when DARPA, ONR, NIH, and other federal agencies have loads of federally funded IP that could be transferred (either developed, licensed, or sold) but isn't, it must be driven by incentive and enabled in some way.
What, in your opinion, is working and what is not?
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